The assignment content is related to finance and investments, specifically discussing the effects of inflation rates on different investment portfolios and calculating yield-to-maturity, annual rate of return, and stock prices using various financial models.
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. Complete 11 of the 12 problems below: 1.The required reserve ratio is given asrr. a.(7 pts) Show that the money multiplier,, is equal to; whererris the required, reserve ratio, DD is the demand deposit. (HINT: begin with MS =tDD).MSis defined as the money supply. b.(3 pts) If the FED buys $1,000,000 of government securities, what is the net effect on the money supply? (Be sure to specify if your answer is a net increase or net decrease of the money supply). Answer: If FED buys government securities than it leads to increase in money supply in the economy. So, FED buying $1,000,000 of government increase will lead to net increase in money supply in economy. 2.(10 pts) President Trump promises cuts to the wealthy and corporations. His claim will be that additional tax cuts will continue to stimulate economic growth (reduce unemployment and increase real output) and place downward pressure on interest rates? Argue in support or against President Bush economic stimulus. Be thorough in your analysis. Answer: My view is against the Tax cuts proposed by President Trump. A)It will reduce federal revenues by a huge amount B)It will lead to increase in federal deficit which is already very high currently C)Decrease in fed revenues will lead to delay in payment of debt owned by American government D)Such reduction in revenues will lead to reduce allocation to Healthcare and child care and also spending on poor sections of society E)Reducing interest will again lead increase in borrowing of funds and such cheaper borrowing can again lead to housing crisis as happened in 2008. 3.The first period spot interest rate isti1, the expected interest rate in the second time period ist+1i1e, and the two-year (annual interest rate, for two years) spot interest rate isti2. a.(5 pts) Show thatti2= [(1 +ti1)(1+t+1i1e)]1/2- 1 b.(5 pts) If the one-year spot rate is 4% and the 2-year spot interest rate is 2%, 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, what is the net effect on the real interest rate, nominal interest rate and the quantity of loanable funds? Answer:
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Inflation is difference between nominal and real interest rates. So, if inflation is tended to increase next year then nominal interest rate will remain constant but real interest will decrease. Demand for loanable funds will decrease due to increasing interest rates. 5.As a portfolio manager for an insurance company, you are about to invest funds in one 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 of default. You plan to maintain this investment over a one-year period. The return of each investment over a one-year horizon will be about the same if interest rates do not change over the next year. However, you anticipate that the U.S. inflation rate will decline substantially over the next year, while most of the other portfolio managers in the United States expect inflation to increase slightly. (a.)(5) If your expectations are correct, how will the return of each investment be affected over the one-year horizon? Answer: Decrease in inflation leads to increase in net returns from bonds. Impact of inflation on different securities is as follows: 1)Net returns after inflation will increase in this case 2)As zero coupon bonds pay interest at maturity so there will be no change 3)Net returns after inflation will increase in this case (5 pts) If your expectations are correct, which of the three investments should have the highest return over the one-year horizon? Why? Answer: Increase in inflation leads to decrease in net returns from bonds. Impact of inflation on different securities is as follows: 1)Net returns after decrease will increase in this case 2)As zero coupon bonds pay interest at maturity so there will be no change 3)Net returns after decrease will increase in this case 6.(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 is selling 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 in interest rates, would you expect its price in one year to be higher, lower, or unchanged? Explain why. Answer: YTM can be less than coupon only when the bond is selling at premium as compared to its price.
If interest rates remain unchanged then price of bond will be lower as compared to previous years. Because YTM will increase in next year and consequently price will decrease. 8.(10 pts) A $1 million commercial paper issue sold at a discounted price of $982,000. It matures in 100 days. Calculate its annual rate of return. Answer: Annual Rate of Return is: Start Value End Value Period in YearsAnnual Rate of Return Values98200010000000.2739726036.8546% Remarks(100/365) =((End Value/Start Value)^(1/Periods) -1 9.(10 pts) Traditional Film is a company in a declining business. Dividends are expected to decrease at a 10% rate. Last year’s dividend was $3 per share. The required return for Traditional Film is 25%. What would you pay for a share of the stock? Answer: The above question can be solved using Dividend Discount Model: Price = Dividend of Next Year / (Cost of Capital – Growth Rate ) So, Price = 2.7 / { 25% - ( - 10%)} = 2.7/0.35 = $7.71 10.(10 pts) An analyst has made the following explicit estimates of EkG stock’s future dividends: T12345 Div$1.25$1.37$1.40$1.40$1.50 After 5 years the stock is expected to quit growing and pay a constant dividend of $1.50 forever. If investors require a 10% return from the stock with EkG’s risk, what should be the stock’s price? Answer:
T12345After 5 Years Stock Price is Sum of all Dividends Div$1.25$1.37$1.40$1.40$1.50$1.50 Return$1.14$1.13$1.05$0.96$0.93$15.00$20.21 Annuity Factor1.11.211.3311.46411.610510.1 11.(10 pts) What is the difference between the standard deviation of a stock’s return and a stock’s beta coefficient? Answer: Standard Deviation (SD): SD is also referred as volatility of a stock i.e. measure of dispersion of its return. SD is calculated as square root of variance of stock from its mean. High SD means returns of a stock vary largely and are spread out compared to mean returns. Low SD means returns of a stock are very close or near to its mean. SD measures total risk of a stock. Beta: Beta in simple terms is volatility of a stock as compared to market index. For example: Apple’s Beta is 1.5 it means if S&P500 rises by 1% then apple is expected to rise 1.5%. Beta measures systematic risk of stock. Higher beta means the stock is more volatile compared to index. Lower beta means the stock is less volatile compared to index. 12.(10 pts) Provide an algebraic expression for the expected return of an N-asset investment portfolio and its beta coefficient. The expected return on each asset is defined as Riand its beta coefficient is βi; where i =1, 2, …, N. Explain these expressions. Answer: Algebraic expression forcalculating Expected return ofN-assetInvestment portfolio is as follows: Here, Bportfolio: Beta of porfolio calculated using weight of stocks and their individual betas. Expected Return Market: It is expected return of market calculated using previous datas of makret
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