FINS 1612 Tutorial question for Tutorial 4 (week 5)
6Interest rates play an important role in monetary policy determinations, economic performance and the business cycle, and the cost of funds. Financial market participants must therefore understand the term structure of interest rates.
a. Define in detail the term yield and explain how a yield curve is constructed.
Yield: total return on an investment, comprising interest received and any capital gain or loss.
Yield curve is a graph, at a point in time, of yields on an identical security with different terms to maturity. X-axis represents bond maturity and y-axis represents yield per year.
b. Identify three different types of yield curves. Describe each of these yield curves and draw a fully labelled diagram of each curve.
Normal or positive yield curve: longer term interest rates are higher than shorter term rates
Inverse or negative curve: short term interest rates are higher than long term rates.
Humped yield curve: shape of yield curve changes over time from normal to inverse.
7Market participants observe that the yield curve is normal (upward sloping). Use expectationstheory to explain this observation.
Current short-term interest rate and expectations about future short-term interest rates are used to explain the shape and changes in shape of the yield curve.
Longer term rates will be equal to the average of the short-term rates expected over the period.
Interest rate on a long-term bond equals the average of the expected one-year-bond interest rates over the life of the long-term bond.
Theory is based. On assumptions
Large number of investors with reasonably homogenous expextations
No transactions costs ans no impediments to interest rates moving to their competitive equilibrium levels
In=vestors aim to maximise returns and view all bonds as perfect substitutes
9The segmented markets theory extends our understanding of factors that influence the determination of interest rates.
a. Identify and explain two assumptions of the expectations approach that are challenged by the segmented markets approach to interest rate determination.
Under the segmented market. Theory, securities with different time to maturities are NOT viewed by investors as being perfect substitutes for one another.
The segmented markets theory rejects two expectation theory assumptions:
- all bonds are perfect substitutes. For one another.
- Investors are indifferent between holding short-term securities and holding long-term, securities.
b. It may be argued that the segmented markets approach is negated by modern risk management practices, arbitrage and speculation. Explain what is meant by this assertion.
The segmented markets approach implies. That investors with a certain investment time horizon will only trade securities with a certain maturity.
Arbitrageurs actively seeks free-lunch opportunity. They are indifferent about the maturity of the bonds they hold since they will trade any bond to take advantage of any potential gain arising from the market in=efficiencies.
End-chapter essay questions:
3a. Briefly explain the concept of corporate governance within the context of a corporation.
Corporate government relates to the relationships between the shareholders, the board of directors and the executive management.
Shareholders are the holder of share issued by a company. They are the real owner of a company.
The board of directors, or the board, is a group of people selected by shareholders to project shareholders. The board is responsible for objectives and policied of a company and appoint the executive management.
The executive management is responsible for daily management of the company, it included all high-level manager such as CEO,CFO,etc.
b. What is the relationship between corporate governance and the so-called agency problem?
One of key amin for a company is to maximise shareholder value.
Agency problems arise from the separation of ownership and control of a corporation.
Managers do the daily work and may not necessarily act in the best interests of the shareholders.
The board of directors must implement policies that align the interest of managers with those of the shareholders.
4Most developed or developing countries seek to establish modern and efficient stock exchanges.
a. Identify and discuss the five principal functions of a modern and efficient stock exchange.
Function 1: facilitate the trading of financial assets- ordinary shares, debt securities, and derivatives.
Function 2: provide a trading system- ASX (Australian securities exchange) uses the ASX trade platform.
Function 3: provide a settlement system-ASX use the CHESS, which instantaneously records the transaction and facilitates the settlement (within 2 business days)
Function 4: market integrity-ASX monitors the behavior of listed. Companied and authorized brokers
Function 5: provision of a well-informed market- ASX ensures the continuous information disclosure
b. Why is it important to maintain modern and efficient stock exchanges?
1. a stock exchange provides a market where companied may become listed corporations. (issue shares)
2. the stock exchange facilitates. Efficient access to large. Amounts. Of funding (issuing ordinary shares, debt securities, and hybrid security)
Hybrid security combined both the debt and equity characteristics.
3. a modern and efficient stock exchange encourages investors to make investments (trade shares, bonds, or derivatives)
5Discuss why a strong primary market is important for economic growth within a country and explain how each of the main participants in the primary issue of securities interacts with each other during the share issuance process.
6. a. Discuss the secondary market role of a stock exchange and its importance to the corporation. Illustrate your answer by using examples.
1. primary market role of a stock exchange market facilitates the issuing of new listed securities.
2. the secondary market role of a stock exchange market facilitates the trading of all existing securities at current market prices.
3. an active, organized and liquid secondary market will give investors confidence and encourage them to trade.
b. What is meant by the liquidity of the share market? Explain why liquidity in the secondary market is important both to shareholders and to the corporation.
12 a. Using the example of the trading and settlement platforms used by the ASX, explain the process whereby one investor places a buy order for 1000 Rio Tinto Limited shares and another investor places a sell order for 1000 Rio Tinto Limited shares; both orders at market price.
b. Within the context of the above Rio Tinto share transaction, define and provide examples of the following:
•share contract note
•T + 2 business days
13 a. It may be argued that information is the life-blood of an efficient stock market. Explain this proposition.
b. Within the context of the ASX, explain the requirements and purpose of continuous reporting.
c. Identify, using examples, five different pieces of information that are regarded as being material and therefore should be reported to the stock exchange.
14Outline the regulatory structure and the responsibilities of the main supervisors of market integrity and market participants' behaviour in Australian stock exchanges.
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