Question: An important way in which the Federal

> You sold a security for $980 that you purchased five years before for $795. What was the holding period return? Prove that this return overstates the annualized, compound return.

> An investor buys a stock for $35 and sells it for $56.38 after five years. a) What is the holding period return? b) What is the true annual rate of return?

> You are given the following information concerning four stocks: Using 20X0 as the base year, construct three aggregate measures of the market that simulate the Dow Jones Industrial Average, the S&P 500 stock index, and the Value Line stock index (i

> Given the following information concerning four stocks, a) Construct a simple price-weighted average, a value-weighted average, and a geometric average. b) What is the percentage increase in each average if the stocks’ prices become: i

> How do you purchase a publicly traded bond?

> Bell Corp. issues a bond with the following features The current interest rate on comparable debt is 7 percent, so the bond initially sells for $713. What is the accrued interest on the bond for each of the next five years? Principal $1,000 Coupon 0

> “Foreign exchange rates, like stock prices, should follow a random walk.” Is this statement true, false, or uncertain? Explain your answer.

> A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $5 billion with 100 million shares outstanding. Assuming that the split conveys no new information about the company, what is

> If the public expects a corporation to lose $5 a share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis say will happen to the price of the stock when the $4 l

> If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory?

> “If bonds of different maturities are close substitutes, their interest rates are more likely to move together.” Is this statement true, false, or uncertain? Explain your answer.

> Why do U.S. Treasury bills have lower interest rates than large-denomination negotiable bank CDs?

> Which should have the higher risk premium on its interest rates, a corporate bond with a Moody’s Baa rating or a corporate bond with a C rating? Why?

> If the income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would it have on interest rates on U.S. Treasury securities?

> Predict what would happen to the risk premiums on corporate bonds if brokerage commissions were lowered in the corporate bond market.

> Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

> How can changes in foreign exchange rates affect the profitability of financial institutions?

> Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?

> What effect would reducing income tax rates have on the interest rates of municipal bonds? Would interest rates of Treasury securities be affected and, if so, how?

> If a yield curve looks like the one below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions about the inflation rate in the future?

> If a yield curve looks like the one shown here, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions about the inflation rate in the fut

> The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%, 13%, 14.5%, 16%, and 17.5%. Using the expectations theory, what will be the interest rates on a three-year bond, a six-year bond, and a nine-year bond?

> Debt issued by Southeastern Corporation currently yields 12%. A municipal bond of equal risk currently yields 8%. At what marginal tax rate would an investor be indifferent between these two bonds?

> How does the after-tax yield on a $1,000,000 municipal bond with a coupon rate of 8% paying interest annually compare with that of a $1,000,000 corporate bond with a coupon rate of 10% paying interest annually? Assume that you are in the 25% tax bracket.

> Government economists have forecasted one-year T-bill rates for the following five years, as follows: Year………………1-year rate 1…………………………..4.25% 2…………………………..5.15% 3………………………….5.50% 4………………………….6.25% 5………………………….7.10% You have a liquidity premium of 0.25

> If the interest rates on one- to five-year bonds are currently 4%, 5%, 6%, 7%, and 8%, and the term premiums for one- to five-year bonds are 0%, 0.25%, 0.35%, 0.40%, and 0.50%, predict what the one-year interest rate will be two years from now.

> One-year T-bill rates over the next four years are expected to be 3%, 4%, 5%, and 5.5%. If four-year T-bonds are yielding 4.5%, what is the liquidity premium on this bond?

> How does an increase in the value of the pound sterling affect American businesses?

> One-year T-bill rates are 2% currently. If interest rates are expected to go up after three years by 2% every year, what should be the required interest rate on a 10-year bond issued today? Assume that the expectations theory holds.

> Which bond would produce a greater return if the expectations theory were to hold true, a two-year bond with an interest rate of 15% or two one-year bonds with sequential interest payments of 13% and 17%?

> One-year T-bill rates are expected to steadily increase by 150 basis points per year over the next six years. Determine the required interest rate on a three-year T-bond and a six-year T-bond if the current one-year interest rate is 7.5%. Assume that the

> Consider the decision to purchase either a five-year corporate bond or a five-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and

> Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves for the following series of one-year interest r

> You observe the following market interest rates, for both borrowing and lending: one-year rate…………………………………………. 5% two-year rate………………………………………… 6% one-year rate one year from now………… 7.25% How can you take advantage of these rates to earn a riskles

> At your favorite bond store, Bonds-R-Us, you see the following prices: a. 1-year $100 zero selling for $90.19 b. 3-year 10% coupon $1000 par bond selling for $1000 c. 2-year 10% coupon $1000 par bond selling for $1000 Assume that the pure expectations th

> Little Monsters, Inc., borrowed $1,000,000 for two years from NorthernBank, Inc., at an 11.5% interest rate. The current risk-free rate is 2%, and Little Monsters’ financial condition warrants a default risk premium of 3% and a liquidity risk premium of

> Using the information from the previous question, assume that investors prefer holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond’s maturity. What will be the interest rates on a three-year bond, a six-ye

> Explain why you would be more or less willing to buy a house under the following circumstances: a. You just inherited $100,000. b. Real estate commissions fall from 6% of the sales price to 4% of the sales price. c. You expect Polaroid stock to double in

> How does a decline in the value of the pound sterling affect British consumers?

> Predict what will happen to interest rates if prices in the bond market become more volatile.

> Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices.

> Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer.

> Using a supply-and-demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.

> What effect will a sudden increase in the volatility of gold prices have on interest rates?

> “No one who is risk-averse will ever buy a security that has a lower expected return, more risk, and less liquidity than another security.” Is this statement true, false, or uncertain? Explain your answer.

> “The more risk-averse people are, the more likely they are to diversify.” Is this statement true, false, or uncertain? Explain your answer.

> How might a sudden increase in people’s expectations of future real estate prices affect interest rates?

> Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).

> What effect might a rise in stock prices have on consumers’ decisions to spend?

> Why does a lower strike price imply that a call option will have a higher premium and a put option a lower premium?

> If the finance company you manage has a gap of +$5 million (rate-sensitive assets greater than rate-sensitive liabilities by $5 million), describe an interest-rate swap that would eliminate the company’s income gap.

> If your company has a payment of 200 million euros due one year from now, how would you hedge the foreign exchange risk in this payment with 125,000 euros futures contracts?

> If the savings and loan you manage has a gap of -$42 million, describe an interest-rate swap that would eliminate the S&L’s income risk from changes in interest rates.

> I own a professional football team, and I plan to diversify by purchasing shares in either a company that owns a pro basketball team or a pharmaceutical company. Which of these two investments is more likely to reduce the overall risk I face? Why?

> Suppose that you buy a call option on a $100,000 Treasury bond futures contract with an exercise price of 110 for a premium of $1,500. If on expiration the futures contract has a price of 111, what is your profit or loss on the contract?

> If you buy a put option on a $100,000 Treasury bond futures contract with an exercise price of 95 and the price of the Treasury bond is 120 at expiration, is the contract in the money, out of the money, or at the money? What is your profit or loss on the

> If you buy a $100,000 February Treasury bond contract for 108 and the price of the deliverable Treasury bond at the expiration date is 102, what is your profit or loss on the contract?

> If the portfolio you manage is holding $25 million of 6s of 2032 Treasury bonds with a price of 110, what forward contract would you enter into to hedge the interest-rate risk on these bonds over the coming year?

> If the pension fund you manage expects to have an inflow of $120 million six months from now, what forward contract would you seek to enter into to lock in current interest rates?

> A swap agreement calls for Durbin Industries to pay interest annually based on a rate of 1.5% over the one-year T-bill rate, currently 6%. In return, Durbin receives interest at a rate of 6% on a fixed-rate basis. The notional principal for the swap is $

> Consider a put contract on a T-bond with an exercise price of 101 12/32. The contract represents $100,000 of bond principal and had a premium of $750. The actual T-bond price falls to 98 16/32 at the expiration. What is the gain or loss on the position?

> A bank customer will be going to London in June to purchase £100,000 in new inventory. The current spot and futures exchange rates are as follows: Exchange Rates Dollars/Pound Period…………………….Rate Spot……………………………1.5342 March………………………..1.6212 June…………………

> Assume the bank in the previous question partially hedges the mortgage by selling three 10-year T-note futures contracts at a price of 100 20/32. Each contract is for $1,000,000. After two months, the futures contract has fallen in price to 98 24/32. Wha

> Futures are available on three-month T-bills with a contract size of $1 million. If you take a long position at 96.22 and later sell the contracts at 96.87, how much would the total net gain or loss be on this transaction?

> A hedger takes a short position in five T-bill futures contracts at the price of 98 5/32. Each contract is for $100,000 principal. When the position is closed, the price is 95 12/32. What is the gain or loss on this transaction?

> Suppose that your company will be receiving 30 million euros six months from now and the euro is currently selling for 1 euro per dollar. If you want to hedge the foreign exchange risk in this payment, what kind of forward contract would you want to ente

> If your company has to make a 10 million euros payment to a German company in June, three months from now, how would you hedge the foreign exchange risk in this payment with a 125,000 euros futures contract?

> A bank issues a $100,000 variable-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% after the first six months, what is the impact on the interest income for the first 12 months? Assume the bank hedged this risk

> Explain why greater volatility or a longer term to maturity leads to a higher premium on both call and put options.

> How would you use the options market to accomplish the same thing as in Problem 5? What are the advantages and disadvantages of using an options contract rather than a futures contract?

> Suppose that the pension you are managing is expecting an inflow of funds of $100 million next year and you want to make sure that you will earn the current interest rate of 8% when you invest the incoming funds in long-term bonds. How would you use the

> If at the expiration date, the deliverable Treasury bond is selling for 101 but the Treasury bond futures contract is selling for 102, what will happen to the futures price? Explain your answer.

> North-Northwest Bank (NNWB) has a differential advantage in issuing variable-rate mortgages but does not want the interest income risk associated with such loans. The bank currently has a portfolio of $25,000,000 in mortgages with an APR of prime +150 ba

> The president of the United States announces in a press conference that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him.

> A trust manager for a $100,000,000 stock portfolio wants to minimize short-term downside risk using Dow put options. The options expire in 60 days, have a strike price of 9,700, and a premium of $50. The Dow is currently at 10,100. How many options shoul

> A banker commits to a two-year $5,000,000 commercial loan and expects to fulfill the agreement in 30 days. The interest rate will be determined at that time. Currently, rates are 7.5% for such loans. To hedge against rates falling, the banker buys a 30-d

> A bank issues a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage? Assume the bank hedged the position wit

> Springer County Bank has assets totaling $180 million with a duration of five years, and liabilities totaling $160 million with a duration of two years. Bank management expects interest rates to fall from 9% to 8.25% shortly. A T-bond futures contract i

> A bank issues a $3 million commercial mortgage with a nominal APR of 8%. The loan is fully amortized over 10 years, requiring monthly payments. The bank plans on selling the loan after two months. If the required nominal APR increases by 45 basis points

> Chicago Bank and Trust has $100 million in assets and $83 million in liabilities. The duration of the assets is 5.9 years, and the duration of the liabilities is 1.8 years. How many futures contracts does this bank need to fully hedge itself against inte

> Laura, a bond portfolio manager, administers a $10 million portfolio. The portfolio currently has a duration of 8.5 years. Laura wants to shorten the duration to 6 years using T-bill futures. T-bill futures have a duration of 0.25 years and are trading a

> Can a financial institution keep borrowers from engaging in risky activities if there are no restrictive covenants written into the loan agreement?

> “If more customers want to borrow funds at the prevailing interest rate, a financial institution can increase its profits by raising interest rates on its loans.” Is this statement true, false, or uncertain? Explain your answer.

> In the aftermath of the global financial crisis, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for many years. Does this make sense? Why or why not?

> Why is being nosy a desirable trait for a banker?

> Why are secured loans an important method of lending for financial institutions?

> “Because diversification is a desirable strategy for avoiding risk, it never makes sense for a financial institution to specialize in making specific types of loans.” Is this statement true, false, or uncertain? Explain your answer.

> A bank almost always insists that the firms it lends to keep compensating balances at the bank. Why?

> If the First National Bank sells $10 million of its securities with maturities greater than two years and replaces them with securities maturing in less than one year, what is the income gap for the bank? What will happen to profits next year if interest

> The following financial statement is for the current year. After you review the data, calculate the duration gap for the bank. Second National Bank Duration Duration Assets (in years) Liabilities (in years) Reserves $5,000,000 0.00 Checkable deposit

> Calculate the change in the market value of assets and liabilities when the average duration of assets is 3.60, the average duration of liabilities 0.88, and interest rates increase from 5% to 5.5%.

> A bank added a bond to its portfolio. The bond has a duration of 12.3 years and cost $1,109. Just after buying the bond, the bank discovered that market interest rates are expected to rise from 8% to 8.75%. What is the expected change in the bond’s value

> Chicago Avenue Bank has the following assets: What is Chicago Avenue Bank’s asset portfolio duration? Duration Asset Value (in years) $100,000,000 $40,000,000 T-bills 0.55 Consumer loans 2.35 Commercial loans $15,000,000 5.90

> Calculate the income gap for a financial institution with rate-sensitive assets of $20 million and rate-sensitive liabilities of $48 million. If interest rates rise from 4% to 4.8%, what is the expected change in income?

> Explain what effect a large federal deficit might have on interest rates.

> A bank’s balance sheet contains interest-sensitive assets of $280 million and interest-sensitive liabilities of $465 million. Calculate the income gap.

> Given the estimates of duration in Problem 27, how should the Friendly Finance Company alter the duration of its liabilities to immunize its net worth from interest-rate risk? Data from Problem 27: If the manager of the Friendly Finance Company revises

> Given the estimates of duration found in Problem 27, how should the Friendly Finance Company alter the duration of its assets to immunize its net worth from interest-rate risk?

> If the manager of the Friendly Finance Company revises the estimates of the duration of the company’s assets to two years and liabilities to four years, what is the effect on net worth if interest rates rise by 3 percentage points?

> Given the estimates of duration in Problem 21, how should the bank alter the duration of its liabilities to immunize its net worth from interest-rate risk? Data from Problem 21: If the manager of the First National Bank revises the estimates of the dura