Assessment 1 (10%) _ Financial Markets BAFI3182_ Online test (Week 4) (10%) (9.7510)

The assessment covers Topic 1, 2,3 and is composed of critical thinking questions, a mix of calculation and problemsolving questions. The test will be online during your timetabled sessions for Week 4 (Topic 1, 2, 3) and is worth 10 %. This is an individual piece of work. The test time is 120 minutes and should be typed out using word processing software.

COURSE TITLE: FINANCIAL MARKETS

MODULE CODE: BAFI3182(SGN) / BAFI3230(HN)

SEMESTER 1, 2022 ASSESSMENT 1, WEEK 4 DURATION: 2 HOURS INSTRUCTIONS TO STUDENTS

There is ONE Section and 5 Questions on this test.

Students are to answer all 5 questions

You will have to use word processing software (Microsoft Word is the expectation) to answer your chosen questions You will have to type your answers out and upon completion, save your file As

a precautionary note, please ensure that you continually save your document as you progress through the assessment questions Add your name and student ID at the start of the document and clearly indicate the questions you have attempted

Please note that this is a timed submission The questions for Assessment 1 will be released during your timetabled sessions for Week 4 and you will have 2 hours to complete the tasks

Submission of your answer file is via Canvas The Canvas link will close at the time indicated No uploads will be allowed after the stipulated time Failure to upload your file within the indicated time will constitute a non-attempt submission

Notes and books can be utilised Answers need to demonstrate your knowledge and understanding

of the questions and explanations need to be in your own words

As, you will be submitting your files via Canvas, your answers will be checked for plagiarism Plagiarism is defined as the representation of the work of any other person from any source whatsoever as your own

This test consists of 3 pages

Subject Code BAFI3182

Subject Name Financial Markets and Institutions

Question 1

You are working as a Priority Relationship manager in Shinhan bank in Vietnam Your client Ms Anna is a surplus unit who has decided to put her saving in Shinhan bank Anna would like to save

an amount of money equal to the final digit number of your student number multiplying with

$1,000 for 12 months (for example: your student number is S3409112, the final digit number is 2 

multiply 2 with $1,000  2*$1,000 = $2,000) ((in the event that your digit is 0, treat is as a 9)) Note that the annual interest rate is equal to second digit of your student ID from the left, for

example, if your student ID number is S3409112, the interest rate is 4% p.a (in the event that your

digit is 0, treat is as a 9) You should also note that the interest is compounded quarterly How much does Anna receive after the saving period?

(2 Marks) SOLUTION

Based on my student ID number: S38xxxx9

Present Value (PV) = 9 x $1,000 = $9,000 (As my final digit number ID is 9)

Interest Rate (i) = 8% = 0.08 (As my second digit number ID from left is 8) (p.a.)

Time (t) = 12 months = 1 year

Since the interest rate is compounded quarterly => Compounding 4 times per year => m=4

Future Value (FV) =? ($)

FV = PV x (1+ i

m)t x m

 FV = 9,000 x (1+0.08

4 )1 x4

 FV = 9,741.88944 ($)

 Therefore, after the saving period of 12 months in Shinhan Bank (Vietnam), Ms Anna will

receive $9,741.88944

Question 2

Your firm is purchasing a new equipment system, which will last for five years You can purchase the system for an upfront cost of $150,000 Your firm can borrow to finance for this project in two years Calculate the effective annual interest rate for your firm given that the nominal annual interest rate is equal to sixth digit of your student ID from the left, for example, if your student ID

number is S3409112, the interest rate is 1% p.a (in the event that your digit is 0, treat is as a 9).

Note that the nominal interest rate is compounded monthly

Briefly discuss what is the difference between an effective annual interest rate and nominal interest rate quote?

(2 Marks) SOLUTION

Based on my student ID number: s3xxxx6x

Nominal Annual Interest Rate (i) = 6% = 0.06 (As my sixth digit number ID from left is 6)

Nominal Interest Rate compounded monthly => Compounding 12 times per year => m=12

 Effective Interest Rate (i e ) =? (%)

i e = (1+ i

m)

m

– 1

= (1+0.06

12 )

12 – 1 = 0.0616778

= 6.16778%

 The annual effective interest rate for my firm given that the nominal interest rate of 6% is

6.16778%

The concept of the interest rate takes two structures, which are nominal interest rate and effective interest rate A nominal interest rate works as per the simple interest and does not take into account

of interest being compounded more than once each year On the other hand, the effective interest rate does take the compounding period into account, hence, the effective interest rate is considered a more exact measure of interest charges

Question 3

What is the shape of the yield curve given the term structure in the graph of Vietnamese Governmental bonds below? Utilising an adequate theoretical lens, discuss what expectations are investors likely to have about future interest rates?

(2 Marks)

According to Market (Pure) Expectation theory, an upward sloping yield curve proposed that

investors expect to raise the short-term interest rate in the future over the period to confront negative influences of higher risk in long-term investment, as well as to enlarge returns, regardless

of maturity Thus, the short-term interest rate will surge which can be considered lead to the increase of long-term interest rate averagely based on these theoretical expectations However, investing long-term tend to be riskier with lesser liquidity, consequently, issuers must offer higher interest rates to make up higher returns for greater risk level associated with long-term

investment-called liquidity premium, attract more investors’ fund supply resources based on Expectations plus

liquidity premium theory This contributed to the increment of yield rate in the future and the

upward-sloping shape of the Vietnam yield curve

The Vietnamese yield bond curves present as a normal yield curve having the typical upward trend with the remarkable interest rate increase in the long-term until Y2 to Y24, which means investors can receive a larger amount of yield of holding bonds in a long-haul period Also theoretically, the normal yield curves (upward sloping curves) present that the long-term interest rate tends to be higher than the shorter-term interest rate However, investment for the long-term will be much riskier, therefore investors would expect higher long-term interest rates in the future to obtain the higher returns, purport to compensate for potentially higher risks of holding long-term bonds Simply take an observation at the "Vietnam (13 Mar 2022)" curve in the diagram, investors had

earned higher yields for their investment projects Evidently, they can earn roughly 1.5% in Y2 and then obtained double (3%) at Y24 Also, the 1M located higher than the 6M line indicated that the bond yield obviously rises in the future All have shown that longer-term bonds can be expected to pay higher returns by investors to attract their reinvestment in Vietnamese Government Bond for achieving optimal profits

Question 4

The following statement is True or False: Assuming the pure expectations theory is correct, an upward-sloping yield curve implies that interest rates are expected to decline in the future Briefly explain

(2 Marks)

According to the Market (pure) expectation theory (as this theory is assumed is correct), an

upward-sloping yield curve implies that many investors expect the future short-term interest rates to rise to evade the long-term risks and maximize their profits A large number of investors believe holding their assets in the long-haul periods is presented to be riskier, for example, changes in the interest rate and exposure to possible defaults Investing money for a long period means investors lock up their invested money in other ways, so the opportunity cost of holding those long-term securities has increased as their returns can be earned from other better investments Furthermore, if investors hold financial assets for a long duration with the fixed-rate interest, they can face their security price fall, and lose many potential profits due to the influences of inflation on the time value of

money Hence, based on the Pure Expectation theory, there will be a surge in short-term interest

rates in the future, which also increases the long-term interest rate because the long-term interest rate is considered as the average of expected short-term interest rates

Long-term investment offers more benefits for most borrowers to satisfy their financial requirements but sustains higher interest rate risks than short-term ones for investors So, to persuade investors to buy long haul securities, financial issuers must propose higher interest rates to recompense greater yields, aiming to reduce the high-risk potential in long-duration investments, and incentivize investors to invest more, which provides a surplus of fund supply in long-haul stages Because of the previous mentions, the slope of the yield curve will move upward to represent the higher yields associated with longer times to maturity The longer the maturity spread, the higher the interest rate level is expected by the financial market investors It demonstrates that

an upward sloping yield curve suggests an increase in interest rate in the future As a result, the

claim of “Assuming the pure expectations theory is correct, an upward-sloping yield curve implies

that interest rates are expected to decline in the future” is considered false.

Question 5

A company plans to purchase a zero-coupon bond with a face value equal to the fourth digit number of your student number from the left multiplying with $1,000,000 (for example, if the

fourth digit of your student ID S3409112, the face price of the bond will be 9 * 1,000,000 =

$9,000,000 in the event that your digit is 0, treat is as a 9), a time to maturity of 1 year, and annually compounded interest The yield to maturity of this bond is equal to fourth digit of your

student ID from the left, (for example, if your student ID number is S3409112, the interest rate is

9% p.a., in the event that your digit is 0, treat is as a 9) Calculate the price that your company is willing to pay for this bond

(2 Marks) SOLUTION

Based on my student ID number: s3xx7xxx

Face Value (FV) = 7 x $1,000,000 = $7,000,000 (As my fourth digit number ID from left is 7) Time to maturity (t) = 1 year

Yield to maturity (y) = 7% =0.07 (As my fourth digit number ID from left is 7) (annually compounded interest)

 Price of bond (PV) =? ($)

PV = FV

(1+ y )t

 PV = 7,000,000

(1+0.07)1

 PV = 6,542,056.075 ($)

 To sum up, the price of zero-coupon bond is $6,542,056.075