BANK 1005(11941) Derivatives and Securities Markets
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Review 3 (Topic 3 – Debt Markets)
Questions and Problems
You should answer the following
Questions and Problems
in your textbook:
Chapter 2: 1, 2, 3, 4, 5, 7, 8
1(b), 2, 4, 5, 7 (a) and (b)
Chapter 10: 4, 10
Consider this feedback as a guide toward writing a sound explanation, not
as the “best
answers”. You do need to employ your learning and thinking to craft a ‘good answer’.
Good writing skills will also result in high quality discussions and arguments. I have
provided some comments to hopefully assist you in thinking deeper.
Learning about the financial markets involves using a “package” of resources and
thinking, rather than just learning these “answers”. You need to show real
understanding of the issues acquired from your learning and thinking in your
explanations/arguments. Often, according to the authors of your book (in the preface),
the problems and questions have been chosen to “provoke debate rather than a search
for the ‘correct answer’.” Take these questions and the suggested feedback in this
What type of investor would be interested in Treasury indexed bonds?
These bonds could be attractive to retirees who want to maintain the real value of
their retirement income and to superannuation funds that are obliged to pay indexed
However, a problem with these indexed bonds is that the nominal rather than the real
rate of return is subject to tax.
This can result in a negative after-tax real return.
result, investors are often attracted to such investments as shares and property that are
regarded as inflation hedges (i.e. their prices increase with the general price level).
How good “inflation hedges” are these assets?
Discuss the advantages and disadvantages of bank bills as a form of
investment and a way of borrowing money.
A bank bill is paper issued by a private borrower promising to pay a certain amount of
money on a specified date where the payment has been guaranteed by a bank.
bills carry the credit rating of the banks guaranteeing them resulting in a rating close
to that of government paper.
This is because banks are widely regarded as
“government guaranteed”, although there is no legislative basis for this view.
The attraction of bank bills as an investment is the safety of the investment.
also provide a good return for investors looking to park money for a short period, for
example, money intended for payments of tax obligations.
If the yield curve is
inverse (as it was in the 1980s), these securities yield a higher return than longer-term
Bills are also attractive as investments when interest rates are expected to
Note that, in this situation, the yield curve will be normal. [We discuss the yield
curve later in the course.]
Bills are an attractive way of borrowing when the yield curve is normal (i.e. short-
term interest rates are lower than long-term interest rates). They are also attractive
when interest rates are expected to fall. In the latter case, the yield curve is likely to be