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Module 3: Assignments Problems and Issues 1) Use...




Module 3: Assignments Problems and Issues 1) Use Excel to complete Problems and Issues 1, 3, 7, 8, 10, and 14 at the end of chapter 7 in the textbook. 8. An investor wishes to ride the yield curve to higher profits on an investment of $1,000. He observes in the market a zero-coupon T-note with one year left to maturity yielding 5 percent and another zero-coupon T-note yielding 7 percent with two years to maturity. What investment strategy should he pursue? Show how this investment strategy would be superior to a simple buy-and-hold strategy. Under what conditions will this strategy succeed? When will it fail? Repeat problem 7, but where the market interest rates are: 7 percent for the 1-year, zero-coupon bond and 5 percent for the 2-year, zero-coupon bond. 10. Calculate the value of duration for a four-year, $1,000 par value U.S. government bond purchased today at a yield to maturity of 15 percent. The bond?s coupon rate is 12 percent, and it pays interest at year?s end. Now suppose the market interest rate on comparable bonds falls to 14 percent. What percentage change in this bond?s price will result? 14. A four-year TIPS bond promises a real annual coupon return of 4 percent and its face value is $1,000. While the annual inflation rate was approximately zero when the bond was first issued, the inflation rate suddenly accelerated to 3 percent and is expected to remain at that level for the bond?s four-year term. What will be the amount of interest paid in nominal dollars each year of the bond?s life? What will be the face (nominal) value of the bond at the end of each year of its life? 2) Use Excel to complete Problems and Issues 2, 4, and 5 at the end of chapter 8 in the textbook. 2. The market yield to maturity on a risky bond is currently listed at 14.50 percent. The risk-free interest rate is estimated to be 9.25 percent. What is the defaultrisk premium, all other factors removed? The promised yield on this bond is 15 percent. A certain investor looking at this bond estimates there is a 25 percent probability the bond will pay 15 percent at maturity, a 50 percent probability it will pay a 10 percent return, and a 25 percent probability it will yield only 5 percent. What is the bond?s expected yield? What is this investor?s anticipated default loss? Will the investor buy this bond? 4. Aaa-rated municipal bonds are carrying a market yield today of 5.25 percent, while Aaa-rated corporate bonds have current market yields of 11.50 percent. What is the break-even tax rate that would make a taxable investor indifferent between these two types of bonds? 5. An investor purchases a 10-year U.S. government bond for $800. The bond?s coupon rate is 10 percent and, at time of purchase, it still had five years remaining until maturity. If the investor holds the bond until it matures and collects the $1,000 par value from the Treasury and his marginal tax rate is 28 percent, what will his after-tax yield to maturity be? 3) Complete Problems and Issues 3, 4, 6, 7 and 8 at the end of chapter 10 in the textbook. 3. How much interest would be earned (on a simple interest basis) from a three-day money market loan for $1 million at an interest rate of 12 percent (annual rate)? Suppose the loan was extended on the third day for an additional day at the going market rate of 11 percent. How much total interest income would the money market lender receive? 4. A government securities dealer is currently borrowing $25 million from a money center bank using repurchase agreements based on Treasury bills. If today?s RP rate is 6.25 percent, how much in interest will the dealer owe the bank for a 24-hour loan? 6. An automobile company, NISSAN, has a temporary cash surplus and lends its funds overnight through a repurchase agreement to a government securities dealer, earning $55,600 in interest income when the RP loan rate stood at 5.70 percent. What was the size of the loan that NISSAN granted to the securities dealer? 7. Ninety-one-day Treasury bills carry an investment return (IR) of 6.25 percent. What is their purchase price? What is their discount rate (DR)? 8. A dealer in government securities is considering buying $875 million in 10-year Treasury notes and $1,425 million dollars in 6-month Treasury bills. Current yields on the T-notes average 7.15 percent, while 6-month T-bill yields average 3.28 percent. The dealer can currently borrow $2,300 million through one-week repurchase agreements at an interest rate of 3.20 percent. Compute the dealer?s expected carry income in each of the following scenarios. (Hint: A spreadsheet can be most useful here. Perform the succession of calculations for the T-note in row 1; the succession of calculations for the T-bill in row 2; and the expenses from the RP in the row 3. Then, compute the carry income from the appropriate columns where income and expenses have been computed for each scenario.) a. The dealer purchases the T-notes and T-bills and finances them with the RP under the terms listed above. Same as part (a) above except that interest rates change to 7.30 percent on the b. T-notes, 5.40 percent on the T-bills and 5.55 percent on the RP, and the dealer must refinance the T-note and T-bill purchases at the new RP rate. c. Same as part (b) above except the dealer had not purchased the T-notes and T-bills until after interest rates changed. d. Repeat part (b) in the case where rates changed to 7 percent on the T-notes, 5.10 percent on the T-bills, and 4.5 percent on the RP. e. Repeat part (b) except the dealer had not purchased the T-notes and T-bills until after the interest rates changed. f. Based on the above results, is it always good for the dealer when interest rates rise? How about when they fall? Please explain. g. Could the dealer have benefited by a short position in case (b) or (d) above? Please explain.


Paper#7179 | Written in 18-Jul-2015

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