Ask Question, Ask an Expert

+1-415-315-9853

info@mywordsolution.com

Ask Financial Management Expert

Section A: Case Study:

On the advice of some of its wealthiest alumni, Clare College has borrowed £15m on a 40-year inflation- linked loan. One year, as any beleaguered banker will tell you, is a long time in the markets. Banks crash, governments bail out and the landscape of the City shifts forever. But in the cloistered colleges of Cambridge University it’s a mere blip in financial history and the brightest academics in the land are banking on the good times rolling round once again.

Clare College, Cambridge is attempting to cash in on the current economic crisis by borrowing money for the first time in its 700- year history to take advantage of cheaper shares. On the advice of some of its wealthiest alumni, it has borrowed £15m on a 40 year inflation- linked loan, which, it hopes, will one day in the distant future reap a profit of £36m.

Only Oxbridge with its bulging endowment coffers could afford to squirrel away £15m over such a long period of time, as Donald Hearn, Clare’s bursar freely admits. “Because we have a very, very long term perspective – we’ve been around for 700 years and plan to be around for at least 700 more- we have the advantage of not worrying about short term thresholds,” he said. “We are putting the £15m away for 40 years and will not touch it for all that time.”

The college has borrowed the money at a real rate of interest of 1.09% to invest it in rock-bottom stocks and shares. The length and type of loan makes it the first of its kind for any British or American college, according to HSBC, who did all the work on the deal. Rather than a conventional loan paying back the same amount of money in 40 years plus interest, the inflation-linked loan means the college will have to pay back an estimated £70m in 2052 but with a projected profit of £36m.

“Because real interest rates adjusted for inflation are so unusually low it happened to be one of those occasions where we could borrow at 1.09% and it’s almost inconceivable that real returns on equities will average less than 1.09% over the next 40 years,” Hearn said.

Because UK institutions have been forced to match their long-term liabilities very closely, long-term inflation-linked yields in the UK are very low. The real yield on the 2052 I/L gilt is 0.8 per cent per year. The real yields on comparable I/L government bonds in the US and France are 3.1 per cent and 2.6 per cent respectively. Clare is borrowing at 1.09 per cent (including a cap on its nominal liability at 7 per cent inflation). One Independent City expert told the Financial Times: “They are almost bound to make money, when you allow for rises in equity prices and dividends over the next 40 years.” This belief is reinforced by Clare’s view that stock markets are now at or near their bottom.

Required:

problem a) Critically assess the theoretical and empirical evidence for the belief that ‘it’s almost inconceivable that real returns on equities will average less than 1.09% over the next 40 years’.

(Your answer should include reference to risk aversion and the equity risk premium). 

problem b) Critically assess the theoretical and empirical evidence for the belief that the strategy outlined in the case is less risky over the long run than it would be over a short period of time.

(Your answer should include reference to the arithmetic mean, geometric mean, and standard deviation in forecasting risk and return over different time periods; and the meaning and relevance to this particular case of ‘mean reversion’).
                            
problem c)
It is suggested in the case study that ‘stock markets are now at or near their bottom’ and ‘they are almost bound to make money’. In relation to these statements, with relevant data and evidence, discuss to what extent market timing is feasible using:

i) Reverse yield gap
ii) Tobin’s q
iii) PE ratios
iv) Charts, including moving averages

problem d) Discuss the theoretical and empirical arguments for Clare College including commodities as an additional long-term asset class.

Section B:

problem a) find out both Macaulay and modified durations of the 8-year, 8.5% coupon bond given a flat yield curve at 10%.

problem b) describe why zero coupon bonds have a higher Macaulay Duration than coupon paying bonds of the same return.                                                      

problem c) Comments on what is meant by the statement: “The financial markets are markets for loanable funds.”

problem d) Define the following international bonds and markets:

i) Eurobond Market
ii) Foreign Bond
iii) Internal Market or National Market
iv) External Market or Offshore Market
v) Interbank Foreign Exchange Market                                           

Section C:

problem a) Generate the price-yield curve for a zero-coupon bond with a face value of £100 and 260 actual days to maturity using the following annual yields: 4%, 4.25%, 4.5%, 4.75%, 5%, 5.25%, 5.5%, 5.75%, 6%, 6.25%, 6.5%, 6.75%, 7%, 7.25, 7.5%, 7.75%, and 8%. Use actual/actual day count convention.

problem b) Given a 10-year, 8% coupon bond with a face value of £100 and semi-annual coupon payments:

i) Generate the bond’s price-yield curve using annual yields ranging from 5% to 10% and differing by .5%.
ii) What is the price change when the yield increases from 8% to 8.5%?
iii) What is the price change when the yield decreases from 8% to 7.5%?
iv) Comment on the capital gain and capital loss you observe in b and c.
v) Comment on the features of the price-yield curve.

problem c) describe why the yield curve for lower quality bonds could be negatively sloped when the yield curves for other bonds are not.                                                             

Financial Management, Finance

  • Category:- Financial Management
  • Reference No.:- M9423

Have any Question? 


Related Questions in Financial Management

The drying rate in an industrial process is dependent on

The drying rate in an industrial process is dependent on many factors and varies according to the following distribution. Minutes Relative Frequency 3 .14 4 .30 5 .27 6 .18 7 .11 Answer the following questions: (Be sure ...

1 a firms profit margin is less than its peer groups which

1. A firm's profit margin is less than its peer group's. Which of the following statements draws an INCORRECT implication from this comparison between asset utilization ratios? The firm may not be managing its cost of go ...

Burton corp is growing quickly dividends are expected to

Burton Corp. is growing quickly. Dividends are expected to grow at a rate of 29 percent for the next three years, with the growth rate falling off to a constant 6.8 percent thereafter. If the required return is 15 percen ...

Companys ore reserves are being depleted so its sales are

Company's ore reserves are being depleted, so its sales are falling. Also, because its pit is getting deeper each year, its costs are rising. As a result, the company's earnings and dividends are declining at the constan ...

You are considering two savings options both options offer

You are considering two savings options. Both options offer a 4% rate of return. The first option is to save $1,200, $1,500, and $2,000 a year over the next three years, respectively. The other option is to save one lump ...

1 tampt has a bond with 7 years to maturity and a coupon

1. T&T has a bond with 7 years to maturity and a coupon rate of 4.6%. The coupon is paid annually. If the current price of the bond is $950, what is the YTM? a. 1.21% b. 2.73% c.5.48% d. 21.49% 2. What is true about pref ...

Operating exposure can be defined as the future home

Operating exposure can be defined as: the future home currency values of the firm's assets and liabilities the extent to which the firm's operating cash flows would be affected by random changes in exchange rates the sen ...

1 a treasury bond has a face value of 10000 and is

1. A Treasury bond has a face value of $10,000 and is currently priced at $10,165.33. The bond has a current yield of 6.276 percent. What is the coupon rate on a $10,000 bond? 2. Hi-Tek plans to pay a $6 per share divide ...

Which one of the following statements most accurately

Which one of the following statements most accurately describes how Earned Value (EV) data should be used to determine the budget requirement for a contract? Develop an Estimate at Completion and add appropriate profit o ...

1 assume you graduate with 31300 in student loans at an

1. Assume you graduate with $31,300 in student loans at an interest rate of 5.25 percent, compounded monthly. If you want to have this debt paid in full within three years, how much must you pay each month? 2. Sara is th ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro

Describe what you learned about the impact of economic

Describe what you learned about the impact of economic, social, and demographic trends affecting the US labor environmen