This document is an assignment submission by Barira Nafisa Zaman for the course FIN424 Financial Markets. It addresses 9 questions related to concepts like forward rates, after-tax yields, and debt security yields. For each question, it provides the answer and an explanation of the underlying logic or relationship. For example, it explains that a higher tax rate would decrease the after-tax yield from a corporate bond if the before-tax yield is held constant, as more of the yield would go towards taxes. It also notes that a higher risk-free rate or default risk premium would require an increase in the appropriate yield offered on a security.
This document is an assignment submission by Barira Nafisa Zaman for the course FIN424 Financial Markets. It addresses 9 questions related to concepts like forward rates, after-tax yields, and debt security yields. For each question, it provides the answer and an explanation of the underlying logic or relationship. For example, it explains that a higher tax rate would decrease the after-tax yield from a corporate bond if the before-tax yield is held constant, as more of the yield would go towards taxes. It also notes that a higher risk-free rate or default risk premium would require an increase in the appropriate yield offered on a security.
This document is an assignment submission by Barira Nafisa Zaman for the course FIN424 Financial Markets. It addresses 9 questions related to concepts like forward rates, after-tax yields, and debt security yields. For each question, it provides the answer and an explanation of the underlying logic or relationship. For example, it explains that a higher tax rate would decrease the after-tax yield from a corporate bond if the before-tax yield is held constant, as more of the yield would go towards taxes. It also notes that a higher risk-free rate or default risk premium would require an increase in the appropriate yield offered on a security.
This document is an assignment submission by Barira Nafisa Zaman for the course FIN424 Financial Markets. It addresses 9 questions related to concepts like forward rates, after-tax yields, and debt security yields. For each question, it provides the answer and an explanation of the underlying logic or relationship. For example, it explains that a higher tax rate would decrease the after-tax yield from a corporate bond if the before-tax yield is held constant, as more of the yield would go towards taxes. It also notes that a higher risk-free rate or default risk premium would require an increase in the appropriate yield offered on a security.
Download as DOCX, PDF, TXT or read online from Scribd
Download as docx, pdf, or txt
You are on page 1/ 3
ASSIGNMENT - 1
Financial Market FIN424
SUBMITTED BY
Barira Nafisa Zaman
ID- 20104013
SUBMITTED TO
Sayla Sowat Siddiqui
Assistant Professor, BBS BRAC University
Submission Date 19 October, 2023 7. Forward Rate a. Determine the forward rate for various one-year interest rate scenarios if the two-year interest rate is 8 percent, assuming no liquidity premium. Explain the relationship between the one-year interest rate and the one-year forward rate, holding the two-year interest rate constant. Answer. When the one-year interest rate increases, the forward rate decreases. If the one-year interest rate matches the two-year interest rate, the one-year forward rate becomes zero, and if the one-year rate surpasses the two-year rate, it turns negative. By keeping the two-year interest rate constant, an increase in the one-year interest rate results in a reduction in the forward rate. The smaller the difference between the two-year and one-year interest rates, the lower the interest rate needed in the second year for the combination of the two one-year rates to equal the two-year rate.
b. Determine the one-year forward rate for the same one-year interest rate scenarios in question (a), assuming a liquidity premium of 0.4 percent. Does the relationship between the one-year interest rate and the forward rate change when the liquidity premium is considered?? Answer. The overall connection between the one-year interest rate and the one-year forward rate remains valid.
c. Determine how the one-year forward rate would be affected if the quoted two-year interest rate rises, while both the quoted one-year interest rate and the liquidity premium are held constant. Explain the logic of this relationship. Answer. The forward rate rises as the two-year interest rate increases. A larger gap between the two-year and one-year interest rates requires a higher interest rate in the second year for the combination of the two one-year rates to match the two-year rate.
d. Determine how the one-year forward rate would be affected if the liquidity premium rises, holding the quoted one-year interest rates constant. Also, hold the two-year interest rate constant. Explain the logic of this relationship. Answer. Keeping the one-year and two-year interest rates constant, the forward rate decreases when the liquidity premium is higher. When the liquidity premium is elevated, a larger part of the interest rate difference (two-year rate minus one-year rate) is attributed to interest rate expectations, leading to a lower one-year forward rate. 8. After-tax Yield. Determine how the after-tax yield from investing in a corporate bond is affected by higher tax rates, holding the before-tax yield constant. Explain the logic of this relationship. Answer. When the tax rate is increased while keeping the before-tax yield constant, the after-tax yield decreases. A higher tax rate results in a larger portion of the before-tax yield being set aside for taxes, leaving a smaller portion of the before-tax yield available to the investor.
9. Debt Security Yield.
a. Determine how the appropriate yield to be offered on a security is affected by a higher risk-free rate. Explain the logic of this relationship. Answer. If the risk-free rate goes up, the required yield for a security must also increase. A higher yield is needed to attract investors because they still seek a specific premium over the risk-free rate.
b. Determine how the appropriate yield to be offered on a security is affected by a higher
default risk premium. Explain the logic of this relationship. Answer. the required yield for that security should be raised if the default premium on a security rises. This is because investors would demand a higher return to offset the increased default risk.
