1) Write down the formula that is used to calculate the yield to maturity on a twenty-year 10% coupon bond with $1,000 face value that sells for $2,000.
2) To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don’t have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12%, the yield to maturity on a normal $1,000 fixed-payment loan in which you pay $126 per for 25 years.
3) You are offered two bonds, a one-year U.S. treasury bond with a yield to maturity of 9% and a one-year U.S treasury bill with a yield on a discount basis of 8.9% Which would you rather own?
4) An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework?
5) Using both the liquidity preference framework and the supply and demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recession).
6) Using both the supply and demand for bonds and liquidity preference frameworks, show what the effect is on interest rates when the riskiness of bonds rises. Are the results the same in the two frameworks?
7) If the price level falls next year, remaining fixed thereafter, and the money supply is fixed, what is likely to happen to interest rates over the next two years?
(Hint: Take account of both the price-level effect and the expected inflation effect.)
8) If yield curves, on average, were flat, what would this say about the liquidity (term) premiums in the term structure? Would you be more or less willing to accept the expectations theory?
9) 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 paths of one-year interest rates over the next five years:
a. 5%, 6%, 7%, 6%, 5%
b. 5%, 4%, 3%, 4%, 5%
How would your yield curves change if people preferred shorter-term bonds over longer-term bonds?
10) 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?
11) After careful analysis, you have determined that a firm’s dividends should grow at 7% on average in the foreseeable future. The firm’s last dividend was $3. Compute the current price of this stock, assuming this required return is 18%.
12) “If stock prices did not follow a random walk, there would be unexploited profit opportunities in the market.” Is this statement true, false, or uncertain? Explain your answer.
13) If higher money growth is associated with higher future inflation, and if announced money growth turns out to be extremely high but still is less than the market expected, what do you think would happen to long-term bond prices?
14) Explain how the separation of ownership and control in American corporations might lead to poor management.
15) How does the provision of several types of financial services by one firm lead to conflicts of interest?