FIL 241 Exam 2 (Ch 4-7) questions with complete solution 2022

FIL 241 Exam 2 (Ch 4-7) questions with complete solution 2022Government imposes some unnecessary costs on businesses. What impact do such costs have on companies (e.g., investing, creation of jobs)? (WSJ_WhiteHouseToScale...) The costs diverted to fulfilling rules cuts a firm's ability to expand and make profit. Government imposes some unnecessary costs on businesses. What impact do such costs have on economy's ability to recover? (WSJ_WhiteHouseToScale...) The needless rules impact the entire economy and slow the growth of all firms. What is the impact on the prosperity of a country when some people are employed doing meaningless jobs? (WSJ_WhiteHouseToScale...) Since the economic growth is slower, the prosperity and ability for a country to recover from a crisis is slower. People are getting paid to do work that has no positive impact on the economy What were the changes in taxes in Illinois in 2011? (WSJ_LiberalsLoveThe1%...) $2 billion dollar tax hike. Income tax rose 67% and corporate tax rose from 7.3% to 9.5% Does an increase in a tax rate necessarily increase government tax income? Why? (WSJ_LiberalsLoveThe1%...) No, because some companies and individuals will leave the state in order to avoid the higher tax rates. What impact did the increase in taxes have on businesses? (WSJ_LiberalsLoveThe1%...) Small and medium-sized businesses are paying higher tax rates. Those businesses are unable to invest that 2.2% increase in their business. Why did some companies get exceptions about paying taxes? How does that affect capital allocation? (WSJ_LiberalsLoveThe1%...) The state knew that if the largest companies left the state, the state economy would suffer greatly, and jobs in the state would be lost Why is efficient capital allocation important? How does it affect financial markets? (WSJ_LiberalsLoveThe1%...) Resources are finite. If the state capital allocation is inefficient, they need more money to run programs. Because they need more money, they need to acquire that from the people and industry, so it limits the funds available to the financial markets. Why is it a problem that government helps some companies with their international business? (Chicago_Tribune_EndCorporateWelfare...) It creates an unfair market where some companies receive more benefit than others, and the government becomes a competitive advantage of a company. What are interest rates? The price for borrowing money What function do interest rates serve? They help to allocate resources efficiently when prices are correct What are the determinants of interest rates? -Supply and Demand of Funds (money) Who Supplies loanable funds? -consumer savings -business savings -state and local government budget surplus(seldom) -federal government budget surplus(seldom) -federal reserve increase in money supply Who demands loanable funds? -consumer credit purchases -business investments -state and local government budget deficit -federal government budget deficit What relation does Fisher equation explain? The relation between real and nominal interest rates according to inflation What is the difference between real and nominal interest rates? -Real:inflation is adjusted, determines "how much more you will be able to buy," is not precise, often biased because understated inflation works in the government's favor. -nominal:inflation is not adjusted and is what we consider "normal" interest rates (price for borrowing) How can we decompose real interest rates? compensation for delayed consumption and compensation for risk What are some of the variables used to predict interest rates? -changes in money supply -changes in government expenditures -change in GDP -changes in inflation (expected) -unemployment rate (which all also affect each other and interest rates also affect all of these variables) Can we predict interest rates? Not exactly, its very complicated but we can use variables to generally predict what could happen to the interest rates depending on what happens to the variables (aka. predicting economic activity which is not always consistent or unbiased) So generally no.... if you can you would make a LOT of money Why is any amount of money today worth more than the same amount of money in the future? -Time value of money prevents you from investing it and growing it right now -interest rate risk will decrease your money over time -inflation can devalue it What is the difference between annual and monthly compounding? Indicates the interest rate per year/month and affects the payments received. Monthly makes more money because interest is earned each month and then the next month interest is earned on that higher amount whereas annually only earns interest on one amount per year What is the principal (face; par value) of a bond? -typically $100, $1,000, $10,000, $100,000, etc -the amount received at the point of maturity What is a coupon payment? (coupon rate?) -the amount paid as a percentage of the par value (coupon rate x par value) which is received over the payment periods throughout the life of the bond -coupon rate is the percentage that determines each payment, used only to figure the payments How do we estimate the price of a bond? We discount the future cash flows, utilize the information given, and enter in calculator (yield to maturity) What are the differences between par, discount, and premium bonds? par: sold at face value (coupon rate=market rate) discount: sold under face value premium: sold above face value (these do not affect whether its a good or bad bond) What are zero coupon bonds? Bonds that do not pay coupon payments, but because of that, their face value is higher and are usually sold at a steep discount What is yield to maturity ?(expected yield, realized yield, total return) -The percentage rate (market rate) promised/expected to be paid annually until maturity.(same as expected yield) -Realized yield is the yield actually received -total return is the amount actually received in the end, after all payments are made How do changes in interest rates affect bond prices? (long vs short maturity bonds) -changes in interest rates cause the value of the bonds to increase or decrease depending on inflation which affects interest rates (if interest rates in the market decrease, bond prices rise) -longer maturity bonds are at higher risk because of interest rate changes -shorter maturity bonds are less susceptible to risk because the period for rates to fluctuate is shorter How do we measure bond price volatility? by estimating the percentage change in price. (Long term are more volatile) What is a relation between bond price volatility and coupon rate? as coupon rate increases, interest rate risk decreases...meaning bond price volatility decreases because higher payments lead to lower risk What is the duration of a bond? -duration is the measure of time ON AVERAGE in which you recieve cash flows from a bond (and is also a good measure of interest rate risk) -duration is more precise How does the duration of a bond relate to interest rate risk? higher duration leads to higher interest rate risk because the longer the period the more prices will fluctuate. How can we manage interest rate risk? -through duration -reducing interest rate risk can be accomplished through longer durations because you can be sure of interest rates rather than being unsure year to year Does declaring bankruptcy mean going from face value to zero? No Puerto Rico, when bond prices slid, was it Trump who decided their debt? -No -it was a judge,etc -probably a good thing becasue to make markets efficient, money needs to go to the best uses which will weed out the weak Are Assets short or long term? -long term because they have zero maturity (ex. you can withdraw you money from the bank at any time) -when interest rates increase, the value of assets will decrease more than equity/liabilities Are Equity and Liabilities short or long term? -short term (ex. if you borrow from the bak they cannot call you at any time asking for all of their money back immediately) -when interest rates increase, the value of equity/liabilities will not decrease as much as assets Why does the problem lie within assets and equity/liabilities having different terms? If they have the same duration, it would not be as big of a deal if interest rates increased because money would be lost equally rather than being mismatched (we would rather lose money equally) What is the term structure of interest rates? relationship between yield and term to maturity on securities that differ only in maturity what is the treasury yield curve? charts years to maturity vs interest rates