This essay sample on Define Scofflaws provides all necessary basic info on this matter, including the most common “for and against” arguments. Below are the introduction, body and conclusion parts of this essay.
The yield to maturity is 12%. You plan to buy this bond, hold it for 2. 5 years, and then sell the bond a. What total cash will you receive from the bond after the 2. 5 years? Assume that periodic cash flows are reinvested at 12%. Given the required discount rate is 12% you need to grow any cash that you receive to 2. Years from the date you receive it. For example the scofflaws you receive at 1 year will become 189. 65. You then need to take the Poof the remaining scofflaws at the 2. 5 year point. For example the scofflaws at year 3 becomes 180/1. AAA. 5.
The value of the scofflaws becomes $733. 69. B. If immediately after buying this bond all market interest rates drop to 11% (including your reinvestment rate), what will be the impact on your total cash flow after 2. 5 years? How does this compare to part (a)? This is solved in the same way as for part (a) and the value of the scofflaws becomes $733. 74. C. Assuming all market interest rates are 12%, what is the duration of this bond? This is solved by dividing the sum of the the time weighted present value of the scofflaws by the present value of the scofflaws.
The duration is 2. 5. Note that as the duration and the holding period in parts (a) and (b) are the same you are insulated from changes in interest rates (essentially the losses in reinvestment rates for the early scofflaws are offset by the gains in value for the scofflaws paid later). Year 4 Promised Payment 160 170 180 230 Chapter 11 Questions 1 . What characteristics define the money markets? The money markets can be characterized as having securities that trade in one year 29 years ago with 6 months remaining before it matures a money market instrument?
Money market securities have an original maturity of less than one year, so the bond would not be considered a money market security. 3. Why do banks not eliminate the need for money markets? Banks have higher costs than the money market owing to the need to maintain reserve requirements. The lower cost structure of the money markets, coupled with the economies of scale resulting from high volume and large-denomination securities, allows for higher interest rates. 4. Distinguish between a term security and a demand security? Term securities have a specific maturity date. Demand securities can be redeemed at any time.
A six-month certificate of deposit is a term security. A checking account is a demand security. 5. What was the purpose motivating regulators to impose interest ceilings on bank savings accounts? What effect did this eventually have on the money markets? Following the Great Depression, regulators were primarily concerned with stopping banks from failing. By removing interest-rate intention, bank risk was substantially reduced. The problem with these regulations was that when market interest rates rose above the established interest-rate ceiling, investors withdrew their funds from banks. 6. Why does the U. S.
Government use the money markets? The U. S. Government sells large numbers of securities in the money markets to support government spending. Over the past several decades, the government has spent more each year than it has received in tax revenues. It makes up the difference by borrowing. Part of what it borrows comes from the money markets. 7. Why do businesses use the money markets? Businesses both invest and borrow in the money markets. They borrow to meet short-term cash flow needs, often by issuing commercial paper. They invest in all types of money market securities as an alternative to holding idle cash balances. 8.
What purpose initially motivated Merrill Lynch to offer money market mutual funds to its customers? Merrill Lynch initially felt that it could better service it’s regular customers by making it easier to buy and sell securities from an account held at the brokerage house. The brokerage could offer a market interest rate on these funds by investing them in the money markets. . Why are more funds from property and casualty insurance companies than funds from life insurance companies invested in the money markets? Life insurance companies can invest for the long term because the timing for their liabilities is known with reasonable accuracy.
Property and casualty insurance companies cannot predict the natural disasters that cause large payouts on policies. 10. Which of the money market securities is the most liquid and considered the most risk-free? Why? Treasury bills are usually viewed as the most liquid and least risky of securities because they are backed by the strength of the U. S. Government and trade in extremely large volumes. 1 1 . Distinguish between competitive bidding and non-competitive bidding for Treasury Securities. A treasury auction will sell a certain face amount of securities.
The non-competitive bids will all settle at the yield dictated by the auction. Thus the face amount of non-competitive bids are removed from the total amount to be auctioned by competitive bid. The competitive bids are ranked according to yield and the auction is settled at the lowest amount. Winning competitive and non-competitive bids are settled at this yield. 12. Who issues federal funds, and what is the usual purpose of these funds? Federal funds are sold by banks to other banks. They are used to invest excess reserves and to raise reserves if a bank is short. 13.
Does the Federal Reserve directly set the federal funds interest rate? How does the Fed influence this rate? The Federal Reserve cannot directly set the federal funds rate of interest. It can influence the interest rate by adding funds to or withdrawing reserves from the economy. 14. Who issues commercial paper and for what purpose? Large businesses with very good credit standings sell commercial paper to raise horn-term funds. The most common use of these funds it to extend short-term loans to customers for the purchase of the firm’s products. 15. Why are banker’s acceptances so popular for international transactions?
You know if you invest in 91 -day commercial paper today and invest the proceeds in 91 -day commercial paper this would be equivalent to investing in 182- day commercial paper. Thus The actual answer is 3. 97%. 11 In a Treasury auction of $2. 1 billion par value 91 -day T-bills, the following bids were submitted. If only these competitive bids are received, who will receive T-Bill, in what quantity and at what price? If the Treasury also received $mm in non- competitive bids then who will receive T-bills, in what quantity and at what price? Bidder Bid Amount Price $0. 9940 $75th-an $0. 901 $1. Ban $0. 9925 $1 ban $0. 9936 5 $60th-n $0. 9939 If there are only competitive bids then the auction will settle at the highest price which clears the auction amount. This includes bidders 1, 4 and 5. The winning price will be $0. 9936. If there is an additional $mm in non-competitive bids then only $1. 3 billion will be auctioned competitively. This means that bidders 1, 5 will win the auction. All bills will be settled at a price of $0. 936. Additional Questions 1. In the book there is an example of a 25-year fixed payment loan worth $1,000 with a fixed annual payment of $85. 81.
This gives a yield to maturity of 7%. Set up an excel spreadsheet that a. Splits the fixed payment into interest and principal for each cash flow. Note this will be a different amount for each cash flow. B. Create a graph with two lines – one for the interest payment and one for the principal payment. C. Explain why the two lines look like they do At the beginning of the loan the principal outstanding is largest which means that the majority of the payment goes towards interest. As the loan payments continue the principal is slowly reduced and thus the proportion of principal paid increases.
The last payment must pay off the remaining loan balance so the interest paid becomes very small. 2. During the sass’s recession the Federal Reserve chairman, Paul Evolve, raised interest rates significantly to try to reduce inflation. In what ways can raising interest rates reduce inflation? 3. In exercise 11 of chapter Sis’s quantitative problems there is a mistake in the bidding process. What is it? The bids are in terms of price rather than yield. In an actual auction the yield is converted too rice and rounded to 6th decimal place (1000 face amount rounded to the nearest penny). . How often are T-bills auctioned? Find the announcement and results of the latest EWE T-bill auction on the Treasury Direct website. Find a. The amount to be auctioned b. The amount that went to non-competitive bidders c. The amount that went to competitive bidders T-bills are auctioned weekly although not all maturities are auctioned every week. Generally 13-week and 26-week bills are auctioned on Monday and 4-week bills are auctioned on Tuesday. 52-week bills are auctioned every 4 weeks. A tentative auction schedule is published on the web through next January.