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Mathetics

Longer-term bonds react more strongly to interest rate fluctuations than shorter-term bonds because they have more future cash flows that will be affected by rate changes. Shorter-term bonds have fewer remaining cash flows so are less impacted by interest rate shifts. Additionally, as a bond nears maturity the impact of interest rate changes on its final payment becomes less volatile. Risk is one of the three critical factors in finance. The future is uncertain so it is important to consider risk and the likelihood of receiving future cash flows in order to accurately assess their value.

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11 views3 pages

Mathetics

Longer-term bonds react more strongly to interest rate fluctuations than shorter-term bonds because they have more future cash flows that will be affected by rate changes. Shorter-term bonds have fewer remaining cash flows so are less impacted by interest rate shifts. Additionally, as a bond nears maturity the impact of interest rate changes on its final payment becomes less volatile. Risk is one of the three critical factors in finance. The future is uncertain so it is important to consider risk and the likelihood of receiving future cash flows in order to accurately assess their value.

Uploaded by

nguyendangkhoak1100086
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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1.

Explain why prices of longer-term bonds react more strongly to


fluctuations in interest rates than those of shorter-term bonds.

Longer-term bonds are more sensitive to changes in interest rates


because:

- they have more future cash flows remaining. These cash flows will
be influenced by the rate changes.
- In contrast, shorter-term bonds have fewer cash flows left, so
they're less affected by interest rate shifts.
- In addition, as the bond moves toward its maturity date, the
impact of interest rate fluctuations on the present value of its final
payment becomes less volatile.

2. Select one of the three critical factors in finance, and briefly


explain its importance.

Risk
The future is uncertain. The valuation of future cash flows depends on
the likelihood of receiving them, and it is crucial to consider this
uncertainty or risk in order to accurately assess their worth.

3. Distinguish between the terms “bond”, “note”, “debenture” and


“consol”.
- Bond – strictly speaking, any debt security, but in common
practice, refers to a long‐term debt security.
- Note – strictly speaking, any debt security, but in common practice
(used on its own) refers to a medium‐term security. Also, in
combination with other words, can be used for short‐term debt
securities (e.g. promissory note, Treasury note).
- Debenture – unsecured bonds.
- Consol – a debt security that does not mature.
4. Briefly explain how long term rates become the average of
expected future short term rates under the Pure Expectations
Theory.

If long-term interest rates differ from the expected average short-term


rates, people will choose to borrow or invest either short-term or
long-term, depending on where they see benefits like lower borrowing
costs or higher returns. Eventually, market forces will push long-term
rates to align with the average of expected short-term rates, getting rid
of any perceived advantage.

5. What information does a stock's beta provide about the share?

- The beta of a stock indicates how much it is influenced by overall


market risk.

- More precisely, it reflects the percentage change in a stock's excess


return caused by market risk factors when there is a 1% change in the
market's excess return.

6. What is a sunk cost"? Should it be included as an incremental


cash flow? Why/why not?
- ​Sunk costs, regardless of whether a project is accepted or rejected, are
costs that have already been incurred or are certain to be incurred.
These costs can include expenses related to feasibility studies, project
preparation, or data gathering, which would still be spent even if the
project is ultimately rejected.
- Sunk costs should be disregarded in NPV (Net Present Value) analysis.
The objective of NPV analysis is to assess the net present value of
accepting a project, enabling us to determine whether this decision will
increase the firm's value.
MCQ

1. to increase the value of the firm => The project must make more
than the cost of capital.

2. The traditional view of markets assumes that investors are


rational.

3. What does the Efficient Market Hypothesis tell us?=> How to


recognise an efficient market.

4. How to recognise an efficient market.=> Speculating

5. Assuming two investments have equal lives, a high discount rate


tends to favour => the investment with large cash flow early.

6. a terminal cash flow?


=> 1.The expected salvage value of the asset.
2. Any tax payments or refunds associated with the salvage value
of the asset.
3. Recapture of any investment in working capital that was
included as an incremental cash outlay.

7. What is the NPV decision rule for discretionary mutually exclusive


projects?
=> Accept the project with the highest NPV, as long as the NPV is
positive.

8. How is the realised percentage return from investing in a share


calculated?
=> Dividends received plus the difference between the selling price
and the purchase price, divided by the purchase price.

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