Interest Rates and Debt Securities Assessment
We commonly speak about ”the” interest rate in financial markets but indeed the financial markets generate many interest rates at an one time. The interest rates are each associated with a defined type of financial security and the rates will then differ based upon the characteristics of that security. Moreover, as we look across time, interest rates will adjust not just because of the nature of the financial security and maybe the default risk of the originating organization but importantly because of environmental changes that impact all rates, such as inflation. We have two purposes in this assignment: 1) to understand these various drivers to interest rates, and 2) to better understand the valuation methods associated with debt securities.
A debt security can have both simple cash flow structures, in which one cash payment is exchanged by the investor for one future cash payment, and more complicated cash flow structure, in which one cash payment by the investor is exchanged for a series of future cash flow. In each case however, the method we will use to form the valuation of the financial security will be the discounting process (i.e. present values) that we examined earlier in the course.
1. Review the resources listed in the Books and Resources area below to prepare for this week’s assignments.
2. Complete the following Spotlight on Skills if you need assistance with the tools used to complete your assignments.
Spotlight on Skills: APA Form and Style
Throughout this course, and others here at University, you are required to follow APA form and style when preparing assignments. If you are unfamiliar with APA form and style, take this tutorial: The Basics of APA Style. Are you already familiar with APA form and style? Keep up with the 2010 changes by taking this tutorial: What’s New in the Sixth Edition. Check out this blog for deeper discussions and examples: APA Style Blog. You can visit: Frequently Asked Questions About APA Style.
Books and Resources for this Week:
Brigham, E. F., & Houston, J. F. (2011) Fundamentals of financial management + Thomson One – Business School Edition
Read Chapters 6 and 7 .
Write an assessment to address the following problems/questions:
1.Form a discussion on the possible determinants of market interest rates. For each determinant offer illustration for when that determinant may tend to be either stronger or weaker and what is the driving force for that differential impact. For example, when would the default risk premium be stronger verse weaker and what seems to be the drivers to that stronger or weak impact?
2.Present and explain the yield curve. Present the three main type of yield curve with regard to shape. Illustrate with numerical examples how future inflation impacts they yield curve.
3.Describe the different types of debt securities. This should be a list of the various securities in each class along with relevant information that defines each security.
4.Develop a valuation model for the long-term corporate bond with a face value at maturity of $100,000, a maturity of 10 years, a coupon interest rate of 6%, and a market yield of 8%. The coupons are assumed to be paid semi-annually. In your development and presentation, include a time line showing the relevant cash flows along with all of the steps that allow you to generate the value (price of the bond).
5.Given the problem above, identify how the bond price will be expected to adjust across time as the bond approaches maturity. You should calculate the price after each 2-year period has passed – i.e., after year 2, year 4, year 6, year 8 and year 10. Graph the resulting movement in the price across time using the resulting values. Explain how this movement in the bond price across time is important for the investor.
Support your paper with at least three (3) resources. In addition to these specified resources, other appropriate scholarly resources, including older articles, may be included. Your paper should demonstrate thoughtful consideration of the ideas and concepts that are presented in the course and provide new thoughts and insights relating directly to this topic. Your response should reflect scholarly writing and current APA standards. Be sure to adhere to Northcentral University’s Academic Integrity Policy.
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