Reinvestment Risk - Assignment Example

The paper "Reinvestment Risk" is a great example of an assignment on finance and accounting.

6a. Net Interest Income=Interest income- Interest expense.

Interest income=10% X $10,000

=$1000.

Interest expense= 6%x $10,000

=$600

Therefore, Net interest income =$1000- $600

=$400.

b) 2nd-year Net interest income

Interest income= 11% X10, 000

= $1100.

Interest expense=7% x10, 000

=$700.

Therefore, net interest income=$1100-$700

=$400

The result is due reinvestment risk because despite the investor reinvesting there is no change in the net income after the change in interest rates while refinancing risks is due to the inability of the investor to meet the liability of their investment (Franzoni, Nowak, & Phalippou, 2012).

c.)Value of assets=debt +equity

Assets= cash + bond

=$1000+$9446

=$10,446

Debt=certificate of deposit t+ equity

= 10,000+y

Therefore, $10446=10000+y

Equity=10446-10000

=$446

d ) If the market interest rates decrease by 1% by the end of year 1, then the market value of equity will be higher than $1000 because of the existing reinvestment risks, such that a decrease in the interest rates will increase the chances of reinvestment of the bond thus an increase in the market value.

e.)The operating performance and the market value of the firm have been greatly affected by the maturity period and the changes in the interest rates. An increase in the interest rates reduces the value of assets and increases the value of liabilities while a decrease in market interest rates increases the rate of assets and decreases the value of liabilities.

12) Net interest income=interest income-interest expense

Interest income=10% x50, 000,000

=$5,000,000

Interest expense=8%x 50,000,000

=4,000,000

Therefore, net interest income=$5000000-$4000000

=$1,000,000

When the interest rates increases at the end of year 1,

Interest income=11%x50, 000,000

=$5,500,000

Interest expense=9%x50, 000,000

=$4500000

Therefore, net interest income=5500000-4500000=$1,000,000

There will be zero impact on net interest income if the interest rates increase by 1% at the end of year 1.This is because the bond has been held to maturity and even if the interest rate changes the value of the investment does not change.

Chapter 5

16). value of assets = value debt +value equity

Therefore,

$340=$295+equity

Equity=$340-$295

=$45.

b) WAMA= (value of asset/total value of asset) x time to maturity

Total value of assets= $340

Treasury bond= ($175/$340) x1

0.51

Corporate bond= (165/340) x14

6.79

Therefore WAMA= 0.51+6.79

=7.3

C) WAML= (value of liability/total value of liabilities) x time to maturity

The certificate of deposit has already matured.

Total value of 5year deposit= (160/295) x4

=2.17

Therefore, WAML= 2.17

d) Maturity gap =WAMA - WAML

=7.3-2.17

=5.13

e) Since the maturity gap is greater than zero it implies that an increase in the market interest rates will result in to decrease in M Match’s equity while a decrease in the market interest rates will result in an increase in M Match’s equity.

f) Value of Treasury bond= $175-(2% x175)

=$171.5

Value of corporate bond =$165 - (2% x165)

=$161.7

Value Certificate of deposit=$135 + (2% x 135)

$132.3

Five year deposit =$160 x (2% x160)

=$156.8

g) Asset value = debt +Equity

$171.5 +$161.7= ($132.3 +$156.8) + Equity

Therefore equity=333.2-289.1

=$44.1

Therefore the impact of the equity is a decrease of $0.09.

Percentage change=0.09/45 x100

=2%

CHAPTER 6

1) Current price=cash flow at maturity/ (1+yield to maturity)n

Cash flow to maturity= 7%/2+100

=103.5

Currentprice=3.5/(1.03525)1+3.5/(1.03525)2+3.5/(1.03525)3+3.5/(1.03525)4+3.5/(1.03525)5+3.5/(1.03525)6+3.5/(1.03525)7+3.5/(1.03525)8+3.5/(1.03525)9+103.5/(1.03525)10

=$109. 376

2) a Interest= 10% x$1000

=$100

Total cash flows= $1000+$100

=$1,100

Quarterly payments=$1100/4

=$275

6) Duration =yield to maturity/interest rate

=0.115/0.1

=1.15 years

This Euro note will have a duration of 1.15 years. This is the measure of the length of time it will take the Euro note cash flows to repay the investors the price they paid for it. The lesser the duration Euro note the faster the investors will get back their investment through coupon payment.

If the yield is 5.5%’

Then duration=0.055/0.1

                        =0.55 years    

CHAPTER 7

 Funding gap=Total current assets –total current liabilities.

30 days period funding gap =$75-$ 170

                                   = ($95)

91days period funding gap= ($75+$75)-($170)

                       = ($20)

2 year period reprising gap = ($75+$75+$50)-$170

                                   =$30

1. b) Net interest income = interest income – interest expense

                                   = (7.1% x$75)-(7.05% x $170)

                                   = (6.66)

                        The impact of the increase in the rate of interest on the net interest income is ($6.66-$6.61) which is equal to 0.05.

1. c) Duration gap= duration of assets-duration of liabilities

                        =3.41-3.5

                        =0.09 year

1. d) From the funding gap and the duration gap calculated above it is true that the interest risk exposure is very high and thus the investor will take a very long time before they recoup their investment.
2. e) New value of note =0.995x $75

                        =$74.625

The market value of the interest rate will decrease when the interest rate increases by 50basis points with approximately 0.375 since both have the same value and rise by the same rate.