Question

Discussion Post 2 Discussion Post 2: FIN 4385 Due date: March 27 (Tuesday) by 11.59 PM Submit your response by assigned date. Although there is no limit on the length of your answer it is expected to be concise and to the point. Q. You believe interest rates will soon fall. a. Would you rather own a three-year, 6 percent coupon, fixed-rate bond or an equivalent-risk, three-year, floating-rate bond currently paying 6 percent interest? b. Would your answer to (a) change if you were contemplating issuing a bond rather than owning one? If so, how? c. Would your answer to (a) change if, as an investor, you believed interest rates would soon rise? If so, why? d. In the current market scenario with low interest rate if you are planning to buy a new house in next 60 days would you prefer a fixed rate mortgage or variable rate mortgage? Explain?

Answer 1

a) Considering that I believe that interest rates will soon fall, I will own a three year 6 percent fixed rate bond instead of three year floating rate bond (currently 6 percent). The reason for the same is that as the interest rate falls, interest received on floating rate will also fall whereas interest received on fixed bond will remain same. Hence more the cash flow better the bond yield.

b)Yes, my answer to (a) will change in case i was contemplating issuing a bond, In this case i would rather issue a three year floating rate bond (currently 6 percent) instead of issuing a three year - 6 percent fixed rate bond. Floating rate bond will decrease my interest outflow in this case as I expect that interest rates will fall very soon.

c) Yes, my answer to (a) will change if as an investor I believe that interest rates would rise very soon. In this case I would rather own a three year floating rate bond (currently 6 percent) instead of issuing a three year - 6 percent fixed rate bond. Increase in interest rates will increase the interest received on floating rate bond as the compared to fixed rate bonds in which the interest received would remain constant.

d) As stated that current market scenario is of low interest rate, I would prefer to have a fixed rate mortgage instead of variable rate mortgage. As the interest rates are low in current market, i would try to lock in low fixed interest rate mortgage for longer tenure. In future when interest rates rises, cash outflow from fixed rate mortgage will be at lower fixed rate instead of increased floating rate.