1. 2. {It} points} True or false? (a) (2 points) When evaluating investment projects, for the projects with higher vari anoe of sales forecasts , firms should apply higher discount rates . (h) {2 points]I Consider a firm maximizing its market value. When selecting among two mutually exclusive projects with the same initial investment, this firm may optimally select the project with the lower internal rate of return . (c) [2 points] When computing the NPV of potential new investments, 3 firm should discount expected future cash flows attributed to the project using the rm's cost of capital as the discount rate . (d) (2 points ) If the yield curve is flat, then yield to maturity on a risk -free coupon bond is equal to the expected return (in annualized terms} the investor would collect by holding the bond to its maturity. (e) {'2 points ) Consider a nominal risk free cash flow. 'When computing the prisent value in the presence of inflation risk, it is generally wrong to discount the expected real cash flows at the real riskfree interest rates. {12 points ) Consider a state space mode] with two periods and three states at time t = 1: 1, 2, and 3. All three states are equally likely. Primitive statecontingent claims on each state are traded in the market, and their timeU prices are: a: = 0.4; as = 0.3; as = 0.2. In addition to the primitive claims , the riskfree asset is traded . (a) (4 points ) Based on absence of arbitrage ,what is the risk free interest rate in this market? {h} (4 points ) Consider a cash ow (3', equal to $1, $2, and $4, in states 1, 2, and 3, respectively. What is the expected value of this cash flow (as of time U)? (c) (4 points) Compute the tim eU market value of the cash flow 0,. {11 points ) Alice is taking out a bank loan to pay for a new addition to her house . She is com paring two options: a Illyear loan with an annual APR. of 6%, compounded monthly; and a 5year loan, with an annual APR of 6.7%, compounded monthly. The market interest rate is 4% {EAR}, and is the same for all maturities. Alice needs to borrow $5{I,ilil . (a) (3 points} Compute the EAR on each of the two loans. (h) (4 points) Compute the monthly payments on each of the two loans. (e) {3 points] Compute the present value of payments on each of the two loans. {d} {1 point} Is the tenyear loan a better deal, judging by the present value of the payments that Alice would need to make between now and the maturity of the loan? "Yes" or "no." . {17 points) Consider a frictionless market. Several Treasury bonds (with face values of $100} are traded in the market .Their coupon rates and yield tomaturity are given in the following table
