4. Suppose that currently one-year pure-discount bonds yield 2.2% and two-year pure-discount bonds yield 2.8%. a. Calculate
Question:
4. Suppose that currently one-year pure-discount bonds yield 2.2% and two-year pure-discount
bonds yield 2.8%.
a. Calculate the implied forward rate (yield) for a one-year bond to be issued next year.
b. If you believe the pure expectations model, what do you predict will be the one-year rate next
year?
c. If, instead, you believe the liquidity preference model, would your predicted one-year rate for
next year be higher or lower than your answer to (b)? Explain.
5.
Suppose the New York stock exchange were to impose a fee of $.0025 per share in addition to
all existing fees and costs on all transactions carried out on the exchange.
a. What effect, if any, would this tend to have on the price of securities trading on the exchange?
What effect on their expected returns? Explain your reasoning. (Remember, the exchange-
imposed fee is not built into quoted securities prices. It is collected by the exchange directly
from buyers and sellers as an additional expense.)
b. Suppose Fastrac Inc. now trades for 24 1/8 bid, 24 1/4 asked, while SloMo Enterprises trades
at 25 3/4 bid 27 asked. What, if any, differences might you expect to observe between investors
holding Fastrac Inc. and those holding SlowMo Enterprises? Explain.
c. Which of these two securities would find its returns most affected by the additional cost of
trading? Why?
Financial Institutions Management A Risk Management Approach
ISBN: 978-0071051590
8th edition
Authors: Marcia Cornett, Patricia McGraw, Anthony Saunders