Question
1. A. Determine the price of a five year 10% coupon treasury bond, sold to yield 12%. B. You buy the above bond above for
1. A. Determine the price of a five year 10% coupon treasury bond, sold to yield 12%.
B. You buy the above bond above for the price you calculated expecting to earn the promised YTM. What ending wealth (value) should you have after two years?
C. (Continued from 1A and 1B). Assume a flat yield curve at 12%. What ending wealth did you actually have? Is it what you calculated in B? If not, explain why not.
2. A convertible bond has a coupon rate of 10% and a 10 year life. Bonds in the same risk class are sold to yield 8%. This bond is convertible to 50 shares of stock and the current stock price is $21. What is the price of the bond?
3. The Chair of the Federal Reserve indicated this morning that inflation will be higher than expected. From yesterdays close,
(i) Today, would you expect short term interest rates to be higher or lower?
(ii) Today, would you expect bond prices to be higher or lower?
(iii) Would you expect long term interest rates to be higher or lower? Why?
(iv) Explain the following observation. Todays inflation is about 3.0% and the yield on 10 year treasuries is 2.9%.
STOCKS
4. There are two investments that have generated the following return in the last 4 years.
Year Return (A) Return (B)
1 15% 30%
2 10% -20%
3 10% -10%
4 5% 40%
Both have a return of 10% per year and thus an investor who invested in $1.00 A or $1.00 in B would have the same net ending wealth. Agree or Disagree? What rate of return would they earn if not 10%?
5. Can a growth company be a value investment? Say Apple? Explain.
6. What's the difference between a growth and a value investment?
7. There is a lot of evidence that stock markets are efficient- implying that they price things in a fair manner. Why do we need professional money managers?
Say you interviewing with a mutual fund and they want to know: How will you generate abnormal returns in an efficient market? Explain how you would with at least two examples of inefficiencies that can be exploited.
8. From Ray Dalios Economic Machine:
(i) What is the role of credit in an economy? Think of an economy without credit and an economy with the credit. Which one would higher/lower growth and why?
(ii) When there is a recession, what can the Federal Reserve do to encourage growth? What can the government do to encourage growth?
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