Lesson Learning Objectives
By the conclusion of this Lesson you should be able:
• Understand what an interest rate is, how the various types are calculated, how changes in money growth over time effects the interest rate, and explain the three factors affecting the risk structure of interest rates
• Recognize the distinctions between yield to maturity, current yield, rate of return, and rate of capital gain
• Describe how to calculate cash flows and yield to maturity of the four types of credit market instruments
• List and describe the factors that affect the money market and the equilibrium interest rate
• Identify the factors that affect the demand for assets
• List and explain the three theories of why interest rates vary across different maturities
• Summarize the reasons why behavioral finance suggest that the efficient market hypothesis may not hold
• Understand the factors impacting stock prices and be able to calculate the price of common stock
The following Assignments should be completed and submitted to the course faculty via the learning platform for evaluation and grading. Submit your responses to these questions in one WORD document. List the question first, and then your response.
Be sure to properly site your sources, both in-text and with a reference list at the conclusion. If you use an online source to support your answers, you must provide a properly formatted link to the source. You should use APA citation format and make sure your sources are credible. In most cases, your responses should be no more than 200 words.
Short Answer Questions
1. Do bondholders fare better when the yield to maturity increases or when it decreases? Why?
2. Why would a government choose to issue a perpetuity which requires payments forever, instead of a terminal loan, such as a fixed-payment loan, discount bond, or coupon bond?
3. Explain why you would be more or less willing to buy gold under the following circumstances:
a. Gold again becomes acceptable as a medium of exchange
b. Prices in the gold market become more volatile
c. You expect inflation to rise, and gold prices tend to move with the aggregate price
d. You expect interest rates to rise
4. Explain what effect a large federal deficit should have on interest rates.
5. Risk premiums on corporate bonds are usually anticyclical, that is, they decrease during business cycle expansions and increase during recessions. Why is this so?
6. Prior to 2008, mortgage lenders required a house inspection to assess a home’s value, and often used the same one or two inspection companies in the same geographical market. Following the collapse of the housing market in 2008, mortgage lenders required a house inspection, but this inspection was arranged through a third party. How does the pre-2008 scenario illustrate a conflict of interest similar to the role that credit-rating agencies played in the global financial crisis?
7. “Forecasters’ predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational.” Is this statement true, false, or uncertain? Explain your answer.
8. Suppose that increases in the money supply lead to a rise in stock prices. Does this mean that when you see that the money supply has sharply increased in the past week, you should go out and buy stocks? Why or why not?
Professional Development Questions
1. A $1000-face-value bond has a 10% coupon rate, its current price is $960, and its price is expected to increase to $980 next year. Calculate the current yield, the expected rate of capital gain, and the expected rate of return.
2. Compute the price of a share of stock that pays a $1 per year dividend and that you expect to be able to sell in one year for $20, assuming you require a 15% return.