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- Stock Market Futures Market January KLSE composite index stands at 1162. Investor expects to purchase a RM10million stock portfolio in two months’ time Buys March KLSE CI contracts at 1158 March KLSE composite index has risen to 1171, making the acquisition costs of the shares more expensive. Sells March KLSE CI contracts at 1173 b. Assume that the investor wants to cover the full value of their expected investment. How many March KLSE CI futures contracts must they purchase? c. Calculate the profit/loss on the spot transaction. d. Calculate the profit/loss on the futures transaction. e. Is the hedging strategy efficient?Your Company, manager of the Gigantic Mutual Fund, knows that her fund currently is well diversified and that it has a CAPM beta of 1.0 The risk-free rate is 8% and the CAPM risk premium of 6.2%. She has been learning about measures of risk and knows that there are (at least) two factors: changes in industrial production index, δ1 and unexpected inflation, δ2 The APT equation is E(Ri) – Rf = [δ1 – Rf]bi1 + [δ2 – Rf]bi2, E(Ri) = 0.08 + [0.05]bi1 + [0.11]bi2. Required If his portfolio currently has a sensitivity to the first factor of bi1= -0.5, what is its sensitivity to unexpected inflation? If she rebalances her portfolio to keep the same expected return but reduce her exposure to inflation to zero (i.e., bi1= 0) what will its sensitivity to the first factor become?Assume that it is January 1, 2003. The rate of inflation is expected to be 4 percent thought 2003. However, increased government deficits and renewed vigor in the economy are then expected to push information rates higher. Investors expect the inflation rate to be 5 percent in 2004, 6 per percent cent in 2005, and 7 percent in 2006. The real risk-free rate, k*, is expected to remain at 2 percent over the next 5years. Assume that on maturity risk premiums are required on bonds with 5 years of less to maturity. The current interest rate on 5 year T-bonds is 8 Percent. What is the average expected inflation rate over the next 4 year? What should be the prevailing interest rate on 4-year T-bond? What is the implied expected inflation rate in 2007, or Year 5, give that Treasury bonds which mature in the year yield 8 percent?
- 9 A program, if implemented, will operate for 10 years for certain. Your best guess is that after year 10 and following each year thereafter there will be a 0.02 probability the program will end. Real net benefits are $25 the first year and are expected to grow 1% per year as long as the program is in operation. Benefits accrue at the end of the year. The real discount rate is 3.5%. What is the NPV of the horizon value of net benefits following year 10, as seen from time 0, the beginning of the first yearA.The inflation premium, when the real interest rate is 2% and the risk-free rate and risk premium are 5% and 3% respectively, is * 10% 8% 5% 3% B. Factors that influence the equilibrium interest rate are * Risk Liquidity preference Inflation All of the above C. A bond that has a Par value greater than its price is called * Discount bond Premium bond Par value bond All of the above D. Because equity holders are the last to receive any distributions, they expect greater returns to compensate them for the additional risk they bear. * True False E. Interest rate is the compensation paid by the lender of funds to the borrower. * True False F. Bonds issued by a corporation are * equity instruments long term debt instruments G. Debt holders claim on income and assets are * Senior to equity holders Subordinate to equity holders None of the above H. Funds provided by the firm’s owners (investors or stockholders) is called * Equity financing Debt financing Borrowed…If your portfolio expected annual average total return was 10% and long-term inflation was about 3%, what would your REAL average annual returns be with a 100% equity portfolio? 10% 7% 3% 5% If you put your retirement funds in a savings account earning 0.5% and inflation was 3%, how much would you lose in value each year against inflation by not earning more than inflation on your retirement savings? 0.5% less 3% for minus 2.5% 3% 0.5% 10.2%
- Parker is 50 and wants to retire in 15 years. His family has a history of living well into their 90s. Therefore, he estimates that he will live to age 95. He currently has a salary of $120,000 and expects that he will need about 65% of that amount annually at the beginning of each year if he were retired. He can earn 9 percent in his portfolio while he is working. However, he expects that he will only earn 7 percent in his portfolio during retirement. He expects inflation to continue at 3 percent. Parker currently has $350,000 invested for his retirement. His Social Security benefit in today’s dollars is $30,000 per year at normal age retirement of age 67. His Social Security benefit will be reduced by 6 2/3 percent for each year he begins collecting before full age retirement. How much does he need to save at the end of each ear to meet his retirement goals (assume he does not wish to leave a financial legacy)?The demand D (in billions of £) for a bond with coupon rate 5% and face value FV = 1000, andtwo years to maturity as a function of its price P is D = 4000 − 2P. The supply in (billions of£) as a function of the price of the bond is S = 2P + 400. b) Suppose that the yield to maturity of the bond is i = 0.05. What is the quantitydemanded/supplied at this interest rate? What happens to the demand/supply of the bond asthe interest rate increases? Explain why. c) What is the equilibrium interest rate?The demand D (in billions of £) for a bond with coupon rate 5% and face value FV = 1000, andtwo years to maturity as a function of its price P is D = 4000 − 2P. The supply in (billions of£) as a function of the price of the bond is S = 2P + 400. b) Suppose that the yield to maturity of the bond is i = 0.05. What is the quantitydemanded/supplied at this interest rate? What happens to the demand/supply of the bond asthe interest rate increases? Explain why. c) What is the equilibrium interest rate? d) Suppose that the bond trades at premium. Is there excess demand or supply? Explain.e) There is a business cycle expansion, so both supply and demand shifts. After the shift, thenew demand curve is given by: D = 4000 + X − 2P, whereas the new supply curve is S =2P + 200. For which values of X will the interest increase/decrease? Which values of X arein line with empirical data?
- An investor has $24,000 to invest in bonds of AAA and B qualities. The AAA bonds yield an average of 6% and the B bonds yield 10%. The investor requires that at least three times as much money should be invested in AAA bonds as in B bonds. How much should be invested in each type of bond to maximize the return? What is the maximum return? Define the variables needed to solve this problem. Organize your given information. (This part NOT graded, but encouraged.) Write the complete linear programming problem, which includes the objective function and all constraints. Graph and make sure all lines are labeled and shaded/solution region is clear and easy to identify. Create a corner point chart. Remember to mark your solution. Answer in a complete sentence or two: How much should be invested in each type of bond to maximize the return? What is the maximum return?This refers to the percentage that allows the investors to be compensated for any loss in purchasing power due to inflation. *A. Inflation PremiumB. Liquidity Risk PremiumC. None of the choicesD. Maturity Risk PremiumE. Real Risk Free of InterestOver the next three years, the expected path of 1-year interst rates is 4,1, and 1 percent. Today you buy $1 of one-year bond and when it matures you plan to use the money you receive to reinvest in one-year bond again. Then your expected rate of return for this $1 investment is _____% (round to the nearest integer). If the expectations theory of the term structure is true, then your expected rate of return for buying a two-year bond today is ____%, which implies that the current interest rate on 2-year bond must be ____%