Financial and Economic Analysis (BMBA 9113)
Problem Set II (120 points)
DUE DATE: Friday, October 25
SEND TO: Tony@Covingtonadvisors.com
Directions: Answer the following problems IN DETAIL. Your analysis must be typed and should be free of grammatical errors and “slang” terms.” Wherever appropriate, make sure you supplement your discussion with graphical analysis and equations. The graphs may be hand drawn, but please make sure they are neat. There are no restrictions or requirements on working in groups. The one exception is that each person must hand in his/her OWN work. In economic terms, there are no input restrictions; however, the output MUST be yours.
1. (15 points) The operative question among macro policy specialists and investors is “when will the Federal Reserve begin to taper its accommodative policies?” Given present-day conditions in the U.S. and globally, why might you argue that the Federal Reserve should continue its accommodative policies at least for the rest of 2013? Please use the “money line-spending line” diagram and aggregate demand and supply curves as part of your analysis.
2. (5 points) Returning to the first problem on the first problem set, which of the five companies are most likely to be impacted by an ongoing accommodative monetary policy? Why? Do their betas tell you anything?
3. (5 points) Four U.S. firms currently have debt rated as “Aaa,” two of which are headquartered in New Jersey, Automatic Data Processing and Johnson & Johnson. Based on the current term structure of interest and the current stance of monetary policy, what would be your strategy at this time as a member of the treasury department of either corporation? Why?
4. (10 points) After considerable negotiation with its owners, you have purchased a home for $556,700. After a 20 percent down payment, you finance the remainder under a twenty-year mortgage at the annual percentage rate (APR) of 3.44%).
a. (4 points) What are your monthly payments? Show ALL your work, including your use of the formula.
b. (6 points) Over time, what is the total cost of the home? After the third monthly payment, what is the total amount that you owe each in interest and principal? Show ALL your work, including your use of the formulas. (Note: In the intermediate steps of your calculations, take the decimal point to five places. At the final calculation, round off to two places.)
7. (5 points) Name the advantages a zero-coupon bond has over a coupon bond? What are the disadvantages?
8. (5 points) Demonstrate that you understand the difference among coupon yield, current yield, and yield to maturity with the following illustration for Morgan Stanley debt, par value of $1000: current price of $930, coupon rate of 4.1%, issue date of September 15, 2010, settlement date of October 10, 2010, and maturity date of January 15, 2015. (Note: To solve for the yield to maturity, please use the formula provided on Blackboard.)
9. (5 points) What is the maximum price that you would pay up for a series of A-rated debentures, each with a face value of $1000, that promise to pay 31 more semiannual coupons of $23.25 each at a yield to maturity of 4.16%? Please show how you arrive at your result.
10. (10 points) You are provided with the following monthly expected returns, each of which is represented by E(Ri), and betas for the following stocks. Please estimate the capital asset pricing model and draw conclusions about the significance and realism of the results. (Note: Please use conventional tests of the R-squared and coefficients.) On the basis of your results, please name at least three of the stocks that you would recommend as “buys.”
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