and Interest Rates 1 Running Head: INTEREST RATES AND SECURITY PRICING
Interest Rates and Security Pricing Susana Silvestri FIN-350 24-Apr-11
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Privacy protection has become an important public policy issue in the financial service industry. Why does this issue appear to be more important today than in the past? What are the costs and benefits of additional legislation and regulation designed to protect customer privacy? Is there evidence as to how these regulations benefit the public?
Privacy Protection has become a very important public policy issue due to the Identity Theft. Financial institutions utilize the unique personalized instrument that identifies an individual, the Social Security and the Drivers License or Identification Cards are some of these instruments utilized to be able to establish services and credit for the clients. Nowadays, all the technology advances, makes it really easy for the thefts to acquire someone else identity to take advantage of their credit. These actions will make the client a victim of identity theft by compromising their personal biggest asset, their identity. Some of the legislation and regulation designed to help the protection of the customers privacy has been established by the Federal Financial Institutions Examination Council which ordered financial institutions to have more security measures when accessing customers online account. The security questions that are getting added to these access procedures will include answers that only the customer is aware of.
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If you were managing a small bank or insurance agency in your local community, what current and future trends in financial services and institutions would likely have the greatest impact on your institution? Why? What responses could you make to each trend you have listed? If I had the opportunity to be a manager of a local institution in my community, my approach will probably be to operate an insurance company were consolidation of services are offered to the client without having to look around by giving them incentives to remain and acquire as many of the services offered. Some of the services could be geared towards the actual business branch like health, dental, life, auto, and home insurance to mention the most common ones. Then by helping the elderly understand who their Medicare and the additional supplements can reduce there overall expenses. We must remember that the best advertising is by word of mouth and if one family member is satisfied, it will spread to everyone else in their household. Making a one stop for all insurance need under one company will alleviate some of the hassles of shopping for different policies. Another possible product will be the travelers insurance which is usually sold by travel agents only and the prices are extravagantly high.
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What is the significance of the life-cycle hypothesis for the management of financial institutions? Of an aging population? Of ongoing changes in the basic family unit and the spread of universal education? The life-cycle hypothesis states that as individuals aged, their income lifetime expectancy will reduce because their closer time to retirement, for this reason, the financial institutions must find a way to better serve the elderly by incorporating better retirement and state planning. Nowadays, it is very common to see a household with only one parent, marriages are happening at later ages and consciousness on the amount of children conceived is also taken in consideration. All these require these individuals to borrow money in order for them to have a standard life style. The financial institutions must keep in mind those factors to be able to help and accommodate the needs of those individuals. As we see our youth become adults, we realize that education is playing a very important role in their lives and more students and parents or guardians are borrowing in order for these students to fulfill a better future for them.
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Why are government regulations to enforce financial disclosure and a level playing field important to the success of the financial system?
Government regulations in charge of keeping a good standard on the financial sector have come to the point of creating what is called financial disclosure and a level playing field. The financial disclosure is to ensure that customers are inform of the term of service and their financial conditions to facilitate the customers trust and better investments. The level playing field refers to the rules that will press for the earning taxation and the power to offer a full range of services to be equal among the financial institutions.
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What is functional regulation and why does it appear to be needed in the modern financial system? Functional Regulation is where an expert on certain type of function is to oversee that specific function in the financial system pooling their reports to show an overall of the financial institution. In these times, when the modern financial systems are so advanced, there must always be a check and balance to follow and these regulators help the proper function of these institutions.
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What are the advantages and the disadvantages of having government-sponsored insurance in the financial system? Why is moral hazard often a problem with a government-sponsored system? Government-sponsored insurance in the financial system are put in place since 1930 to insure the clients savings. The advantages are 100% in favor of the client, which is entrusting their savings with an specific financial institution, now, the main disadvantage to the Governmentsponsored insurance, is that some times will encourage to financial institutions managers to take greater risks with the publics money creating what it is commonly known as moral hazard.
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How might the regulation of capital serve to limit and control risk-taking by financial institutions? The regulation of capital serves as a great tool to limit and control risk-taking by financial institutions, by giving the financial institution stockholders the responsibility to respond for any insufficient capital to cover any current or anticipated risk exposure. When the stockholders are hold financially responsible, they will be more aware of the firms risks and possible liabilities.
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Suppose that total savings and business investment demand in the economy behave as shown in the table that follows (dollars are in billions): Total Investment Demand for Funds 155 $170 142 135 128 111 92 86 Volume of Total Savings Expected $80 96 103 135 178 207 249 285 Alternative Market Interest Rates 5% 6 7 8 9 10 11 12
According to the classical theory of interest, what equilibrium interest rate will prevail given the above schedules of planned saving and investment? What could cause the equilibrium rate to change?
According to the classical theory of interest, the equilibrium rate on the above schedule of planned saving and investment will be at 8%, this equilibrium is found when the quantity of savings supplied to the market and the quantity of funds demanded for investment is exactly equal. When one of those two elements (Total investment demand for funds or Volume of total saving expected) change without the other changing in the same direction, it will cause the equilibrium to be lost.
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Suppose the total demand for money is described by the following equation: MD = 30 - 2i where i is the prevailing market interest rate. The total supply of money is described by the following equation: MS = 3 + 7i According to liquidity preference, what is the equilibrium interest rate? Equilibrium is the balance in between supply and demand, in other words MD =MS 3 + 7i = 30 2i 7i + 2i = 30 3 9i = 27 I = 3 showing the equilibrium as 3% 9 x 3 = 27 27 = 27
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A firm is considering the adoption of a project that is expected to generate revenues for 10 years. These expected revenues (in dollars) are: Year 1: Year 2: Year 3: Year 4: Year 5: Year 6: Year 7: Year 8: Year 9: Year 10: $200,000 250,000 300,000 300,000 280,000 $270,000 255,000 240,000 150,000 75,000
The total cost of the project, to be paid immediately upon adoption, is $1.6 million. Use a spreadsheet to compute the net present value of the project if: a. The firms cost of capital is 6 percent. Should the project be adopted?
We must use the NPV function provided by Excel
NPV (6%) $151,096.78
The NPV shows a generated amount (positive) of $151,096.78. Based on this findings, the project should be adopted. b. The firms cost of capital is 8 percent. Should the project be adopted? Suppose the firm has a second project that requires an initial outlay of We must use the NPV function provided by Excel
NPV (8%) $7,119.05
The NPV shows a generated amount (positive) of $7,119.05. Based on this findings, the project should be adopted.
Suppose the firm has a second project that requires an initial outlay of $800,000 and is expected to generate revenues for only five years, and those revenues are of the same amounts as given above for years 1 to 5. Use the same spreadsheet to compute the net present value of this project if:
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c. The firms cost of capital is 6 percent. Is this project one that the firm would like to adopt? The cash flows are Investment Year 1: Year 2: Year 3: Year 4: Year 5: NPV (at 6%)
-800000 200,000 250,000 300,000 300,000 280,000 $309,924.53
Since the NPV is positive the project can be adopted If these are the only two projects that the firm is contemplating, what should the firm do if: d. Its capital budget is $1 million and its cost of capital is 6 percent? If the capital budget is $1 million and the cost of capital is 6%, only the second project can be done and should be accepted. e. Its capital budget is $3 million and its cost of capital is 6 percent?
If the capital budget is $3 millions and the cost of capital is 6%, both projects can be done and both should be accepted.
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s $1.6 oject if:
on this
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of $800,000 evenues are of the same amounts as given present value of this project if:
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e firm would
t should the firm do if: e second project
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Suppose a 10-year bond is issued with an annual coupon rate of 8 percent when the market rate of interest is also 8 percent. If the market rate rises to 9 percent, what hapens to the price of this bond? What happens to the bonds price if the market rate falls to 6 percent? Explain why. When a 10-year bond is issued with an annual coupon rate of 8% when the market rate of interest rises to 9%, the price of the bond tends to fall. When a 10-year bond is issued with an annual coupon rate of 8% when the market rate of interest falls to 6%, the price of the bond tends to rise.
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An investor is interested in purchasing a new 20-year government bond carrying a 10 percent annual coupon rate with interest paid twice a year. The bonds current market price is $875 for a $1,000 par value instrument. If the investor buys the bond at the going price and holds to maturity, what will be his or her yield to maturity? Suppose the investor sells the bond at the end of 10 years for $950. What is the investors holding-period yield? First we must organize our given information: FV = PV = NPER = PMT = RATE = 1000 -875 40 (20 x 2 = 40, the coupons are semi annual) 50 5.81%
Now, if the bond is sold at the end of the 10 years instead of 20 and the sale price is $950.00 we will then change our information to read as follows: FV = PV = NPER = PMT = RATE = 950 -875 20 (20 x 2 = 40, the coupons are semi annual) 50 5.95%
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Calculate the bank discount rate of return (DR) and the YTM-equivalent return for the following money market instruments: A. Purchase price, $96; par value, $100; maturity, 90 days.
PV = FV = NPER = RATE = -96 100 90 0.045%
B. Purchase price, $97.50; par value, $100; maturity, 270 days.
PV = FV = NPER = RATE = -97.5 100 270 0.009%
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You have just placed $1,500 in a bank savings deposit and plan to hold that deposit for eight years, earning 5 percent per annum. If the bank compounds interest daily, what will be the total value of the deposit in eight years? How does your answer change if the bank switches to monthly compounding? Quarterly compounding?
Compound intervals Monthly -1,500 -1,500 8 96 5.50% 0.46% $2,302.03 $2,325.98
Given PV = NPER = RATE = FV =
Annual
Quarterly -1,500 32 1.50% $2,415.49
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A commercial loan extended to CIBER-LAND Corporation for $2.5 million assesses an interest charge of $350,000 up front. Using the discount loan method of calculating loan rates, what is the effective interest rate on this loan? Suppose that instead of deducting the interest owed up front, the companys lender agrees to extend the full $2.5 million and add the amount of interest owed to the face amount of CIBERs note. What, then, is the loans effective interest rate?(Assume term of one year)
Given PV = FV = NPER = RATE = -2,500,000 2850000 1 14%