Financial Institutions and Markets
A bank has two 3-year commercial loans with a present value of $70 million. The first is a $30 million loan that requires a single payment of $37.8 million in 3 years, with no other payments until then. The second is for $40 million. It requires an annual interest payment of $3.2 million. The principal of $40 million is due in 3 years.
What is the duration of the bank’s commercial loan portfolio?
What will happen to the value of its portfolio if the general level of interest rates increase from 8% to 8.5%? (MO1.2)
Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions). (MO1.2)
Consider the decision to purchase either a 5-year corporate bond or a 5-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and a par value of $1,000. It is currently yielding 7%. Which of the two bonds would be more beneficial to you? Assume that your marginal tax rate is 35%. (MO1.2)
Which should have the higher risk premium on its interest rates, a corporate bond with a Moody’s Baa rating or a corporate bond with a C rating? Why? (MO1.3)
Explain why you would be more or less willing to buy a share of Polaroid stock in the following situations:
Your wealth level falls
You expect it to appreciate in value
The bond market becomes more liquid
You expect gold to appreciate in value
Prices in the bond market become more volatile (MO1.4)
“If stock prices did not follow a random walk, there would be unexpected profit opportunities in the market.” Is this statement true, false, or uncertain? Explain your answer.
What is the duration of the bank’s commercial loan portfolio?
What will happen to the value of its portfolio if the general level of interest rates increase from 8% to 8.5%? (MO1.2)
Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions). (MO1.2)
Consider the decision to purchase either a 5-year corporate bond or a 5-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and a par value of $1,000. It is currently yielding 7%. Which of the two bonds would be more beneficial to you? Assume that your marginal tax rate is 35%. (MO1.2)
Which should have the higher risk premium on its interest rates, a corporate bond with a Moody’s Baa rating or a corporate bond with a C rating? Why? (MO1.3)
Explain why you would be more or less willing to buy a share of Polaroid stock in the following situations:
Your wealth level falls
You expect it to appreciate in value
The bond market becomes more liquid
You expect gold to appreciate in value
Prices in the bond market become more volatile (MO1.4)
“If stock prices did not follow a random walk, there would be unexpected profit opportunities in the market.” Is this statement true, false, or uncertain? Explain your answer.