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Questions and Answers of Finance

You have paid $980.30 for an 8% coupon bond with a face value of $1,000 that matures in five years. You plan on holding the bond for one year. If you want to earn a 9% rate of return on this
Calculate the duration of a $1,000, 6% coupon bond with three years to maturity. Assume that all market interest rates are 7%.
Consider the bond in the previous question. Calculate the expected price change if interest rates drop to 6.75% using the duration approximation. Calculate the actual price change using discounted
The duration of a $100 million portfolio is 10 years. $40 million in new securities are added to the portfolio, increasing the duration of the portfolio to 12.5 years. What is the duration of the $40
A bank has two 3-year commercial loans with a present value of $70 million. The first is a $30 million loan that requires a single payment of $37.8 million in three years, with no other payments till
Consider a bond that promises the following cash flows. The yield to maturity is 12%.You plan to buy this bond, hold it for 2.5 years, and then sell the bond.a. What total cash will you receive from
I own a professional football team, and I plan to diversify by purchasing shares in either a company that owns a pro basketball team or a pharmaceutical company. Which of these two investments is
An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply-and-demand analysis for bonds, show what effect this action has on interest
Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).
Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices.
Predict what will happen to interest rates if prices in the bond market become more volatile.
You own a $1,000-par zero-coupon bond that has five years of remaining maturity. You plan on selling the bond in one year, and believe that the required yield next year will have the following
Consider a $1,000-par junk bond paying a 12% annual coupon with two years to maturity. The issuing company has a 20% chance of defaulting this year; in which case, the bond would not pay anything. If
Last month, corporations supplied $250 billion in one-year discount bonds to investors at an average market rate of 11.8%. This month, an additional $25 billion in one-year discount bonds became
An economist has concluded that, near the point of equilibrium, the demand curve and supply curve for one-year discount bonds can be estimated using the following equations:Bd: Price = -2/5Quantity +
The demand curve and supply curve for one-year discount bonds were estimated using the following equations:Bd: Price = -2/5Quantity + 940Bs: Price = Quantity + 500Following a dramatic increase in the
The demand curve and supply curve for one-year discount bonds were estimated using the following equations:Bd: Price = -2/5Quantity + 990Bs: Price = Quantity + 500As the stock market continued to
Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so? Discuss.
“If bonds of different maturities are close substitutes, their interest rates are more likely to move together.” Is this statement true, false, or uncertain? Explain your answer.
If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory?
If a yield curve looks like the one shown here, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the marketâ€™s
If a yield curve looks like the one below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the marketâ€™s
Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will
Government economists have forecasted one-year T-bill rates for the following five years, as follows:Year 1-year rate (%)1 .........4.252 .........5.153 .........5.504 .........6.255 .........7.10You
How does the after-tax yield on a $1,000,000 municipal bond with a coupon rate of 8% paying interest annually, compare with that of a $1,000,000 corporate bond with a coupon rate of 10% paying
Consider the decision to purchase either a five-year corporate bond or a five-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding
Debt issued by Southeastern Corporation currently yields 12%. A municipal bond of equal risk currently yields 8%. At what marginal tax rate would an investor be indifferent between these two bonds?
One-year T-bill rates are expected to steadily increase by 150 basis points per year over the next six years. Determine the required interest rate on a three-year T-bond and a six-year T-bond if the
The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%, 13%, 14.5%, 16%, and 17.5%. Using the expectations theory, what will be the interest rates on a three-year
Using the information from the previous question, now assume that investors prefer holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond’s maturity.
Which bond would produce a greater return if the expectations theory were to hold true, a two-year bond with an interest rate of 15% or two one-year bonds with sequential interest payments of 13% and
Little Monsters, Inc., borrowed $1,000,000 for two years from NorthernBank, Inc., at an 11.5% interest rate. The current risk-free rate is 2%, and Little Monsters’ financial condition warrants a
One-year T-bill rates are 2% currently. If interest rates are expected to go up after three years by 2% every year, what should be the required interest rate on a 10-year bond issued today? Assume
One-year T-bill rates over the next four years are expected to be 3%, 4%, 5%, and 5.5%. If four-year T-bonds are yielding 4.5%, what is the liquidity premium on this bond?
At your favorite bond store, Bonds-R-Us, you see the following prices:One-year $100 zero selling for $90.19Three-year 10% coupon $1,000 par bond selling for $1,000Two-year 10% coupon $1,000 par bond
You observe the following market interest rates, for both borrowing and lending:One-year rate = 5%Two-year rate = 6%One-year rate one year from now = 7.25%How can you take advantage of these rates to
If the interest rates on one- to five-year bonds are currently 4%, 5%, 6%, 7%, and 8%, and the term premiums for one- to five-year bonds are 0%, 0.25%, 0.35%, 0.40%, and 0.50%, predict what the
Can a person with optimal expectations expect the price of Google to rise by 10% in the next month?
Can we expect the value of the dollar to rise by 2% next week if our expectations are optimal?
“Human fear is the source of stock market crashes, so these crashes indicate that expectations in the stock market cannot be optimal.” Is this statement true, false, or uncertain? Explain your
A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $5 billion with 100 million shares outstanding. Assuming that the
Rich people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection?
You are in the market for a used car. At a used car lot, you know that the blue book value for the cars you are looking at is between $20,000 and $24,000. If you believe the dealer knows as much
Now, you believe the dealer knows more about the cars than you. How much are you willing to pay? Why? How can this be resolved in a competitive market?
You own a house worth $400,000 that is located on a river. If the river floods moderately, the house will be completely destroyed. This happens about once every 50 years. If you build a seawall, the
How did a decline in housing prices help trigger the subprime financial crisis starting in 2007?
How can opening up to capital flows from abroad lead to a financial crisis?
Why are more resources not devoted to adequate prudential supervision of the financial system to limit excessive risk taking, when it is clear that this supervision is needed to prevent financial
Compare the structure and independence of the Federal Reserve System and the European System of Central Banks.
In the 1960s and 1970s, the Federal Reserve System lost member banks at a rapid rate. How can the theory of bureaucratic behavior explain the Fed’s campaign for legislation to require all
“Unemployment is a bad thing, and the government should make every effort to eliminate it.” Do you agree or disagree? Explain your answer.
Which goals of the Fed frequently conflict?
“If the demand for reserves did not fluctuate, the Fed could pursue both a nonborrowed reserves target and an interest-rate target at the same time.” Is this statement true, false, or uncertain?
The benefits of using Fed discount operations to prevent bank panics are straightforward. What are the costs?
What are the benefits of using a nominal anchor for the conduct of monetary policy?
Why might inflation targeting increase support for the independence of the central bank to conduct monetary policy?
Consider a bank policy to maintain 12% of deposits as reserves. The bank currently has $10 million in deposits and holds $400,000 in excess reserves. What is the required reserve on a new deposit of
Estimates of unemployment for the upcoming year have been developed as follows:What is the expected unemployment rate? The standarddeviation?
The Federal Reserve wants to increase the supply of reserves, so it purchases 1 million dollars worth of bonds from the public. Show the effect of this open market operation using T-accounts.
Use T-accounts to show the effect of the Federal Reserve being paid back a $500,000 discount loan from a bank.
The short-term nominal interest rate is 5%, with an expected inflation of 2%. Economists forecast that next year’s nominal rate will increase by 100 basis points, but inflation will fall to 1.5%.
If the required reserve ratio is 10%, how much of a new $10,000 deposit can a bank lend? What is the potential impact on the money supply?
A bank currently holds $150,000 in excess reserves. If the current reserve requirement is 12.5%, how much could the money supply change? How could this happen?
The trading desk at the Federal Reserve sold $100,000,000 in T-bills to the public. If the current reserve requirement is 8.0%, how much could the money supply change?
What characteristics define the money markets?
Why do banks not eliminate the need for money markets?
Distinguish between a term security and a demand security.
What was the purpose motivating regulators to impose interest ceilings on bank savings accounts? What effect did this eventually have on the money markets?
Why does the U.S. government use the money markets?
Why do businesses use the money markets?
What purpose initially motivated Merrill Lynch to offer money market mutual funds to its customers?
Why are more funds from property and casualty insurance companies than funds from life insurance companies invested in the money markets?
Which of the money market securities is the most liquid and considered the most risk-free? Why?
Distinguish between competitive bidding and noncompetitive bidding for Treasury securities.
Who issues commercial paper and for what purpose?
Why are banker’s acceptances so popular for international transactions?
What would be your annualized discount rate % and your annualized investment rate % on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?
What is the annualized discount rate % and your annualized investment rate % on a Treasury bill that you purchase for $9,940 that will mature in 91 days for $10,000?
If you want to earn an annualized discount rate of 3.5%, what is the most you can pay for a 91-day Treasury bill that pays $5,000 at maturity?
What is the annualized discount and investment rate % on a Treasury bill that you purchase for $9,900 that will mature in 91 days for $10,000?
The price of 182-day commercial paper is $7,840. If the annualized investment rate is 4.093%, what will the paper pay at maturity?
How much would you pay for a Treasury bill that matures in 182 days and pays $10,000 if you require a 1.8% discount rate?
The price of $8,000 face value commercial paper is $7,930. If the annualized discount rate is 4%, when will the paper mature? If the annualized investment rate % is 4%, when will the paper mature?
How much would you pay for a Treasury bill that matures in one year and pays $10,000 if you require a 3% discount rate?
The annualized discount rate on a particular money market instrument, is 3.75%. The face value is $200,000, and it matures in 51 days. What is its price? What would be the price if it had 71 days
The annualized yield is 3% for 91-day commercial paper, and 3.5% for 182-day commercial paper. What is the expected 91-day commercial paper rate 91 days from now?
Distinguish between the primary market and the secondary market for securities.
A bond provides information about its par value, coupon interest rate, and maturity date. Define each of these.
The U.S. Treasury issues bills, notes, and bonds. How do these three securities differ?
In addition to Treasury securities, some agencies of the government issue bonds. List three such agencies, and state what the funds raised by the bond issues are used for.
A call provision on a bond allows the issuer to redeem the bond at will. Investors do not like call provisions and so require higher interest on callable bonds. Why do issuers continue to issue
What is a sinking fund? Do investors like bonds that contain this feature? Why?
Describe the two ways whereby capital market securities pass from the issuer to the public.
Consider the two bonds described below:a. If both bonds had a required return of 8%, what would the bondsâ€™ prices be?b. Describe what it means if a bond sells at a discount, a premium, and at
A two-year $1,000 par zero-coupon bond is currently priced at $819.00. A two-year $1,000 annuity is currently priced at $1,712.52. If you want to invest $50,000 in one of the two securities, which is
Consider the following cash flows. All market interest rates are 12%.a. What price would you pay for these cash flows?What total wealth do you expect after 2.5 years if you sell the rights to the
The yield on a corporate bond is 10%, and it is currently selling at par. The marginal tax rate is 20%. A par value municipal bond with a coupon rate of 8.50% is available. Which security is a
If the municipal bond rate is 4.25% and the corporate bond rate is 6.25%, what is the marginal tax rate, assuming investors are indifferent between the two bonds?
M&E, Inc., has an outstanding convertible bond. The bond can be converted into 20 shares of common equity (currently trading at $52/share). The bond has five years of remaining maturity, a $1,000 par
Assume the debt in the previous question is trading at $1,035. How can you earn a riskless profit from this situation (arbitrage)?

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