Question 2: Consider the financial-market imperfection model with asymmetric information. The firm needs one unit of capital to start a project that will produce y distributed uniformly over [0, 2y]. The firm owns W<1, and needs to borrow 1-W from the bank. There are infinite number of banks providing infinite amount of capital. The risk-free interest is r. We assume p1+r. 1) Suppose both the firm and the bank can observe y perfectly. Can you propose a feasible contract that makes borrowing possible? 2) Suppose the bank can only observe y with a cost C. Can you propose a feasible contract that makes borrowing possible? You can make your own assumptions on parameter values. 3) Based on your answer to 2), mark the area in a W-y diagram that represents the collection of (W, y) value combinations with which an investment project will be funded.

Question 2: Consider the financial-market imperfection model with asymmetric information. The firm needs one unit of capital to start a project that will produce y distributed uniformly over [0, 2y]. The firm owns W<1, and needs to borrow 1-W from the bank. There are infinite number of banks providing infinite amount of capital. The risk-free interest is r. We assume p1+r. 1) Suppose both the firm and the bank can observe y perfectly. Can you propose a feasible contract that makes borrowing possible? 2) Suppose the bank can only observe y with a cost C. Can you propose a feasible contract that makes borrowing possible? You can make your own assumptions on parameter values. 3) Based on your answer to 2), mark the area in a W-y diagram that represents the collection of (W, y) value combinations with which an investment project will be funded.

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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Uneven Cash Flow Stream Find the present values of the following cash flow streams. The appropriate interest rate is 12%. (Hint: It is fairly easy to work this problem dealing with the individual cash flows. However, if you have a financial calculator, read the section of the manual that describes how to enter cash flows such as the ones in this problem. This will take a little time, but the investment will pay huge dividends throughout the course. Note that, when working with the calculator's cash flow register, you must enter CF0 = 0. Note also that it is quite easy to work the problem with Excel, using procedures described in the Ch04 Tool Kit.xlsx.) Do not round intermediate calculations. Round your answers to the nearest cent. Year Cash Stream A Cash Stream B 1 $100 $250 2 400 400 3 400 400 4 400 400 5 250 100 Stream A: $ Stream B: $ What is the value of each cash flow stream at a 0% interest rate? Round your answers to the nearest dollar. Stream…
Which of the following statements is false? A. Basel II use the value at risk (VaR) with a one-year time horizon and a 99.9% confidence level for calculating capital for credit risk and operational risk. B. 20 BP = 0.2% C. Basel I is increasing the amount of capital that banks are required to hold and the proportion of that capital that must be equity. D. Model-building approach is a model for the joint distribution of changes in market variables and using historical data to estimate the model parameters.
Suppose that the First United Bank of America has two loans. Each is due to be repaid one period hence and has independent and identically distributed cash flows. Each loan will repay $300 with a probability of 0.8 and $150 with a probability of 0.2. However, while the bank knows this, the investors cannot distinguish this loan from that of the Third TransAmerica Bank, which has the same number of loans, but will pay $300 with a probability of 0.5 and $150 with a probability of 0.5. There is a prior belief of 0.5 that the First United Bank of America has the higher-valued portfolio. Suppose that the First United wished to securitize these loans, and if it does so without a credit enhancement, the cost of communicating the true value is 7.5% of the true value. Assume that the discount rate is zero and that everybody is risk-neutral. Consider the following securitization scenario. The First United can create two classes of bondholders in a senior- subordinated structure or junior-senior…
2. Consider the model of Moral Hazard where firms choose between investing one unit of output in a less risky or more risky project. The safer project yields with probability and zero otherwise while the risky project yields 2 with probability and zero otherwise i.e. TG = G = TB B = 2. Suppose firms finance their investment by borrowing 1 unit from a the fiinancial market at interest rate R. The financial market is risk neutral and requires an expected rate of return equal to the risk free rate which is assumed to be zero. Will there be an equilibrium with lending to firms from the financial market A. Yes B. No C. Not enough information D. None of A-C
1.
A6) Finance 1. What of the following statements is not correct? _____ the higher the sales growth rate g is, the larger AFN will be—other things held constant. The higher the capital intensity ratio, the larger AFN will be—other things held constant. The higher the firm’s spontaneous liabilities, the smaller AFN will be—other things held constant. The higher the payout ratio, the larger AFN will be if other things held constant.
The following question illustrates the APT. Imagine that there are only two pervasive macroeconomic factors. Investments X, Y, and Z have the following sensitivities to these two factors: Investment b1 b2 X 1.75 0 Y −1.00 2.00 Z 2.00 1.00 We assume that the expected risk premium is 7.8% on factor 1 and 11.8% on factor 2. Treasury bills obviously offer zero risk premium. According to the APT, what is the risk premium on each of the three stocks? Suppose you buy $500 of X and $125 of Y and sell $375 of Z. What is the sensitivity of your portfolio to each of the two factors? What is the expected risk premium? Suppose you buy $200 of X and $150 of Y and sell $100 of Z. What is the sensitivity of your portfolio to each of the two factors? What is the expected risk premium? Finally, suppose you buy $400 of X and $50 of Y and sell $200 of Z. What is your portfolio's sensitivity now to each of the two factors? And what is the expected risk premium?
If you solve for what fraction of your wealth (y) you should invest in the risky asset and you get the answer of 1.4, what does this mean? Assume you can borrow at the risk free rate. a) That you should invest 100% of your wealth in the risky asset b) That you should invest 140% of your wealth in the risky asset by borrowing at the risk free rate c) That you should short 140% of the risky asset and invest in the risk free asset d) That you should invest somewhere between 100% and 140% of your wealth in the risky asset by borrowing at the risk free rate.
1. A credit portfolio manager is expecting corporate credit spreads to widen over the next several months. What are two ways that she can take advantage of the excess return (+coupon payments) relative to risk-free assets (i.e. treasuries) but limit the impact of the expected moves?

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