3330%20PS2 - Cornell University Fall 2009 Economics 3330:...

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Cornell University Fall 2009 Economics 3330: Problem Set 2 Due 9/23/09 1. True/False/Explain State whether each of the following is true or false and explain your answer. Please limit your explanations to no more than two sentences. a. If a bond falls in value by $12 when the discount rate rises from 0.03 to 0.04, then it cannot fall an additional $14.40 when the discount rate rises further to 0.05. b. According to Hyman Minsky’s “Financial Instability Hypothesis” article, “hedge finance” units neither gain nor lose money when interest rates change because they are fully hedged. (Article is available in Course Documents section of Blackboard site.) c. If the NPV of a project is positive, then the IRR must be less than the discount rate. 2. Valuing Management Fees A common fee structure in hedge funds is for the manager to receive 2% of the assets under management per year as well as a performance fee of 20% of the annual returns over a benchmark. This question addresses the compensation of managers who do not generate any returns over their benchmark, so for simplicity we will assume that no performance fee is assessed. The lock-up period refers to the period of time when assets cannot be withdrawn from management. Suppose that the initial assets under management (AUM) are 100. For purposes of this question, assume that the management fee is charged at the end of the year but based on the AUM at the beginning of the year. (This assumption is not realistic but simplifies calculations.) Suppose first that there is a management fee of 2% per year and that the manager earns a 2% return on the invested funds. a. How much does the manager receive at the end of the first year? At the end of the second year? b. The fees can be viewed as the cash flows of a perpetuity. If the discount rate is 2%, what is the value of the perpetuity? What is your answer as a percentage of AUM. c.
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3330%20PS2 - Cornell University Fall 2009 Economics 3330:...

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