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Inflation-Proofing Your Portfolio

   

Added on  2019-09-13

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.Complete 11 of the 12 problems below:1.The required reserve ratio is given as rr.a.(7 pts) Show that the money multiplier, MSDD, is equal to 1rr; where rr isthe required, reserve ratio, DD is the demand deposit. (HINT: begin withMS = ()1rrtotDD). MS is defined as the money supply.b.(3 pts) If the FED buys $1,000,000 of government securities, what is thenet effect on the money supply? (Be sure to specify if your answer is a netincrease or net decrease of the money supply).Answer:If FED buys government securities than it leads to increase in moneysupply in the economy. So, FED buying $1,000,000 of governmentincrease will lead to net increase in money supply in economy.2. (10 pts) President Trump promises cuts to the wealthy and corporations. Hisclaim will be that additional tax cuts will continue to stimulate economic growth(reduce unemployment and increase real output) and place downward pressure oninterest rates? Argue in support or against President Bush economic stimulus. Bethorough in your analysis.Answer:My view is against the Tax cuts proposed by President Trump.A)It will reduce federal revenues by a huge amountB)It will lead to increase in federal deficit which is already very high currentlyC)Decrease in fed revenues will lead to delay in payment of debt owned byAmerican governmentD)Such reduction in revenues will lead to reduce allocation to Healthcare andchild care and also spending on poor sections of societyE)Reducing interest will again lead increase in borrowing of funds and suchcheaper borrowing can again lead to housing crisis as happened in 2008.3.The first period spot interest rate is ti1, the expected interest rate in the second timeperiod is t+1i1e, and the two-year (annual interest rate, for two years) spot interestrate is ti2.a.(5 pts) Show that ti2 = [(1 + ti1)(1+ t+1i1e)]1/2 - 1b.(5 pts) If the one-year spot rate is 4% and the 2-year spot interest rate is2%, what is the expected interest rate for time period 2?c.(5 pts) Is the yield curve upward-sloping or downward-sloping? Why? 4.(10 pts) If market participants fully expect inflation in the next year to increase, whatis the net effect on the real interest rate, nominal interest rate and the quantity ofloanable funds?Answer:
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Inflation is difference between nominal and real interest rates. So, if inflation istended to increase next year then nominal interest rate will remain constant but realinterest will decrease. Demand for loanable funds will decrease due to increasinginterest rates.5.As a portfolio manager for an insurance company, you are about to invest funds inone of three possible investments: (1) 10-year coupon bonds issued by the U.S.Treasury, (2) 20-year zero-coupon bonds issued by the U.S. Treasury, or (3) one-year Treasury securities. Each possible investment is perceived to have no risk ofdefault. You plan to maintain this investment over a one-year period. The return ofeach investment over a one-year horizon will be about the same if interest rates donot change over the next year. However, you anticipate that the U.S. inflation ratewill decline substantially over the next year, while most of the other portfoliomanagers in the United States expect inflation to increase slightly.(a.)(5) If your expectations are correct, how will the return of each investment beaffected over the one-year horizon?Answer:Decrease in inflation leads to increase in net returns from bonds. Impact of inflationon different securities is as follows:1)Net returns after inflation will increase in this case2)As zero coupon bonds pay interest at maturity so there will be no change3)Net returns after inflation will increase in this case(5 pts) If your expectations are correct, which of the three investments should havethe highest return over the one-year horizon? Why?Answer:Increase in inflation leads to decrease in net returns from bonds. Impact of inflationon different securities is as follows:1)Net returns after decrease will increase in this case2)As zero coupon bonds pay interest at maturity so there will be no change3)Net returns after decrease will increase in this case6.(10 pts) Calculate the yield to maturity on a 10 percent coupon bond (paid semi-annually), with a $1000 face value and 20 years remaining to maturity. The bond isselling at $950.Answer:Approx YTM : [Coupon + (Face Value – Price)/Number of Years] / {(Face Value +Price)/2 }YTM : [ 100 + (1000-950)/40 ] / { (1000 + 950) / 2 } = 10.54%7.(10 pts) A bond’s yield to maturity is less than its coupon. Assuming no change ininterest rates, would you expect its price in one year to be higher, lower, orunchanged? Explain why.Answer:YTM can be less than coupon only when the bond is selling at premium as comparedto its price.
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