1) (25 points total)

a) Based on the data from http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield , draw the yield curve for “Daily treasury yield curve rates”.

All you need to do is to import interest rate data (for 06/24/13) for different yields (of 1, 2, 3, 5, 7, 10, 20, 30 years) into an excel sheet and draw the yield curve.

Terms to Maturity

1

2

3

5

7

10

20

30

interest rate on 6/24/2013

 

 

 

 

 

 

 

 

 

 

2) (25 points) David wants to buy a machine for his firm. He expects to incur the maintenance cost of $500 at the end of the 1st year and this rate is going to increase by 10% per year. David expects to make $600 from the machine in the 1st year. This rate is going to increase by 20% per year. At the end of the 10th year, he is going to sell the machine with price of $1000. The required return on investment in this machine for David is 30%. What is the maximum price that David accepts today for this machine? Show your work clearly.

 

3) (25 points) You want to get a mortgage to buy a house which is worth $100,000 (so the value of your loan is $100,000). The bank makes you the following two offers. Which one will you take?

A) 30-year fixed payment loan with monthly payment of $525.

B) 10-year fixed payment loan with monthly payment of $994.

Hint:

To solve this problem, you need to calculate the yield to maturity of these two options. To calculate the yield to maturity of each one, you can use the following procedure:

First, write/derive the formula for the relationship between current value of the loan and fixed payment amount and yield to maturity. Note that the payments are monthly, so you need to use monthly interest rates.

Second, you need to guess a reasonable monthly interest rate, plug it into the formula and check whether this interest rate satisfies the formula or not. Repeat this process for several interest rates until the right hand side of the formula (the present value of cash flows) and the left hand side (the value of the loan) become approximately equal. 

 

4) (25 points) If bond investors decide that 30-year bonds are no longer as desirable an investment, predict what will happen to the yield curve, assuming (a) the expectations theory of the term structure holds; and (b) the segmented markets theory of the term structure holds.

5) (10 points) Using the Gordon growth model, explain why stock prices fell sharply during the recent financial crisis that started in August 2007.

 

 

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