Final

Question 1

What is the risk-free rate and how is it theoretically derived? Use the interest rate model to explain its derivation.

Answer 1

1.) kpr+Infl+LR+DR+MR
2.)
~LR=0 -> massive market
~DR=0 -> can print $$
~MR=0 -> for ST Treasure

3.) Risk-free
4.) krf= kpr+Infl -> 90-day treasury bill

Question 2

Long-term interest rates set by:

Answer 2

The forces of supply and demand in the market for debt.

Question 3

Why does a normal. yield curve slop up and to the right (use the interest rate model to help explain your answer)? What causes the yield curve to invert (DON’T explain what an inverted yield curve is explain WHY it inverts)?

Answer 3

1.) k=kpr + Infl + LR + DR + MR
2.) Draw 1st graph going up and to the right, draw 2nd graph going down to the left.

US Treas.
A. Graph 1
- LR = 0
- DR = 0
- MR -> Increases w/ time so, the yld curve slopes up and to the right.
B. Graph 2
- Market Expectations -> the market collectively believes interest rates are heading lower and therefore wants to be positioned at the long-end of the curve for greater price appreciation in a declining interest rate environment.

Question 4

What rate of return sets a NPV equal to zero?

Answer 4

IRR

Question 5

Give one reason why MIRR is a better measure of return than IRR?

Answer 5

A) It assumes cash flows are reinvested at the firms cost of capital vs. the IRR of the project.

B) Provides only one solution for cash flows the flip from positive to negative cash flows.

Question 6

If a bond is no longer trading at par, why are the YTM and the current yield no longer equal?

Answer 6

Because the YTM now consists of 2 returns instead of just 1 (the interest) the current yield and the capital gain or loss on the bond if held to maturity.

Question 7

What is the fair value of a stock?

Answer 7

PV of future cash flows.

Question 8

Relating to CAPM:
A) What are the two risks associated with a stock under portfolio theory?

Answer 8

Systemic and firm specific

Question 9

Which risk is assumed to be diversified away?

Answer 9

Firm specific

Question 10

t what price would your bond’s current yield, YTM, and coupon rate all be identical?

Answer 10

When the bond trades at par

Question 11

Interest rates and bond prices:

Answer 11

Move in opposite directions

Question 12

If you expect interest rates to drop significantly over the next several years which type of bond would you prefer to purchase assuming identical risk and coupon rates or YTM at the time of issuance?

Answer 12

A long-term zero-coupon bond (w/ many years left to maturity)

Question 13

The rate of return that makes the current bond price equal to the present value of the bond’s future cash inflows is the:

Answer 13

YTM

Question 14

If an investor has to sell a bond prior to maturity and interest rates have risen since the bond was purchased (just like Silicon Valley Bank), the investor is exposed to:

Answer 14

Interest rate risk

Question 15

Which of the following situations at the time of purchase would result in a capital loss on a bond held to maturity?

Answer 15

If bond’s current yield is lower than the coupon rate, but higher than the YTM

Question 16

If you observe a stock price that consistency rises and falls more than the market (on a percentage basis) on any given day, the stock’s likely has a beta that is:

Answer 16

Less than zero (?)

Question 17

According to portfolio theory and the CAPM, this type of risk is avoidable through proper diversification:

Answer 17

Unsystematic risk

Question 18

Which of the following is generally considered to be the risk-free rate of return?

Answer 18

90-day Treasury Bill rate

Question 19

As the riskiness of a security increases the return associated with a security will:

Answer 19

Increase

Question 20

Which of the following should be the goal of a company’s management team?

Answer 20

Maximize investors’ expectations of the future profits of the company

Question 21

Explain what might cause a normal yield curve to invert and what an inverted yield curve might be signaling. DO NOT JUST. explain what an inverted yield curve is…explain WHY it happens…the thought process behind the inversion.

Answer 21

The inverted yield curve signals there may be a recession. People expect the feds to stimulate the economy by cutting interest rates. Everybody tried to have long-term bonds during this time because they will have the most monetary return compared to short-term bonds where you have to continuously re-invest because interest keeps changing.