1. A notional principal amount is the amount used as a reference to calculate the amount of interest due on a given financial instrument.
2. A coupon rate is the annual rate of interest at which bondholders receive their coupons on a regular basis until the maturity of the bond whereas yield to maturity is the rate of return of a bond based on the assumption that the issued bond will run up to maturity. The coupon rate enables investor to know the attractiveness of the bond at the face value while the yield to maturity information is essential in understanding the present value of bonds
3. Yes. It can be done by borrowing the foreign currency in an amount equivalent to the present value of the 800,000 Euros or convert the currency into domestic currency at the spot exchange rate.
4. The bond prices and interest rates move in opposite directions because the values of fixed income investments have a negative correlation. It is important to care about the movements as it enables the investor to make decisions of either recalling the bond or allowing it to run until maturity.
5. The value of money fluctuates over a certain period of time. $1000 dollars today cannot be said to have the same value after five years due to inflation factors that decrease its purchasing power. The time value of money concept explains why it is important to prefer present value of money rather than the future value. It is important to understand these concepts as they help investors in making investment decisions where fixed interest is paid on a regular basis.
6. a) The yield curve is a graphical representation of the movement of interest rates of government securities such as Treasury bills, notes and bonds. The curve shows the various yields for different securities at varying times. The curve can offer a good insight into the expected behavior of interests in the market depending on the slope of the curve.
b) The expected rise or fall of interests affects financing decisions for businesses across all sectors of the economy. Business would consider taking credit facilities depending on the expected interest rates. Most market analysts use the curve to predict economic recessions. An inverted curve for instance is a good predictor of an impending recession in the economy. And since interests are a major factor in the economy, it can be said that the behavior of curve offers a glimpse into the general direction of the economy because of its ability to predict interest rates.
7. Changes in money supply in the economy are important because they affect liquidity in the market which is an important ingredient in regulating inflation. The changes in money supply affect the interest rates which in turn impacts on the availability of credit facilities essential for economic activities. The changes should be kept within limits that spur economic growth and development
8. Company A is better capitalized because of the level of equity in the capital structure. The debt expense is charged first on the companys profits before dividends are paid to the shareholders. Such constitution of equity in the capital structure presents a lower risk of failure to generate the regular financial obligations to the financiers of the debt. Also, company B has quasi capital in its capital structure.
9. A long position is created when a trader purchase a currency pair with the anticipation that the price of the purchase currency would rise. If the currency value goes up as anticipated, the trader will sell the currency at higher value whereas a short position is maintained when one sells a currency as a result of the expectation of depreciation in value. To be in a square position the trader positions are equal and offsetting with each other. There is no exposure to trading risks
Meisler, J. M., Archer, M. D., & Bland, J. (2013). Forex essentials in 15 trades: The global-view.com guide to successful currency trading. Hoboken, NJ: Wiley.
Mishkin, F. S. (2005). The economics of money, banking, and financial markets. Reading, MA: Addison-Wesley.
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