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Subective Question Of Mgt411


Question No: 1(Marks: 3)
Briefly discuss different types of investment grades of Long term ratings
be PACRA.
Answer
PACRA is the Pakistan Credit rating agency which rates different companies in
Pakistan who offer bonds or stocks to investors. They rate companies
independently to protect investors from companies who might default and not pay
the investors. Based on their ratings given to different companies people who
want to invest will know which companies to go for investment and which to
avoid. The different types of investment grades given of long term ratings given
by them are:
AAA: This is highest credit quality and has lowest expectation of risk
AA: Very high credit quality and very low expectation of risk
A: High credit quality and low expectation of risk
BB: Good credit quality and as of now there is low expectation of credit risk.
BBB: Good credit quality. ‘BBB’ ratings indicate that there is currently a low expectation of credit
Risk
Question No: 2 ( Marks: 3 )
Find out YTM of 1 year 10% coupon bond selling at $120. (Face value of
bond = $100).
Answer
Current yield = yearly coupon payment/price paid
Current yield = 10/120
Current yield = 0.08333
Current yield = 8.33%
Capital gain or Loss = Change in the price of the bond/ price of the bond
Capital Gain or Loss = 120 – 100/ 100
Capital Gain or loss = 20/100 = 0.02 loss above the face value
Now,
Current yield – Capital loss
=8.33 – 0.2
= 8.13
So
Bond Price > Face Value:
130>100
Coupon Rate > Current Yield > Yield to Maturity
10% > 8.33% > 8.13%
Question No: 3 ( Marks: 3 )
Financial intermediary reduce costs”. How?
Answer
Financial intermediary is naturally an foundations that make easy the control of funds
between lenders and borrowers not directly that acts as the middle man between investors
and firms raising fund is called financial intermediary.
Financial intermediary will reduce transaction cost because they are specializing in the
issuance of standardized securities.
Question No: 4 ( Marks: 5 )
Define financial intermediaries. What functions the financial intermediaries
performs regarding savings?
Answer:
Financial intermediary is naturally an foundations that make easy the control of funds
between lenders and borrowers not directly that acts as the middle man between investors
and firms raising fund is called financial intermediary.
Financial intermediary will reduce transaction cost because they are specializing in the
issuance of standardized securities
1. Maturity transformation
Converting short-term liabilities to long term assets just like banks deal with large
number of lenders and borrowers, and settle their conflicting needs
2. Risk transformation
Converting risky investments into relatively risk-free ones For example ending to
multiple borrowers to spread the risk
3. Convenience
Matching small deposits with large loans and large deposits with small loans
Question No: 5 ( Marks: 5 )
Suppose that over the past 20 years, the average annual return on investments has been
12%. For each dollar invested at the beginning of the period, How much money would
investors have at the end of 20 years?
Answer
FV= (1+i)^n -1/i
(1+.12)^20-1/.12 =72.052
72.052x (1.12) = 80.698
Question No: 6 ( Marks: 5 )
Briefly explain the factors which shift the bond demand.
Answer:
Factors that shift Bond Demand are
• Expected inflation
If expected inflation fall then demand for bond increases, curve of bond demand shift to
right.
• Expected return on bonds
If the expected return on bonds rise then people will invest money more ,as result demand
for bond will rise
• Risk relative to alternatives
If other stocks are more risky then demand for bonds increases then shift the demand
curve bond
Liquidity of bonds
If liquidity of bonds becomes more than other stocks or investments then shift the
demand curve bond
• Wealth
As the consumer received more wealth their demands for good raise. They will invest
their money in market result will be economy grows and bond prices will increase.
Question No: 7 ( Marks: 3 )
Discuss briefly the facts about term Structure.
Answer
Term structure facts
The relationship among bonds with the same risk characteristics but different maturities is called
the term structure of interest rates.
1) Long term yields tend to be higher than short term bond.
2) Interest rates of different maturities tend to move to gather
3) Yields on short term bond are more volatile than long term bonds yields
Question No: 8 ( Marks: 3 )
Find out YTM of 1 year 12% coupon bond selling at $130. (Face value of
bond = $100).
Solution:
Current yield = yearly coupon payment/price paid
Current yield = 12/130
Current yield = 0.0923
Current yield = 9.23%
Capital Gain or Loss = 130 – 100/ 100
Capital Gian or loss = 30/100 = 0.3 loss above the face value
Now,
Current yield – Capital loss
=9.23 – 0.3
= 8.93
As we know
Bond Price > Face Value:
130>100
Coupon Rate > Current Yield > Yield to Maturity
12% > 9.25% > 8.93%
Question No: 9 ( Marks: 5 )
Discuss default risk of bond in detail.
Answer
Default Risk: It is define as that “there is no guarantee that a bond issuer will make the
payment which he promised.
When there is higher default risk the higher the probability that those who have the bond
will not receive the promised payments and thus higher the yield. The investor which are
risk averse require some compensation for risk, more compensation is require for higher
risk.
For example
Suppose risk free rate is 10%
ABC corp. issue one year bond at 10%
Price without risk= (100 +10)/1.1= Rs.100
Suppose, there is probability that ABC corp. goes bankrupt, get nothing than two possible
payoffs: Rs.110 and Rs.0
Important characteristics.
1) A large number of shares are out standing.
2) Price of individual shares are low.
3) Shareholder can replace managers who are doing bad.
4) Due to limited liability investor only losses do not exceed the amount they paid.
5) An individual share represents only small fraction of value of the company.
6) This allow individual to make relatively small investment.
7) Stockholders receive he proceeds of a firm’s activities only after all other
creditors are paid.
Question No: 10 ( Marks: 3 )
Differentiate between yield to maturity and current yield.
Answer
Yield To Maturity
The most useful measure of the return on holding a bond is called the yield to
maturity (YTM).
This is the yield bondholders receive if they hold the bond to its maturity when
the final principal payment is made
It can be calculated from the present value formula.
The value of i that solves this equation is the yield to maturity
If the price of the bond is $100, then the yield to maturity equals the coupon rate.
Since the price rises as the yield falls, when the price is above $100, the yield to
maturity must be below the coupon rate.
Current yield
Current yield is a commonly used, easy-to-compute measure of the proceeds
the bondholder receives for making a loan.
It is the yearly coupon payment divided by the price
The current yield measures that part of the return from buying the bond that
arises solely from the coupon payments
Question No: 11 ( Marks: 3 )
Discuss briefly the facts about term Structure.
Facts of Term Structure
Interest Rates of different maturities tend to move together
Yields on short-term bond are more volatile than yields on long-term bonds
Long-term yields tend to be higher than short-term yields.
Question No: 12 ( Marks: 5 )
Discuss bubbles in your own word
Answer
Bubbles are persistent and expanding gaps between actual stock prices and
those warranted by the fundamentals.
These bubbles inevitably burst, creating crashes.
They affect all of us because they distort the economic decisions companies and
consumers make If bubbles result in real investment that is both excessive and
inefficiently distributed, crashes do the opposite; the shift to excessive pessimism
causes a collapse in investment and economic growth When bubbles grow large
enough and result in crashes the stock market can destabilize the real economy
Question No: 31 ( Marks: 5 )
Briefly discuss short term ratings by Pakistan Credit Rating Agency.
Answer
Pakistan Credit Rating Agency.
A1+: highest capacity for timely repayment
A1: Strong capacity for timely repayment
A2: satisfactory capacity for timely repayment may be susceptible to adverse
economic conditions
A3: an adequate capacity for timely repayment. More susceptible to adverse
economic condition
B: timely repayment is susceptible to adverse changes in business, economic, or
financial conditions
C: an inadequate capacity to ensure timely repayment
D: high risk of default or which are currently in default
Question No: 13 ( Marks: 5 )
Define stock and also discuss its important characteristics.
Stock & its importance
Stocks provide a key instrument for holding personal wealth as well as a way to
diversify, spreading and reducing the risks that we face. For companies, they are
one of several ways to obtain financing. Additionally, Stocks and stock markets
are one of the central links between the financial world and the real economy.
Common Stock
Valuing Stock
Stocks, also known as common stock or equity, are shares in a firm’s ownership
From their early days, stocks had two important characteristics that today are
taken for granted:
The shares are issued in small denominations and the shares are transferable
Until recently, stockowners received a certificate from the issuing company, but
now it is a computerized process where the shares are registered in the names
of brokerage firms that hold them on the owner’s behalf.
The ownership of common stock conveys a number of rights
A stockholder is entitled to participate in the shares of the enterprise, but this is a
residual claim meaning the leftovers after all other creditors have been paid
Question No: 14 Marks: 3 )
Give a single line definition of the following.
Answer:
1) Credit risk: This is a risk which arises when loans are not repaid. It is avoided
by diversification and checking credit worthiness.
2) Interest-rate risk: The assets and liabilities of a bank are sensitive to interest
rate but liabilities are of short term and assets of long term so by an increase in
interest rate banks have the risk that value of assets fall more than that of
liabilities affecting the net worth or capital of bank.
3) Liquidity risk: It is a risk associated with a sudden increase in demand
Of funds. If bank can not meet the withdrawal requirement of all its customers,
bank is considered illiquid and it may fail.
Question No: 15 ( Marks: 3 )
How Financial System promotes economic efficiency? List down points
1. They provide the channel for transfer of funds between saver and
borrowers
2. provide risk sharing like insurance
3. provide payments like bank accounts
4. Help those people which do not have enough capital to use profitable
opportunity.
Question No: 16Marks: 3 )
Describe the role of Central bank as “The Bankers Bank”
Answer
The central Bank works as a Banker’s Bank. The role which it plays is
1. Lender of last resort. If banks go illiquid or during financial stress central
2. Bank provides discount loans to banks.
3. Manage interbank payment system
4. Monitors the working of banks and stabilizing financial system
Question No: 17 ( Marks: 3 )
Why stocks are risky?
Stockholders receive profits only after the firm has paid everyone else, including
bondholders
1. It is as if the stockholders bought the firm by putting up some of their own
wealth and borrowing the rest
2. This borrowing creates leverage, and leverage creates risk
3. Imagine a software business that needs only one computer costing $1,000 and
purchase can be financed by any combination of stocks (equity) and bonds
(debt). Interest rate on bonds is 10%. Company earns $160 in good years and
$80 in bad years with equal probability
Question No: 18 Marks: 3 )
What is the effect of an increase in potential output on inflation and output?
Answer:
Increase in potential output shifts long run aggregate supply curve to right, this
shift has no impact on short run aggregate supply curve so inflation and output
remains unchanged. But in long run now as potential output is increased so
current output will be below potential output creating recessionary output gap
causing inflation to fall and output begins to rise.
Question No: 19 Marks: 5 )
Which relationship is shown by the monetary policy reaction curve?
What will be the change in monetary policy reaction curve if the given
factors change?
a. An increase in the Central Bank’s Inflation Target
b. An increase in the Long-run real interest rate
Answer:
Monetary policy reaction curve gives a relationship between inflation
and real interest rate. It is set so that when current inflation equals target
inflation, real interest rate equals long run real interest rate.
a. Increase in central bank’s inflation target shifts the monetary policy reaction
curve to right
b. Increase in long run real interest rate shifts the curve to left
Commodity money
E-money
Question No: 20 (Marks: 5 )
You are the founder of an automobile company. Describe the idiosyncratic
& systematic risks that your company faces.
Answer
IDIOSYNCRATIC RISK
Unsystematic risk or risk that is uncorrelated to the overall market risk. In other
words, the risk that is firm specific and can be diversified through holding a
portfolio of stocks
WHAT IS SYSTEMATIC RISKS:
The risk inherent to the entire market or entire market segment Also known as "undiversifiable
risk" or "market risk." Systematic risks affect everyone. Systemic risk,
market risk and un-diversifiable risk is risk which applies to whole market or
market segment.
Question No: 21 ( Marks: 5 )
Ahmad purchases a 10 year 8% coupon bond with the face value of $100. He
wants to hold this bond for 1-year and then sells a 9-year bond after 1-year.
(i) If interest rate does not change then what will be the rate of return?
Answer
Rate of return = 8/100
Rate of return = 0.08
Rate of return = 8%
(ii) If interest rate falls to 6% then suppose price increases to $109.16. What will
be the capital gain after the price rise?
Answer
If interest rate falls to 6% over the year then through using bond pricing formula
we can see that
You bought a 10-year bond for $100 and sold a 9-year bond for $109.16
Now,
$8 is coupon payment
109.16 – 100 = 9.16 is capital gain
(ii) After the price rise, what will be the one year holding period return?
So now, one year holding Period return = $8/100 + 109.16 – 100 / 100
= 8/100 + 17.16/100
= 17.16 /100
= .1716
= 17.16%



nice

Ye to Midterm k papers ka solution hai. Risks, Bonds, Stocks, Yield to Maturity etc. ye sab Midterm ka syllabus hai

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