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First Plan Ltd. is an Australian company specialises in manufacturing medical supplies and the top management is considering expanding the companys production in order to

First Plan Ltd. is an Australian company specialises in manufacturing medical supplies and the top management is considering expanding the companys production in order to respond to the current health crisis. The company is considering raising capital in the Eurozone to take advantage of the economic conditions (i.e., low interest rates). As a senior financial analyst, you have been asked to analyse the market conditions in the Eurozone and advise the top management on their expansion plan. Consequently, you have collected data on the euro area yield curve of central government bonds. For this purpose, you have downloaded the following data from the European Central Bank (ECB) (Mo = month, yr = Year, Day/Month/Year format):

Time to

Maturity

1 Mo

2 Mo

3 Mo

6 Mo

1 Yr

2 Yr

3 Yr

5 Yr

7 Yr

10 Yr

20 Yr

30 Yr

24/07/2019

-0.65

-0.69

-0.72

-0.74

-0.80

-0.80

-0.77

-0.72

-0.57

-0.43

-0.36

0.29

14/04/2020

-0.60

-0.61

-0.62

-0.63

-0.64

-0.63

-0.60

-0.56

-0.45

-0.35

-0.30

0.11

03/09/2020

-0.60

-0.62

-0.63

-0.65

-0.70

-0.73

-0.73

-0.70

-0.61

-0.51

-0.46

-0.02

REQUIRED:

  1. Considering the yield curve on 3rd September 2020, describe the implied market outlook in the Eurozone to the top management. Compare your answer to the yield curve on 24th July 2019, before the COVID19 pandemic onset.

[4 marks]

  1. If the company agrees to raise capital in the Eurozone, what financial instruments would you suggest for the company to issue, and why? What is the suggested maturity of borrowing from the Eurozone market, and why?

[3 marks]

QUESTION 1 (continued)

  1. Suppose that First Plan Ltd. owns 5000 bonds of 10-year AAA-rated euro area central government bonds. Using the yield curve data provided above, calculate the current price of each bond on 14th April 2020, and the total value of the investment.

10-year AAA-rated Central Government Bonds Notes Fact Sheet

Issuing date

14th April. 2020

Bond expiration date

14th April. 2030

Face value

1000

coupon rate (annual)

1.00%

coupon payment

Quarterly (coupon payment is in April, July, October, and January every year)

[4 marks]

  1. Briefly explain to the top management the expectations plus liquidity premium theory. In your explanation, discuss whether the existence of an inverse yield curve indicate a violation of the liquidity premium assumptions.

[4 marks]

(4 + 3 + 4 + 4 = 15 marks)

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