Review 3 - BANK 1005(11941) Derivatives and Securities...

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BANK 1005(11941) Derivatives and Securities Markets Page 1 of 9 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 Chapter 6: 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 spirit! CHAPTER 2 1. 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 pensions. Why? 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. As a 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? 2. 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. 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. They 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 securities. Bills are also attractive as investments when interest rates are expected to rise. 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 inverse.
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Review 3 - BANK 1005(11941) Derivatives and Securities...

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