A firm determines it will have $1,000,000 in excess cash for the next 6 months.It can invest this excess cash in a 6-month unsecured issue of AAA-rated commercial paper at an annual rate of 3% for the next 6 months.

OR

It can invest the one million dollars in a 12-month unsecured issue of AAA-rated commercial paper at 3.25% but sell it in the secondary market after holding the instrument for 6 months (i.e., selling the instrument 6-months before it matures).

a. Assume the yield curve does not change over the next 6 months from what it is now (noted above).Compute the gain or loss to the firm at the end of 6 months from putting $1 million in 6-month commercial paper versus purchasing 12-month commercial paper and selling it in the secondary market after holding it only for 6 months.Using this information, what will be the total gain or loss to the firm from "riding the yield curve" and where do the gains/losses come from?You need to explain your answer.

b. How would your calculation in (a) change if, at the end of the first 6 months, the yield curve changes such that at the beginning of the second 6-month period the interest rate on new issues of 6-month commercial paper rose to 3.5%?Using this information, what will be the total gain or loss to the firm from "riding the yield curve"?You need to explain your answer.

(This is the first part of the question)

A. Given an upward sloping yield curve, where the current 90-day (6-month) interest rate is 3.5% (4.5%), derive the implied future 90-day spot interest rate 3 months from now.Show all your work.

B. Given the following information, determine the effective rate of interest on a bank loan to a firm when:

The bank line of credit to the firm is $1,000,000.

The interest rate on the borrowed amount is 5%

The commitment fee on the unused portion of the credit line is 1%

The compensating balance on the borrowed amount is 5%.

If the firm borrows $800,000 of its $ 1 million credit line, what is the firm's effective interest rate?What is the cost to the firm if it borrows nothing?Why doesn't the bank simplify the loan process and just publicly advertise what its effective interest rate is?

Answer rating: 100% (QA)

A To derive the implied future 90day spot interest rate 3 months from now we can use the concept of the yield curve Given Current 90day 6month interes... View the full answer