Question 3 (28 marks) The table below details the term structure of interest rates as at 01 January 2020. r(1) r(2) r(3) (5) r(6) r(7) (8) (9) Y(10) Maturity (T) Spot Rate (%) -0.48 -0.3 -0.15 -0.03 0.08 0.18 0.16 0.1 0.04 -0.02 A. Using the information above, describe the shape of the spot yield curve using the terminology covered in this unit. [1 marks] B. Using the data in the table above, which of the three curves: par curve, spot curve and forward curve is the highest before year 7. How would you expect the forward curve to change at year 8 relative to the spot curve (i.e. lie above or below). Please explain your answers. [4 marks] C. Using the data in the table above, calculate all forward rates that can be found using year 2, year 3 and year 4 spot rates. Show all working and formulas used. [5 marks] D. Based on the data in the table above, explain the term structure of the yield curve using the expectations theory, and the market segmentation theory, remembering to contrast the underlying assumptions of the two theories. [6 marks] E. Covid-19 has led to the global contraction. Considering the negative impact of covid-19 on financial markets, how would this affect the credit rating if a company decides to issue debt in the market? Please explain it in terms of factors such as probability of default, recovery rate, credit spread or migration. [6 marks) F. Four Cs of credit analysis is used by analysts to evaluate creditworthiness. For each of the following scenarios, which of the Four Cs should be used for evaluation? Please also explain your answers. [6 marks] Which of the "Four Cs" Scenarios 1. Company X has to pay $50,000 interest expense every year if debt is issued, but it only has an operating cash flow of $40,000 per year. 2. Company A decides to raise funds through debt issue. However, it operates in Video Rental industry which is said to be a declining industry. 3. Company Y decides to issue debt, but its management is less credible with poor track records. Question 3 (28 marks) The table below details the term structure of interest rates as at 01 January 2020. r(1) r(2) r(3) (5) r(6) r(7) (8) (9) Y(10) Maturity (T) Spot Rate (%) -0.48 -0.3 -0.15 -0.03 0.08 0.18 0.16 0.1 0.04 -0.02 A. Using the information above, describe the shape of the spot yield curve using the terminology covered in this unit. [1 marks] B. Using the data in the table above, which of the three curves: par curve, spot curve and forward curve is the highest before year 7. How would you expect the forward curve to change at year 8 relative to the spot curve (i.e. lie above or below). Please explain your answers. [4 marks] C. Using the data in the table above, calculate all forward rates that can be found using year 2, year 3 and year 4 spot rates. Show all working and formulas used. [5 marks] D. Based on the data in the table above, explain the term structure of the yield curve using the expectations theory, and the market segmentation theory, remembering to contrast the underlying assumptions of the two theories. [6 marks] E. Covid-19 has led to the global contraction. Considering the negative impact of covid-19 on financial markets, how would this affect the credit rating if a company decides to issue debt in the market? Please explain it in terms of factors such as probability of default, recovery rate, credit spread or migration. [6 marks) F. Four Cs of credit analysis is used by analysts to evaluate creditworthiness. For each of the following scenarios, which of the Four Cs should be used for evaluation? Please also explain your answers. [6 marks] Which of the "Four Cs" Scenarios 1. Company X has to pay $50,000 interest expense every year if debt is issued, but it only has an operating cash flow of $40,000 per year. 2. Company A decides to raise funds through debt issue. However, it operates in Video Rental industry which is said to be a declining industry. 3. Company Y decides to issue debt, but its management is less credible with poor track records
