Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond p¹, and the optimal consumption in the two states M, CM. Compare the mutual fund and bond market allocations: are CM and CM bigger or smaller than c and c respectively?

Now suppose there is no financial intermediary to handle liquidity shocks. However, at t = 1 a market for bonds opens up and agents can trade their wealth at t = 1 for wealth at t = 2. Each bond pays 1 at t = 2 and its price is pM. Calculate the consumer's optimal investment decision IM at t = 0, the price of the bond p¹, and the optimal consumption in the two states M, CM. Compare the mutual fund and bond market allocations: are CM and CM bigger or smaller than c and c respectively?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Which of the following best explains an upward sloping Treasury yield curve? A. Maturity risk is expected to decline in the future B. Long-term interest rates are more volatile than short-term rates C. Inflation risk premiums are higher for longer terms to maturity D. Default risk is higher for longer terms to maturity
Which of the following is consistent with the pure expectations theory of the yield curve? Check all that apply. A downward-sloping yield curve suggests that the market thinks interest rates in the future will be higher than they are today. ✓ A downward-sloping yield curve suggests that the market thinks interest rates in the future will be lower than they are today. A flat yield curve suggests that the market thinks interest rates in the future will be the same as they are today. A flat yield curve suggests that the market thinks interest rates in the future will be higher than they are today. Maria would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 6 percent and a two-year bond that pays 9 percent. Maria is considering the following investment strategies: Strategy A: In the first year, buy a one-year bond that pays 6 percent. Once that bond matures, buy another one-year bond that pays the forward rate. Strategy B: In the…
D3) Finance Suppose Bond A carried a higher yield than comparable Bond B because of investors’ uncertainty about the future of company B. If you were an investment manager who thought the market was overplaying these fears. In particular, if you thought that yields on Bond A would fall by 50 basis points. Which bonds would you buy or sell? Explain in words.
Do solve all parts A. What risk premium do you use? Why? B. Why is the geometric mean lower than the arithmetic mean for both bonds and bills? C. If you had to use a risk premium with the longer periods, what biases will the investor have?
A portfolio's manager's views on the term structure of interest rates: "Yields reflect expected spot rates and risk premiums. Investors demand risk premiums for holding long-term bonds, and these risk premiums increase with maturity. This manager's views are most consistent with the: A. Segmented markets theory B. Local expectations theory C. Preferred habitat theory OD. Liquidity preference theory
The constant rupee value plan requires a. Investors to fix the expected value of their portfolio b. Investors to fix their periodical installments c. Investors to fix their rebalancing points d. All of the mentioned
Explain the concept of bond price elasticity. Would bond price elasticity suggest a higher price sensitivity for zero-coupon bonds or high-coupon bonds that are offering the same yield to maturity? Why? What does this suggest about the market value volatility of mutual funds containing zero-coupon Treasury bonds versus high-coupon Treasury bonds?
Under the Pure Expectations Theory, if issuers expect interest rates to increase, O Two statements are correct. O borrowers will generally prefer to issue short-term securities rather than long-term securities. O the corresponding decrease in the demand for long-term funds by borrowers places downward pressure on long-term funds. O Three statements are correct. O there is downward pressure on the yield of short-term funds. O Only one statement is correct. O they will prefer to lock in the present interest rate over a long period of time.
“If all securities are fairly priced, all must offer equal expected rates of return.” Comment.
If the YTM is less than the coupon rate, wouldn't the bond price be higher?
Price risk is the risk that Select one: a. the bond principal will not be paid in full or on time. b. market prices increase due to market interest rate changes making bonds more expensive to purchase. c. the bonds in a dedicated portfolio will decrease in value in response to an increase in interest rates. d. the yield-to-maturity will be less than the inflation risk causing the real rate of return to be negative. e. coupon payments will be reinvested at a rate that is less than the bond's yield-to-maturity
We know that a vanilla bond with a coupon rate below the market rate of interest will sell for a discount and that a vanilla bond with a coupon rate above the market rate of interest will sell for a premium. What kind of bond or loan will sell at its par valueregardless of what happens to the market rate of interest?

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