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ECON 310 (Money and Banking) Assignment

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Question;Assignment(This assignment accounts for 25% of your total marks to pass this course)TOTAL: ________/38 marks1|PageQUESTION 1 (10 marks)On September 1, 2012, Al buys a bond for $15,000 that makes coupon payments of $750 after each of thefollowing three years and returns its principal of $15,000 at the end of the three years. In other words, it isa standard coupon bond with a 5 percent annual interest rate making payments once each year.On September 1, 2013, Al receives his first coupon payment of $750. At that time, the market interest rateon bonds like Al's has risen to 6 percent. Al sells his bond to Biff at that time, for a price equal to the presentvalue of the bond's payments.a. How much does Biff pay Al for the bond?b. Calculate Al's current yield, capital-gains yield, and total return for the year.On September 1, 2014, Biff receives a coupon payment of $750. The market interest rate on bonds like hisremains 6 percent. Biff sells his bond to Cass at that time, for a price equal to the present value of the bond'spayments.c. How much does Cass pay Biff for the bond?d. Calculate Biff's current yield, capital-gains yield, and total return for the year.On September 1, 2015, Cass receives a coupon payment of $750 and the principal of $15,000. Over thecourse of the year (between September 1, 2014, and September 1, 2015), the market interest rate on bonds like his rose to 7 percent. But Cass decided to keep the bond.e. What is Cass's total return for the year?Explain and show all your work for each part.QUESTION 2 (6 marks)Consider the bond market to be in equilibrium according to our complete theory of the term structure ofinterest rates. The current interest rate on one-year bonds is 2 percent, and you believe, as does everyone in the market, that in one year the interest rate on one-year bonds will be 3 percent, and in two years, theinterest rate on one-year bonds will be 4 percent. That is, using our standard notation,= 2%, = 3%, and = 4%.Assume that there is no term premium on a one-year bond.a. According to the expectations theory of the term structure of interest rates, what will the interest rate be today on a two-year bond and a three-year bond? That is, what is andSuppose the term premium equals 0.75 percent the number of years to maturity, for the 2-year bond andthe 3-year bond.b. Calculate the interest rate today on the two-year bond and the three-year bond, incorporatingthe term premium.c. Draw the yield curve for today, using the values you calculated in part b. Your drawingshould show three points and should be drawn reasonably to scale, showing the values oneach axis of each point plotted. Explain briefly (in one or two sentences) why the yield curvehas the shape it does.QUESTION 3 (14 marks)Loretta buys a one-year debt security on December 31, 2013, for $10,000, which will pay her a nominalinterest rate of 5% percent. From December 31, 2013, to December 31, 2014, the inflation rate is 2 percent.Loretta has a tax rate of 40 percent.a. How much nominal interest (in dollars) does Loretta earn during the year? Show yourcalculations.b. How much (in dollars) does Loretta pay in taxes on her interest income? Show yourcalculations.c. How much (in dollars) is Loretta's after-tax nominal income? Show your calculations.d. How much principal (in dollars) does Loretta lose because of inflation? Show yourcalculations.e. How much real interest income (in dollars) does Loretta earn? Show your calculations.f. How much (in dollars) is Loretta's after-tax real interest income? Show your calculations.g. What percent of Loretta's nominal interest income goes to: (1) her, in the form of after taxreal interest income, (2) the government, in the form of taxes, and (3) inflation, in the formof lost principal value? Show your calculations.QUESTION 4 (8 marks)Suppose the following version of the APT is a good model of risk in the stock market. There are threefactors: (1) the stock market's excess return, in percentage points, (2) the change over the last year in theinflation rate, in percentage points, and (3) the spread between ten-year Treasury bonds and three-monthTreasury bills, in percentage points. Suppose the stock market's average excess return is 7 percentage pointsand the average risk-free interest rate is 1 percent, the average change in the inflation rate is 0 percentagepoints, and the average spread between ten-year Treasury bonds and three-month Treasury bills is 2percentage points. Each of the following stocks has the beta coefficients shown in the table below:MicrosoftGoldcraftersState Farma.1i2302i1223i110What is the expected return to each of the three stocks? Show your calculations.b. If the market's excess return were to rise 10 percentage points in a particular year (that is,instead of the average of 7 percent, the market's excess return will be 17 percent), whatwould you expect the effect to be on the return to each of the three stocks? Show yourcalculations.c. If the inflation rate was expected to rise 2 percentage points in a particular year (that is,instead of the average of 0 percent, the inflation rate will rise by 2 percentage points), whatwould you expect the effect to be on the return to each of the three stocks?d. If the interest-rate spread rose 2 percentage points in a particular year (that is, instead of theaverage of 2 percentage points, the interest-rate spread will be 4 percentage points), whatwould you expect the effect to be on the return to each of the three stocks?

 

Paper#56128 | Written in 18-Jul-2015

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