IBF_GRP10_Assignment#1_Final

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In-Class Assignment #1 IBF Group 10 Antilegando, Norman (301240438) Cablinan, Jerryme (301245129) Hasan, Mahedi (301291953) Kaur, Mandeep (301243092) Venna, Abhiram (301271905) Instructions: Answer the following questions. Submit your completed assignment as a Word or PDF document. This assignment is to be completed in your normal groups. Ensure that you are properly citing (using APA style) any resources you use (outside of class materials). 1 A. What is the price of a zero-coupon bond with a par value of $10000 and a 10-year maturity, when investors expect a return of 6.5%? B. What would the price be if the economic outlook appeared weaker and investors were now willing to accept a rate of return of 3.5%? Answers: The price of the zero-coupon bond can be calculated using the present value formula i.e., Present Value = Future Value / (1 + Rate of Interest) ^n A PV= $10000/ (1+0.065) ^10 = 10000/1.877 = $5327.65 B PV= $10000/ (1+0.035) ^10 = 10000/1.410 = $7,092.19 When the expected return rate is high in this case 6.5%. The expected value of a bond is $5327.65. This shows an inverse relation between the rate of return and the current value of the bond. Thus, as the rate of return of the bond increases from 3.5% to 6.5%, we notice that the current value of the bond decreases i.e. $7092.19. 2 A. What is the present value of $8000 simple loan to be paid in 5 years at an interest rate of 4.5%? B. What if the loan is paid in 10 years? Answer: Present Value = Future Value / (1 + Rate of Interest) ^n A. PV=$8000/ (1+0.045) ^5 = $8000/1.246 = $6,420.54 B. PV= $8000/ (1+0.045) ^10 = $8000/1.552 = $5,154.63

As per the above solution, we notice that the present value for the loan due in 5 years ($6420.54) is greater than the present value that is due in 10 years ($5154.63). The reason for the following statement is that as the repayment period increases, the interest accumulated on the principle also increases. Therefore, the portion of interest in a 10-year bond will be higher than the interest portion of a 5-year bond. The interest portion on the Loan B = $8000-$5154.63 = $2,845.37 The interest portion on Loan A = $8000-$6420.54 = $1579.46 Thus, we can conclude that the interest portion in a long-term will be higher than the interest portion of a short-term loan. 3. What happens to be demand for Gov't of Canada bonds in the following cases? (increase or decrease) A) There is an increase in Canadian GDP, reflecting a growth in wealth . - INCREASE A growing Canadian GDP signifies increased wealth, suggesting economic expansion and heightened production of goods and services. This surge in GDP translates to more significant financial resources for individuals and businesses. Consequently, there might be reduced demand for GoC bonds as investors seek potentially more lucrative and riskier assets like equities or corporate bonds offering higher yields. Additionally, an expanding GDP may elevate inflation expectations, diminishing the actual value of fixed payments from GoC bonds (Arora, 2021). B) It is expected that the Bank of Canada will increase interest rates. – DECREASE Anticipated interest rate hikes by the Bank of Canada suggest a tightening of monetary policy to curb inflation and stabilize the economy. Higher interest rates elevate the opportunity cost of holding GoC bonds, prompting investors to explore more lucrative options like bank deposits or lending. This projection might diminish demand for GoC bonds, leading investors to sell existing bonds in pursuit of higher interest rates. Consequently, this could lower the price and elevate the yield on GoC bonds, diminishing their attractiveness. C) Flooding and local supply shocks increase input prices, resulting in higher prices for final goods made in Canada. - DECREASE This situation may trigger inflationary pressures. In anticipation of higher inflation, investors may seek higher interest rates to offset potential purchasing power erosion. Consequently, the demand for existing fixed-rate bonds, including those from the Government of Canada, might decrease as their predetermined interest rates appear less attractive amid the expectation of increasing market rates.

D) The perceived risk of stocks listed on the TSX increases. - INCREASE Elevated perceived risk in TSX-listed stocks suggests increased market uncertainty and volatility, influenced by various factors. Higher stock risk implies a more significant potential for financial loss or reduced returns. Consequently, investors may seek the safety of GoC bonds, resulting in higher demand. This shift from stocks to bonds could elevate GoC bond prices, lowering yields and enhancing their attractiveness to investors (Department of Finance Canada, 2023b). E) Higher government spending results in higher prices in the economy. - DECREASE Increased government spending, aimed at boosting aggregate demand and economic output, may impact the demand for GoC bonds. The scenario involving higher budget deficits and public debt hinges on investor reactions. Elevated spending could decrease GoC bond demand if it raises inflation expectations. Conversely, it might increase demand if investors anticipate economic growth, higher tax collections, and reduced government default risk (Fontaine & Walton, 2020). 4. Compare either 20 year or 30 year government bond yields of two countries ( https://www.marketwatch.com/tools/markets/bonds/a-z ). Look at how the yield has changed over time (last 3 years). What might account for some of the changes you observe? Why? (2-3 paragraphs, 200-300 words). Country 20-year Last 3 years Australia 4.305% 3.565% UK 4.460% 4.056% Australia's 20-year bond yield's decline from 4.305% to 3.565% over three years presents an attractive opportunity. It signifies an increase in bond prices, potentially capital gains. The trend suggests strong demand, indicative of investor confidence in Australia's economy and stability. It’s influenced by favorable economic conditions and the implementation of lower interest rates, making bonds a preferred choice for risk-averse investors during uncertain times. Overall, the downward trajectory indicates favorable conditions for those seeking stable returns and security in Australia's bond market (Reserved Bank of Australia, 2024). In contrast, the United Kingdom confronts challenges associated with elevated and volatile global interest rates, potentially stretched asset valuations, and vulnerabilities in corporate and household debt. Geopolitical risks and uncertainties in China's property market further compound the complexity of the UK's financial landscape (European Central Bank, 2023. Despite the UK banking system's strong capitalization, concerns persist regarding asset performance, subdued lending, and potential impacts on net interest margins. Ongoing monitoring, strategic adjustments, and careful capitalization within the banking sector are

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