Question

1.  T-bill yield

a. Determine how the annualized yield of a T-bill would be affected if the purchase price is lower. Explain the logic of this relationship.

b. Determine how the annualized yield of a T-bill would be affected if the selling price is lower. Explain the logic of this relationship.

c. Determine how the annualized yield of a T-bill would be affected if the number of days is shorter, holding the purchase price and selling price constant. Explain the logic of this relationship.

2.  An insurance company purchased bonds issued by Hartnett Company two years ago. To-

day, Hartnett Company has begun to issue junk bonds and is using the funds to repurchase most of its existing stock. Why might the market value of those bonds held by the insurance company be affected by this action?

3.  Explain how the downgrading of bonds for a particular corporation affects the prices of those bonds, the return to investors that currently hold these bonds, and the potential return to other investors who may invest in the bonds in the near future.

4.  Assume the following information for an existing bond that provides annual coupon payments:

Par value = $1,000

Coupon rate = 11%

Maturity = 4 years

Required rate of return by investors = 11%

a. What is the present value of the bond?

b. If the required rate of return by investors were 14 percent instead of 11 percent, what would be the present value of the bond?

c. If the required rate of return by investors were 9 percent, what would be the present value of the bond?

5.  How does the initial rate on adjustable-rate mortgages (ARMs) differ from the rate on fixed-rate mortgages? Why? Explain how caps on ARMs can affect a financial institution’s exposure to interest rate risk.

6.  Consider current conditions that could affect interest rates, including inflation (including oil prices), the economy, the budget deficit, and the Fed’s monetary policy. Based on prevailing conditions, do you think the values of mortgages that are sold in the secondary market will increase or decrease during this semester? Offer some logic to support your answer. Which factor do you think will have the biggest impact on the values of existing mortgages?

Answer 1

1.a)The annualized treasury bill yield is increased if the purchase price is lower,since the amount returned to the investor would represent a larger gain as compare to smaller investment.

b)The annualized treasury bill yield is reduced if the selling price is lower,since the amount returned to the investor would represent a smaller gain relative to the investment.

c)The annualized treasury bill yield is increased if the number of days of the investment is shorter,since the amount returned to the investor is earned over a shorter period of time.