Subject: Business / Finance
QuestionTake-Home Final ExaminationDUE DATE: Wednesday, May 18, 2016 by 11:59PMAnswer all questions below. Make sure to show your work. Your answers must be typed. Let me know if you have any question. (TOTAL POINTS)1. Why do we need the money market? (5 points)2. What is the difference in basis points between the discount rate of return (DR) and the investment rate of return (IR) on a $30 million commercial paper note purchased at a price of $28.5 million and scheduled to mature in 60 days? (8 points)3. Interpret the following statement made by Wall Street analysts and portfolio managers: “Although yields among bonds are related, today’s rumors of a tax cut caused an increase in the yield on municipal bonds, while the yield on corporate bonds declined.” (5 points)4. You take out a 30-year $450,000 mortgage loan with an APR of 7.75 percent and monthly payments. In 16 years you decide to sell your house and payoff the mortgage. What is your monthly payment? What is the principal balance on the loan? What is your total payment? What is your principal payment? What is your interest payment? (20 points)5. Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.7; ; ; . Assume the stock is in equilibrium and exhibits constant growth. (6 points)6. How is the aggregate demand curve derived? What factors shift the curve? (6 points)7. Bayboro Sails is expected to pay dividends of $3.50, $4.00, and $5.00 in the next three years—D1, D2, and D3, respectively. After three years, the dividend is expected to grow at a constant rate equal to 7 percent per year indefinitely. Stockholders require a return of 15 percent to invest in the common stock of Bayboro Sails. Compute the value of Bayboro’s common stock today, P0. (8 points)8. You plan to purchase a house for $350,000 using a 30?year mortgage obtained from your local bank. You will make a down payment of 20 percent of the purchase price.Your bank offers you the following two options for payments:Option 1: Mortgage rate of 10.35 percent and 1 point.Option 2: Mortgage rate of 10.1 percent and 2.5 points.Which option should you choose (assuming you will hold the mortgage until maturity)?(16 points)9. Assume the following information over a five-year period:· Average risk?free rate = 6%· Average return for Crane stock = 11%· Average return for Load stock = 14%· Standard deviation of Crane Stock returns = 2%· Standard deviation of Load stock returns = 4%· Beta of Crane stock = 0.8· Beta of Load stock = 1.1Determine which stock has higher risk?adjusted returns when using the Sharpe index. Which stock has higher risk?adjusted returns when using the Treynor index? (14 points)10. Supposed there is an increase in the velocity of money caused by the increased use of ATM machines. (20 points)How would prices and output be affected in the short run?
If the Federal Reserve’s objective is to keep prices stable in the short-run, how should it respond?
In the long run, what will happen to prices and output? If the Federal Reserve’s objective is to keep prices stable in the long run, how should it respond? When should it undertake its response — immediately or once the “long run” is reached?
Based upon your answer in part (c), how would you respond to those who argue that the Federal Reserve should wait until inflation appears before reacting?11. An investor purchases a 30-year municipal bond for $960. The bond’s coupon rate is 8 percent and, it still had 16 years remaining until maturity. If the investor holds the bond until it matures and collects the $1000 par value from the municipality and his marginal tax rate is 34 percent, what will be his (effective) yield to maturity? (5 points)12. An investor purchases a 30-year U.S. government bond for $1,020. The bond’s coupon rate is 9 percent and, it still had 14 years remaining until maturity. If the investor holds the bond until it matures and collects the $1000 par value from the Treasury and his marginal tax rate is 39 percent (we assume that the bond is taxable), what will be his after-tax (effective) yield to maturity? (5 points)13. Suppose that the public wishes to hold $0.35 in pocket money (currency and coin) and $0.25 in time and savings deposits. Suppose that banks wish to hold $0.20 for each new dollar of transaction money received. Suppose that $0.05 finds its way outside of the domestic banking system. Suppose the reserve requirement on transaction deposits is 3 percent and that on time and savings deposits is 4%. (20 points)a. What is the size of the transaction deposit multiplier?b. What is the size of the money multiplier?c. Suppose $5 million in new excess reserves appear in the banking system. How much will be created in the form of deposits and loans?d. By how much did the leakages of funds from the banking system reduce the size of the transaction deposit multiplier? (Hint: compute the simple transaction deposit multiplier).e. If the Fed purchases $175 billion worth of government securities on the open market, what is the effect on the money supply?14. Microtech Corporation is expanding rapidly, and it currently needs to retain all of its earnings, hence it does not pay any dividends, with the first dividend of $1.00 coming 3 years from today. The dividend should grow rapidly—at a rate of 50 percent per year—during Years 4 and 5. After Year 5, the company should grow at a constant rate of 8 percent per year. If the required return on the stock is 15 percent, what is the value of the stock today? (10 points)15. You expect a share of stock to pay dividends of $1.00, $1.25, and $1.50 in each of the three years. You believe the stock will sell for $20 at the end of the third year. What is the stock price if the discount rate for the stock is 10%? (5 points)16. Compare and contrast the expectations theory and the liquidity premium theory of the term structure of interest rates. (10 points)17. Suppose today’s 10-year rate is 9 percent. Today’s 4-year rate is 7 percent. Estimate the 6-year forward rate in four years if the 10-year rate has a .3 percent liquidity premium.(6 points)18. Consider a 30-year corporate bond paying 9 percent semi-annual coupon. The current yield to maturity is 11 percent. (14 points)a. Find the modified duration. (6 points)b. Refer to part a. If the interest changes by 25 basis points, what is the exact change in price? (4 points)c. Refer to part b. If the interest changes by 25 basis points, what is the approximate change in price? (4 points)19. Consider a 30-year corporate bond paying 8 percent semi-annual coupon. The current yield to maturity is 10 percent. Find the approximate bond’s modified duration by using changes in the interest rate up and down by 5 basis points. (10 points)20. What is a monetary policy target? Explain why it is difficult for the Fed to target both the interest rate and the money supply simultaneously. (7 points)