Please answer all questions 35 Valerie Smith is attempting to construct a bond portfolio with a duration of 9 years She has $500,000 to invest and is considering allocating it between two zero coupon bonds The first zero coupon bond matures in exactly 6 years, and the second zero coupon bond matures in exactly 16 years Both of these bonds are currently selling for a market price of $100 Suppose that the yield curve is flat at 7 5 Is it possible for Valerie to construct a bond portfolio having a duration of 9 years using these two types of zero coupon bonds If so, how (Describe the actual portfolio ) If not, why not 36 Given the bond prices in the question above, you plan to borrow $15 million one year from now (end of year 1) It will be a two year loan (from year 1 to year 3) with interest paid at the ends of year 2 and 3 The cash flow is as follows Year 1 Year 2 Year 3 Borrow $15M Pay interest Pay interest plus principal of 15M Explain how you could arrange this loan today and lock in the interest rate on the loan What transactions today would be required What would the interest rate be You can buy or sell any of the bonds listed above (in the previous question) 37 You purchased a 3 year coupon bond one year ago Its par value is $1,000 and coupon rate is 6 , paid annually At the time you purchased the bond, its yield to maturity was 6 5 Suppose you sell the bond after receiving the first interest payment Fall 2008 Page 18 of 66 (a) What is the total rate of return from holding the bond for the year if the yield to maturity remains at 6 5 when you sell it (b) What if the yield to maturity becomes 6 0 when you sell it 38 You manage a pension fund, which provides retired workers with lifetime annuities The fund must pay out $1 million per year to cover these annuities Assume for simplicity that these payments continue for 20 years and then cease The interest rate is 4 (flat term structure) You plan to cover this obligation by investing in 5 and 20 year maturity Treasury strips (a) What is the duration of the funds 20 year payout obligation (b) You decide to minimize the funds exposure to changes in interest rates How much should you invest in the 5 and 20 year strips What will be the par value of your holdings of each strip (c) After three months, you reexamine the pension funds investment strategy Interest rates have increased You still want to minimize exposure to interest rate risk Will you invest more in 20 year strips and less in 5 year strips Explain briefly 39 Duration and Convexity Consider a 10 year bond with a face value of $100 that pays an annual coupon of 8 Assume spot rates are flat at 5 (a) Find the bond's price and duration (b) Suppose that 10yr yields increase by 10bps Calculate the change in the bond's price using your bond pricing formula and then using the duration approximation How big is the difference (c) Suppose now that 10yr yields increase by 200bps Repeat your calculations for part (b) (d) Given that the bond has a convexity of 33 8, use the convexity adjustment and repeat parts (b) and (c) Has anything changed 40 The yield to maturity of a 10 year zero coupon bond is 4 (a) Suppose that you buy the bond today and hold it for 10 years What is your return (Express this return as an annual rate ) (b) Given only the information provided, can you compute the return on the bond if you hold the bond only for 5 years If you answered yes, compute the return If you answered no, explain why 1 (Inverse) labor demand for low skilled workers in Arizona is determined by w 32 0 2E where E is the number of workers (in millions) and w is the hourly wage There are 30 million native low skilled workers in Arizona who supply labor inelastically If the United States opened its borders to immigration from Mexico, 5 million low skill immigrants would enter Arizona and supply labor inelastically Assume that low skilled immigrants are perfect substitutes for low skilled native workers a Illustrate the effect of immigration in this labor market on a graph b What is the market clearing wage if immigration is not allowed C What is the market clearing wage with open borders d How much is the immigration surplus when the United States opens its borders e How much surplus is transferred from Arizona workers to Arizona firms f Now assume that low skilled immigrants are complements to high skilled (college educated) native workers What do you expect to happen to equilibrium wages and employment for college educated native workers as a result of immigration Why Illustrate your explanation with a graph 2 Debbie is about to choose a career path She has narrowed her options to two alternatives She can either become a marine biologist or a concert pianist Debbie lives two periods In the first, she gets an education In the second, she works in the labor market If Debbie becomes a marine biologist, she will spend $15,000 on education in the first period and earn $472,000 in the second period If she becomes a concert pianist, she will spend $40,000 on education in the first period and then earn $500,000 in the second period a Suppose Debbie has a 5 percent discount rate between periods Which career will she pursue What if she had a 15 percent discount rate Will she choose a different option Why b Suppose musical conservatories raise their tuition so that it now costs Debbie $60,000 to become a concert pianist What career will Debbie pursue if the discount rate is 5 percent 3 Suppose people with 15 years of schooling average earnings of $60,000 while people with 16 years of education average $66,000 a What is the annual rate of return associated with the 16 year of education b It is typically thought that this type of calculation of the returns to schooling is biased, because it doesn't take into account innate ability or innate motivation If this criticism is true, is the actual return to the 16 year of schooling more than or less than your answer in part (a) 4 Consider a competitive economy that has four different jobs that vary by their wage and risk level The table below describes each of the four jobs Job Risk ( F ) Wage ( w ) A 1 5 $3 B 1 4 $12 Ci 1 3 $23 D 1 2 $25 All workers are equally productive, but workers vary in their preferences Consider a worker who values his wage and the risk level according to the following utility function Where does the worker choose to work Suppose the government regulated the workplace and required all jobs to have a risk factor of 1 5 (that is, all jobs become A jobs) What wage would the worker now need to earn in the A job to be equally happy following the regulation Where does the worker choose to work Suppose the government regulated the workplace and required all jobs to have a risk factor of 1 5 (that is, all jobs become A jobs) What wage would the worker now need to earn in the A job to be equally happy following the regulation 5 In order to better understand how sensitive inequality measures are to the choice of measure, provide a graph of an economy with a 90 10 wage gap that is essentially zero but for which the Gini coefficient is close to 1 Your graph should have Share of Households on the x axis and Share of Total Income on the y axis 6 Suppose there are several perfectly competitive firms producing widgets, and each firm has a production function given by q 10 Ew ED, where Ew and E, are the number of whites and blacks employed by the firm respectively It can be shown that the marginal product of labor is then 5 MPF Ew Eb Suppose the market wage for black workers is $10, the market wage for whites is $20, and the price of each widget is $100 a Firm A does not discriminate How many workers of each race would Firm A hire How much profit does this non discriminatory firm earn if there are no other costs b Firm B discriminates against blacks with a discrimination coefficient of 25 How many workers of each race does this firm hire How much profit does it earn c Firm C has a discrimination coefficient equal to 1 25 How many workers of each race does this firm hire How much profit does it earn d What kind of discrimination are Firms B and C exercising i Taste based discrimination ii Statistical discrimination iii Both taste based and statistical discrimination iv Cannot be determinedD Firm B discriminates against blacks with a discrimination coefficient of 25 How many workers of each race does this firm hire How much profit does it earn c Firm C has a discrimination coefficient equal to 1 25 How many workers of each race does this firm hire How much profit does it earn d What kind of discrimination are Firms B and C exercising Taste based discrimination ii Statistical discrimination iii Both taste based and statistical discrimination Cannot be determined e Consider a law that requires any given firm to pay its black workers the same wage as its white workers How effective would this racial wage or employment gap in this model f Suppose entrepreneurs can start new widget producing firms using the same production function as existing firms Also assume firms must shut down if they make negative profits In the model above, how might free entry exit in and out of the widget market help reduce the racial wage and employment gap over the long term

Question

Please answer all questions  35  Valerie Smith is attempting to construct a bond portfolio with a duration of 9 years  She has $500,000 to invest and is considering allocating it between two zero coupon bonds  The first zero coupon bond matures in exactly 6 years, and the second zero coupon bond matures in exactly 16 years  Both of these bonds are currently selling for a market price of $100  Suppose that the yield curve is flat at 7 5   Is it possible for Valerie to construct a bond portfolio having a duration of 9 years using these two types of zero coupon bonds  If so, how  (Describe the actual portfolio ) If not, why not  36  Given the bond prices in the question above, you plan to borrow $15 million one year from now (end of year 1)  It will be a two year loan (from year 1 to year 3) with interest paid at the ends of year 2 and 3  The cash flow is as follows  Year 1 Year 2 Year 3 Borrow $15M Pay interest Pay interest plus principal of 15M  Explain how you could arrange this loan today and  lock in  the interest rate on the loan  What transactions today would be required  What would the interest rate be  You can buy or sell any of the bonds listed above (in the previous question)  37  You purchased a 3 year coupon bond one year ago  Its par value is $1,000 and coupon rate is 6 , paid annually  At the time you purchased the bond, its yield to maturity was 6 5   Suppose you sell the bond after receiving the first interest payment  Fall 2008 Page 18 of 66 (a) What is the total rate of return from holding the bond for the year if the yield to maturity remains at 6 5  when you sell it  (b) What if the yield to maturity becomes 6 0  when you sell it  38  You manage a pension fund, which provides retired workers with lifetime annuities  The fund must pay out $1 million per year to cover these annuities  Assume for simplicity that these payments continue for 20 years and then cease  The interest rate is 4  (flat term structure)  You plan to cover this obligation by investing in 5  and 20 year maturity Treasury strips  (a) What is the duration of the funds 20 year payout obligation  (b) You decide to minimize the funds exposure to changes in interest rates  How much should you invest in the 5  and 20  year strips  What will be the par value of your holdings of each strip  (c) After three months, you reexamine the pension funds investment strategy  Interest rates have increased  You still want to minimize exposure to interest rate risk  Will you invest more in 20 year strips and less in 5 year strips  Explain briefly  39  Duration and Convexity  Consider a 10 year bond with a face value of $100 that pays an annual coupon of 8   Assume spot rates are flat at 5   (a) Find the bond's price and duration  (b) Suppose that 10yr yields increase by 10bps  Calculate the change in the bond's price using your bond pricing formula and then using the duration approximation  How big is the difference  (c) Suppose now that 10yr yields increase by 200bps  Repeat your calculations for part (b)  (d) Given that the bond has a convexity of 33 8, use the convexity adjustment and repeat parts (b) and (c)  Has anything changed  40  The yield to maturity of a 10 year zero coupon bond is 4   (a) Suppose that you buy the bond today and hold it for 10 years  What is your return  (Express this return as an annual rate ) (b) Given only the information provided, can you compute the return on the bond if you hold the bond only for 5 years  If you answered yes, compute the return  If you answered no, explain why 1  (Inverse) labor demand for low skilled workers in Arizona is determined by w 32  0 2E where E is the number of workers (in millions) and w is the hourly wage  There are 30 million native low skilled workers in Arizona who supply labor inelastically  If the United States opened its borders to immigration from Mexico, 5 million low skill immigrants would enter Arizona and supply labor inelastically  Assume that low skilled immigrants are perfect substitutes for low skilled native workers  a  Illustrate the effect of immigration in this labor market on a graph  b  What is the market clearing wage if immigration is not allowed  C  What is the market clearing wage with open borders  d  How much is the immigration surplus when the United States opens its borders  e  How much surplus is transferred from Arizona workers to Arizona firms  f  Now assume that low skilled immigrants are complements to high skilled (college educated) native workers  What do you expect to happen to equilibrium wages and employment for college educated native workers as a result of immigration  Why  Illustrate your explanation with a graph  2  Debbie is about to choose a career path  She has narrowed her options to two alternatives  She can either become a marine biologist or a concert pianist  Debbie lives two periods  In the first, she gets an education  In the second, she works in the labor market  If Debbie becomes a marine biologist, she will spend $15,000 on education in the first period and earn $472,000 in the second period  If she becomes a concert pianist, she will spend $40,000 on education in the first period and then earn $500,000 in the second period  a Suppose Debbie has a 5 percent discount rate between periods  Which career will she pursue  What if she had a 15 percent discount rate  Will she choose a different option  Why  b  Suppose musical conservatories raise their tuition so that it now costs Debbie $60,000 to become a concert pianist  What career will Debbie pursue if the discount rate is 5 percent 3  Suppose people with 15 years of schooling average earnings of $60,000 while people with 16 years of education average $66,000  a  What is the annual rate of return associated with the 16  year of education  b  It is typically thought that this type of calculation of the returns to schooling is biased, because it doesn't take into account innate ability or innate motivation  If this criticism is true, is the actual return to the 16  year of schooling more than or less than your answer in part (a)  4  Consider a competitive economy that has four different jobs that vary by their wage and risk level  The table below describes each of the four jobs  Job Risk ( F ) Wage ( w ) A 1 5 $3 B 1 4 $12 Ci 1 3 $23 D 1 2 $25 All workers are equally productive, but workers vary in their preferences  Consider a worker who values his wage and the risk level according to the following utility function  Where does the worker choose to work  Suppose the government regulated the workplace and required all jobs to have a risk factor of 1 5 (that is, all jobs become A jobs)  What wage would the worker now need to earn in the A job to be equally happy following the regulation Where does the worker choose to work  Suppose the government regulated the workplace and required all jobs to have a risk factor of 1 5 (that is, all jobs become A jobs)  What wage would the worker now need to earn in the A job to be equally happy following the regulation  5  In order to better understand how sensitive inequality measures are to the choice of measure, provide a graph of an economy with a 90 10 wage gap that is essentially zero but for which the Gini coefficient is close to 1  Your graph should have  Share of Households  on the x axis and  Share of Total Income  on the y axis 6  Suppose there are several perfectly competitive firms producing widgets, and each firm has a production function given by q 10 Ew  ED, where Ew and E, are the number of whites and blacks employed by the firm respectively  It can be shown that the marginal product of labor is then 5 MPF Ew   Eb   Suppose the market wage for black workers is $10, the market wage for whites is $20, and the price of each widget is $100  a  Firm A does not discriminate  How many workers of each race would Firm A hire  How much profit does this non discriminatory firm earn if there are no other costs  b  Firm B discriminates against blacks with a discrimination coefficient of  25  How many workers of each race does this firm hire  How much profit does it earn  c  Firm C has a discrimination coefficient equal to 1 25  How many workers of each race does this firm hire  How much profit does it earn  d  What kind of discrimination are Firms B and C exercising  i  Taste based discrimination ii  Statistical discrimination iii  Both taste based and statistical discrimination iv  Cannot be determinedD  Firm B discriminates against blacks with a discrimination coefficient of  25  How many workers of each race does this firm hire  How much profit does it earn  c  Firm C has a discrimination coefficient equal to 1 25  How many workers of each race does this firm hire  How much profit does it earn  d  What kind of discrimination are Firms B and C exercising  Taste based discrimination ii  Statistical discrimination iii  Both taste based and statistical discrimination Cannot be determined e  Consider a law that requires any given firm to pay its black workers the same wage as its white workers  How effective would this racial wage or employment gap in this model  f  Suppose entrepreneurs can start new widget producing firms using the same production function as existing firms  Also assume firms must shut down if they make negative profits  In the model above, how might free entry exit in and out of the widget market help reduce the racial wage and employment gap over the long term

Accepted Answer

The Answer is in the image, click to view ...

Question

:Please answer all questions. 35. Valerie Smith is attempting to construct a bond portfolio with a duration of 9 years. She has $500,000 to invest

Step by Step Solution

Step: 1

Get Instant Access to Expert-Tailored Solutions

Step: 2

Step: 3

Ace Your Homework with AI

Recommended Textbook for

Economics of Strategy

Students also viewed these Economics questions

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question

Question