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# THE UNIVERSITY OF NEW SOUTH WALES SCHOOL OF BANKING AND FINANCE FINS 5513: Investments and Portfolio Selection Semester 1 2012 Assignment 3...

The current prices of 1-year, 2-year and 3 year zero-coupon bonds are \$930.00, \$870.00
and \$810, respectively.
Using the constant growth dividend discount model estimate the following:
a. Calculate the one year short rate in the third year.
b. How can you construct a synthetic two-year forward one-year loan of \$5,000,000 with a
guaranteed cost (you commit now to borrow \$5m for one year starting in two years
time)? State the strategy and show the corresponding cash flows. Assume that you can
purchase and sell fractional quantities of bonds. Show all working and and make clear
the meaning of the transactions
c. Prices of long term bonds are more volatile than prices of short term bonds. However,
market yields to maturity on short term bonds fluctuate more than yields on long term
bonds. How do you reconcile these two observations?

2 The Grading Rubric below outlines the relevant grading criteria and provides more detail on how each criterion will be assessed: Criteria Weight 5 3.5 2 0 Exceeds expectations Meets expectations Marginal Failing 1. Right Tool: Selects the appropriate analytical tool 20 Student always selects the right tool and provides a full explanation. Student generally selects the right tool. Student has some difficulty selecting tool. Student rarely selects the right tool 2. Right Data: Enter appropriate data from the problem into the selected tool and correctly compute solutions 20 A high degree of accuracy in data selection and computation with clear explanation of all steps Generally correct solutions but some lack of full explanation Some errors in data selection and/or computations Very little ability to select data and many errors 3. Markets: Demonstrate knowledge of market securities and trading 20 Detailed and accurate knowledge Reasonable working knowledge Patchy knowledge Little or no knowledge of markets 4. Valuation: Demonstrates understanding of relationship between various valuation measures. 25 Excellent understanding of the relative merits of different valuation methods Understanding of the basic principles of valuation methods Some confusion regarding appropriate valuation methods Little ability to perform valuations 5. Integration: Linking the theory with the practice of investment management 15 Well integrated understanding of theory and practice Working knowledge of practical issues for theories Problems relating theory and practical issues. Too little knowledge of either theory or practice to relate at all
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