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1) Assume that:

(a) Yield on the five-year risk-free bond is 7%.

(b) Yield on the five-year corporate bond issued by company X is 9.5%.

(c) A five-year credit default swap providing insurance against company X defaulting costs 150 basis points per year.

What arbitrage opportunity is there in this circumstance? What arbitrage opportunity would there be if credit default spread were 300 basis points instead of 150 basis points? Provide 2 reasons why arbitrage opportunities like those you identify are less than perfect.

2) Which of the given statements is correct?

a) For the project with normal cash flows, any change in WACC will alter both NPV and IRR.

b) To determine the MIRR, we first compound cash flows at regular IRR to determine the TV, and then we discount TV at the WACC to determine the PV.

c) NPV and IRR methods both suppose that cash flows can be reinvested at WACC. Though, the MIRR method supposes reinvestment at MIRR itself.

d) If two projects have same cost, and if their NPV profiles cross in upper right quadrant, then project with higher IRR probably has more of its cash flows coming in later years.

e) If 2 projects have same cost, and if their NPV profiles cross in upper right quadrant, then project with lower IRR probably has more of its cash flows coming in the later years.

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M914373

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