Fnce 461 International Finance Instructor Michael Ata Assignment 3 Due March 2

Please solve the following questions from the attachment file.

1. (15 marks)a Explain why the domestic yield curve for a bond is concave (ie. increasing at adecreasing rate). 10 marksb Concavity of the yield curve implies that as the time to maturity increases, theaverage yield to the investor must increase. While this feature is believed tohold for domestic bonds, it does not necessarily have to for international bonds;explain why this is the case. 5 marks

FNCE 461 – International FinanceInstructor: Michael AtaAssignment 3Due March 29, 2016 at the beginning of class1. (15 marks)a Explain why the domestic yield curve for a bond is concave (ie. increasing at adecreasing rate). 10 marksb Concavity of the yield curve implies that as the time to maturity increases, theaverage yield to the investor must increase. While this feature is believed tohold for domestic bonds, it does not necessarily have to for international bonds;explain why this is the case. 5 marks2. (10 marks) Some corporations have a stock market price that is above their bookvalue. Explain why this is the case and the general characteristics associated withthis occurrence.3. (30 marks) You are evaluating a firm for potential investment. Suppose the maincharacteristic of this firm for profitable investment is its market share; the higher itsmarket share, the more profitable it would be for investment.a Suppose you are told that its 4-firm concentration ratio is 0.6 and it is thelargest firm in its industry (ie. it has the largest market share). Determinethe firm’s minimum guaranteed size (ie. minimum market share with the giveninformation). 5 marksb Now suppose you must evaluate the firm’s performance through market-shareinfluence in the following way (NOTE: disregard the information in part [a] forthis portion of the question): E[R]=γE[RG ] + (1 − γ)E[RB ]Where E[R] is the expected return over the two states of the world that canoccur; the “good” state of the world (where the firm does well and you getreceive a high return for your investment) denoted by G and the “bad” state ofthe world (the firm does not do well and your return is lower than that of thegood state) denoted by B. You know that if the good state of the world occurs,you will receive 7 million in expectation. If the bad state of the world occurs,you will receive 40 thousand dollars in expectation.γ is the market share influence and is perfectly correlated with the probability ofthe good state of the world occurring; the firm’s market share perfectly reflectsits probability of success (or the good state of the world occurring).i) Suppose you have to invest 2.5 million. If you were a risk-neutral investor,what is the lowest market share the firm could have for you to still invest in it?5 marksii) Suppose the Herfindahl index tells you the “equivalent” number of firms inthe industry is 6.724. Assume that when you are evaluating the firm, you wouldtreat γ as H in the formula given above. Would the indexes’ result suggest thatthis firm is worth investing in if you were a risk neutral investor? What aspectsof the test would make you skeptical of its reliability/ability to accurately predicta firm’s market share? 10 marksiii) Describe how your decision to invest in the firm would be affected throughvalue creation and demand analysis. 10 marks4. (15 marks) A Canadian corporation forecasts its next annual earnings to be 72 CDNper share, with a constant growth rate of 3.5 percent per year, and with a 60 percentpayout ratio. Further assume that the required rate of return for the corporationsstock is 15 percent per annum. Calculate the current price of a share and its intrinsicPE ratio.1 5. (10 marks) Describe why “Bear” Structured Notes are more volatile with respect toprice than regular FRN’s.6. (30 marks) A bond has the following characteristics: it is a ten year bond withcoupon payments of 20,000 per year with an interest rate of 7 percent per year. Atmaturity, the bond owner receives the final coupon payment and the principal, wherethe principal is equal to 2 million dollars.a Determine the implicit price of the bond. 10 marksb Determine the change in price if at the beginning of year six, the interest rateassociated with discounting increased from 7 to 9 percent. Describe in wordswhy the price went up or down. 10 marksc Suppose now that the bond is paid for and remunerated in Japanese Yen, andyou are a U.S. investor. Suppose the USD:YEN spot rate is 192. Calculate theforward rate necessary for you to receive a 20 percent return off the bond inpresent-value terms. (Note: disregard the change in interest rate presented inpart [b]). 10 marks7. (30 marks) There are two countries. Assume that domestic and foreign assets havestandard deviations of σd = 16 percent and σf = 11 percent respectively, with acorrelation of ρd,f = 0.4. The risk-free rate is equal to 3 percent in both countries.a The expected returns of the domestic and foreign assets are both equal to 10percent, E(Rd ) = E(Rf ) = 10 percent. Calculate the Sharpe ratios for thedomestic asset, the foreign asset, and an internationally diversified portfolioequally invested in the domestic and foreign assets. Explain your results. 15marksb Assume now that the expected return on the foreign asset is lower than on thedomestic asset, E(Rd ) = 10 percent but E(Rf ) = 8 percent. Calculate the 2 Sharpe ratio for an internationally diversified portfolio equally invested in thedomestic and foreign assets. Compare your findings to those in part [a]. 15marks8. (15 marks) Emerging markets are generally believed to be riskier to invest in relativeto developed markets. Provide some arguments in favor of investment in emergingmarkets. Describe some ways that emerging markets make investing in their marketsmore attractive.9. (15 marks) Risk in developed markets is typically measured by the standard deviationof returns. Do you think this is an acceptable way to measure risk in emergingmarkets? Why or why not? 3

 

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