1)-Suppose the CFO of an American corporation with surplus cash flow has $90 million to invest
and the corporation does not believe it will need to utilize these funds to retool or expand
production capacity for 1 year. Suppose further that the interest rate on 1 year CD deposits in US
banks is .5 %, while the rate on 1 year CD deposits (denominated in Australian dollars) is
currently 2.5 %. Suppose further that the exchange rate currently is (.8) Australian Dollars per
US$.
What must the CFO expect about the Australian Dollar/US$ exchange rate 1 year from
now if she chooses to invest in the US $ CD's instead of the Australian CD's
2) Suppose a mid-sized regional bank has $1 million dollars which it is considering
investing either in 30 year zero coupon Treasury bonds or in a jumbo 30 year fixed rate
residential mortgage with fixed monthly payments of $5650.Assume that the treasury
bonds are currently priced to yield 4% if held until maturity. Assume that the bank
requires a premium of 150 basis points in the mortgage`s annualized yield over treasury
bond yields before it will lend in the residential mortgage market.
A) Write down the present value equations that the bank would use to determined the
annualized percentage rate of return on the residential mortgage. (Wherever possible, plug
data from the above problem into the equations.
B) How will the bank use the information on the annualized percentage rate of mortgage
obtained in part (a) when deciding whether to invest in T-Bonds or whether to make the
residential mortgage?
3-A) Given the following data on yields of 10 year Treasury notes and 10 year TIPS, what
conclusion do you draw about changes in investors` expectation of inflation rates in the US
during the past year? Show your solutions.
10 Year T-note yield
10 Year TIPS Yield
summer 2012: 1.48%
-0.70%
now
2.68%
0.49%
B)Explain your answer to part (A), that is explain the difference between the yields on
TIPS and the yield regular treasury securities. Include a brief discussion of any factors in
addition to inflation expectations that affect the relationship between yields on TIPS and
yields o treasuries
C) QE3 has been in place since fall 2012 what do the above data suggest about the
change in the required real yield on default risk free long term treasuries during the
period QE3 has been in place?
D) Is the change in required real yield in your answer to (C) consistent with an
improvement investor expectations for future real growth in the economy with declining
real growth expectations?
4) Suppose that several years from now the yield to maturity on 2-year treasury note was
4.85% while the yield on a 1 year note was 5.2%.Assume that neither treasury note had
coupon payments, so the y payment the face value received when the note matured.
a)Why is it unusual for yields on longer term notes to be lower than yields on shorter
term notes?
b)what expectations would lead a risk neutral investor to buy the 2 year note (instead of
the 1 year ) given its lower yield? include your calculations.
5-A)How does the fed`s QE policy affect the balance sheets of the banks with which it
deals in the ''open market''

B)-Explain why the effect of a given volume of treasury and /or mortgage-backed security
purchases by the fed in the open market can have effects on lending, spending, money
creation and real growth that vary widely depending on the behavior of banks and
potential borrowers.
6)Assume that the bonds of highly byHy corporation currently have a yield to maturity of
8% and are due in 1 year. Meanwhile, assume that 1 year treasury securities are yielding
1%.Also assume that investors expect that there is a 4% probability that Byhy Corporation
will default within the next year and that if it defaults they will only be able to recover
30% of the maturity value of the corporation`s bonds.
a) Suppose that several prominent highly leveraged corporations( other than ByHy) default
on their bonds. What would you expect to happen to the price of ByHy`s bonds and why?
Discuss the effects on ByHy`s bonds price of changes in expected and required rates of
return.
b) Assume that after news of the defaults by other highly leveraged corporations, investors
now expect an 8% probability of default and a recovery rate of 20% in the event of
default on ByHy`s bonds. Also assume that increased uncertainty about the future of the high
yield market has caused the required rate of return on ByHy`s bonds to change to
10%.What will be the new yield to maturity on the ByHy`s bonds?

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