FIN 310 QUESTIONS AND ANSWERS SURE A+
✔✔Explain how the credit crisis affected the credit risk premium in the commercial
paper market. - ✔✔during the credit crisis, some institutional investors avoided
commercial paper issued by financial institutions because of the financial problems they
were experiencing. Thus, the premium that some financial institutions had to pay when
issuing commercial paper increased.
✔✔Explain how systemic risk is related to the commercial paper market. That is, why
did problems in the market for mortgage-backed securities affect the commercial paper
market? - ✔✔some issuers of asset-backed commercial paper used mortgage-backed
securities (MBS) as collateral. As the value of MBS declined during the credit crisis,
institutional investors were no longer willing to invest in commercial paper secured by
MBS. Thus, some financial institutions that were heavily invested in MBS could no
longer issue commercial paper because they had no other assets available to post as
collateral.
✔✔Explain why investors that provided guarantees on commercial paper were exposed
to so much risk during the credit crisis. - ✔✔during the credit crisis, the financial
institutions providing credit guarantees were also exposed to high risk because they
provided guarantees for issuers that had excessive exposure to mortgages. The
guarantors would incur substantial costs on their credit guarantees if issuers of
commercial paper default due to the mortgages and other assets they were holding.
✔✔Purpose of investing in money market funds - ✔✔Money markets provide a low
return but have low risk. Investors maintain investments in money market securities for
safety and liquidity.
✔✔T-Bill Yield Calculation - ✔✔Yt= ((SP-PP)/ PP) (365/n)
✔✔T-Bill Discount - ✔✔Yd= ((Par-PP)/Par)(360/n)
- but always use 365 unless stated otherwise
, ✔✔Commercial Paper Yield Calculation - ✔✔Ycp= ((Face Value- Purchase Price)/
Purchase Price)(360/n)
✔✔Required Yield Calculation - ✔✔SP=PP/(1+r) squared
✔✔Effective Yield Calculation - ✔✔Ye = (1 + Yf)(1 + % change in S) - 1
but first you will need to find the % change in S:
= (Prevailing Spot Rate- PP)/PP
✔✔Determine how the annualized yield of a T-bill would be affected if the purchase
price were lower. Explain the logic of this relationship. - ✔✔The annualized Treasury bill
yield is increased if the purchase price is lower, because the amount returned to the
investor would represent a larger gain relative to a smaller investment.
✔✔Determine how the annualized yield of a T-bill would be affected if the selling price
were lower. Explain the logic of this relationship. - ✔✔the annualized Treasury bill yield
is reduced if the selling price is lower, because the amount returned to the investor
would represent a smaller gain relative to the investment.
✔✔Determine how the annualized yield of a T-bill would be affected if the number of
days were reduced, holding the purchase price and selling price constant. Explain the
logic of this relationship. - ✔✔The annualized Treasury bill yield is increased if the
number of days of the investment is shorter, because the amount returned to the
investor is earned over a shorter amount of time.
✔✔Return on NCD aka Yield on NCD Calculation: - ✔✔Yield= (SP-PP+Interest)/ (PP)
✔✔What is a bond indenture? What is the function of a trustee, with respect to the bond
indenture? - ✔✔the bond indenture is a legal document specifying the rights and
obligations of both the issuing firm and the bondholders. It is designed to address all
matters related to the bond issue, such as collateral, and call provisions.
A trustee represents the bondholders in all matters concerning the bond issue, including
the monitoring of the issuing firm's activities to assure compliance with the terms of the
indenture.
✔✔Explain the use of a sinking-fund provision. How can it reduce the investor's risk? -
✔✔a sinking-fund provision is a requirement that the firm retire a certain amount of the
bond issue each year. This reduces the payments necessary at maturity and therefore
can reduce the risk of investors.
✔✔Explain how the credit crisis affected the credit risk premium in the commercial
paper market. - ✔✔during the credit crisis, some institutional investors avoided
commercial paper issued by financial institutions because of the financial problems they
were experiencing. Thus, the premium that some financial institutions had to pay when
issuing commercial paper increased.
✔✔Explain how systemic risk is related to the commercial paper market. That is, why
did problems in the market for mortgage-backed securities affect the commercial paper
market? - ✔✔some issuers of asset-backed commercial paper used mortgage-backed
securities (MBS) as collateral. As the value of MBS declined during the credit crisis,
institutional investors were no longer willing to invest in commercial paper secured by
MBS. Thus, some financial institutions that were heavily invested in MBS could no
longer issue commercial paper because they had no other assets available to post as
collateral.
✔✔Explain why investors that provided guarantees on commercial paper were exposed
to so much risk during the credit crisis. - ✔✔during the credit crisis, the financial
institutions providing credit guarantees were also exposed to high risk because they
provided guarantees for issuers that had excessive exposure to mortgages. The
guarantors would incur substantial costs on their credit guarantees if issuers of
commercial paper default due to the mortgages and other assets they were holding.
✔✔Purpose of investing in money market funds - ✔✔Money markets provide a low
return but have low risk. Investors maintain investments in money market securities for
safety and liquidity.
✔✔T-Bill Yield Calculation - ✔✔Yt= ((SP-PP)/ PP) (365/n)
✔✔T-Bill Discount - ✔✔Yd= ((Par-PP)/Par)(360/n)
- but always use 365 unless stated otherwise
, ✔✔Commercial Paper Yield Calculation - ✔✔Ycp= ((Face Value- Purchase Price)/
Purchase Price)(360/n)
✔✔Required Yield Calculation - ✔✔SP=PP/(1+r) squared
✔✔Effective Yield Calculation - ✔✔Ye = (1 + Yf)(1 + % change in S) - 1
but first you will need to find the % change in S:
= (Prevailing Spot Rate- PP)/PP
✔✔Determine how the annualized yield of a T-bill would be affected if the purchase
price were lower. Explain the logic of this relationship. - ✔✔The annualized Treasury bill
yield is increased if the purchase price is lower, because the amount returned to the
investor would represent a larger gain relative to a smaller investment.
✔✔Determine how the annualized yield of a T-bill would be affected if the selling price
were lower. Explain the logic of this relationship. - ✔✔the annualized Treasury bill yield
is reduced if the selling price is lower, because the amount returned to the investor
would represent a smaller gain relative to the investment.
✔✔Determine how the annualized yield of a T-bill would be affected if the number of
days were reduced, holding the purchase price and selling price constant. Explain the
logic of this relationship. - ✔✔The annualized Treasury bill yield is increased if the
number of days of the investment is shorter, because the amount returned to the
investor is earned over a shorter amount of time.
✔✔Return on NCD aka Yield on NCD Calculation: - ✔✔Yield= (SP-PP+Interest)/ (PP)
✔✔What is a bond indenture? What is the function of a trustee, with respect to the bond
indenture? - ✔✔the bond indenture is a legal document specifying the rights and
obligations of both the issuing firm and the bondholders. It is designed to address all
matters related to the bond issue, such as collateral, and call provisions.
A trustee represents the bondholders in all matters concerning the bond issue, including
the monitoring of the issuing firm's activities to assure compliance with the terms of the
indenture.
✔✔Explain the use of a sinking-fund provision. How can it reduce the investor's risk? -
✔✔a sinking-fund provision is a requirement that the firm retire a certain amount of the
bond issue each year. This reduces the payments necessary at maturity and therefore
can reduce the risk of investors.
