Business & Finance homework help

ECO 315 money and banking
Answer questions 1-3 below according to instructions. Note that there are two pages.
• Show you work for all calculations!
• All written answers should be brief, meaning one or a few sentences.
• Make sure it’s clear which question you are answering at any point. (ex: 1b)
Note that this is your work.
(In brief: you may use notes, the book, videos and internet, but not work with others and not “cut and paste.” See documents referred to above for details.)
1. You will buy a security that pays $75 in one year and $95 in two years. There is no risk of default, and you note that the market interest rate is 4% on a similar security.
a. How much are you willing to pay for this security? Show your calculations. Include two decimals in the price.
b. What is your yield to maturity if you bought at the price you calculated above?
c. After 1 year, you receive the $75 and sell your security for $88. What was your rate of return?
d. What is the market interest rate at the time you are selling? (Write the answer to c. and d. as a percentage, and keep two decimals if relevant. I.e: write 13.25%, not 13% or 0.13)
2. The entry of Covid-19 reduced demand for many goods and services and thereby earnings while also creating uncertainty about how a lot of firms will do in the future.
a. Explain (briefly, in a few sentences) how stock prices will be affected by a sudden crises with a fall in demand for goods and services and increased uncertainty about the future. (Think about the overall stock market and not particular stocks, like toilet paper, that may have a different reaction than the rest of the market)
b. Draw a graph for demand and supply of Treasury bonds. Label the axis and mark clearly the curves and the equilibrium price and quantity. Assume that the bond market starts out in January this year before the consequences of Covid-19 were known.
c. Then show in the same bond graph how the demand and/or supply curve(s) for Treasury bonds will shift as people realize there will be a lock-down and the economy will be negatively affected. Mark clearly the equilibrium before and after people knew about the economic consequences of Covid-19.
d. Explain why you shifted the bond market curve(s) the way you did.
e. Based on your answers to the questions above, would you have preferred being a holder of stocks or Treasury bonds coming into this crises? (That is: Would you have had a higher return by now if you came in to this crises holding stocks or Treasury bonds?) Explain briefly why.
3. Assume that the current 1-year interest rate is 3%, the expected 1-year rate next year is 2%, and the expected 1-year rate in the following year (3rd year) is 4%.
a. Calculate the 2-year interest rate and the 3-year interest rate based on the expectations theory. (Show calculations)
b. Draw the yield curve based on your data above. Label your axis and mark the numbers along the axis, so you can read the actual interest rates in your graph. (This doesn’t need to be 100% precise, but your graph should look consistent with the numbers. Sloppy graphs will lose points.)
c. Assume that investors want a liquidity premium with a higher compensation for holding long-term bonds. Add the liquidity premium in your graph above. Make clear which curve is based only on the expectations theory and which takes into consideration the liquidity premium.
d. Based on this yield curve: What do you think market participants expect from future inflation and the economy (Write brief answers.)
(i) in the next 2 years?
(ii) From year 3?


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