Question

Question1 Matury Curve (A) Curve (B) Curve (C) (a) Consider Yield Curve A as shown above. In your answer-book construct a brief but concise explanation of the shape of this yield curve based on Expectations Theory. Do not make use of any mathematical formulae as part of your explanation. b) Consider Yield Curve B as shown above. In your answer-book construct a brief but concise explanation of the shape of this yield curve based on Liquidity Preference Theory. Do not make use of any mathematical formulae as part of your explanation. (c) Consider Yield Curve C as shown above. In your answer-book construct a brief but concise explanation of the shape of this yield curve based on Market Segmentation Theory Do not make use of any mathematical formulae as part of your explanation. Investor A, who pays income tax at the rate of 25%, buys a portfolio of 100 Share X's and 50 Share Y's at an overall price so as to make a net-yield of 7% pa. on the entire transaction in perpetuity (a) Calculate the price paid by Investor A for the portfolio rounded up to the next euro. Investor A held the portfolio for 4 years from the purchase date. It turned out that Share X's dividend amounts and Share Y's dividend amounts did not in fact increase from the amounts first paid to Investor A (and detailed previously) during this 4-year period. At this point Investor B buys 25% of Investor A's X shares and 5096 of Investor A's Y shares. Investor B is not subject to any form of tax. Investor B held the shares for a further 4 years before selling all of them on the market for a total price of 150. (b) Calculate the total price at which Investor A sold the shares to Investor B if Investor B made a yield of 7% pa. on the transaction. Assume there were no increases to dividend amounts over this further 4-year period. Investor A held the remaining portfolio of shares for a further 4 years before selling it on the market for a price of €350. Investor A pays capital gains tax at the rate of 20%. Inflation averaged at 2.5% p.a for the first 3.5 years of Investor A's transaction and 2% pa. thereafter (c) Calculate a good estimate of the net annual real yield obtained by Investor A on the transaction. (d) Did Share X contribute more or less in the way of a 'real unitized return' than Share Y to Investor A on this transaction? Explain clearly your rationale on this point.

Answer 1

Answer:

Question 1

given 3 curves as shown above.

(a) from yield curve A explanation of the shape of yield curve based on Expectations Theory is:

Expectation theory:

The expectation theory asserts on the following points

This theory gives the rationale for the shape of yield curve.

The long term rate is an average of expected future short term interest rests.

The yield curve will be upward sloping when the interest rates are expected to rise in future.

The yield curve will be downward sloping when the interest rates are expected to decline in future.

(b) from yield curve B explanation of the shape of yield curve based on Liquidity preference theory is:

Liquidity preference theory:

Liquidity preference theory is based on the following propositions:

This uncertainty of interest rates increases with time.

This is the reason that the lenders prefer to lend for the shorter periods and borrowers prefer to borrow for the longer periods.

Long term securities are more risky than the short term securities.

The risk premium related to the long term securities are called liquidity premium.

The yield curve under liquidity preference theory is upward sloping because of the liquidity premium.

(c) from yield curve C explanation of the shape of yield curve based on Market segmentation theory is:

Market segmentation theory:

The market segmentation theory asserts on the following points:

The long term and short term securities are not the substitute of each other.

Both of these securities have different markets.

Some investors prefer to invest in the long term securities while the others prefer to invest in short term securities.

The shape of yield curve will be determined by the demand and supply factors of the securities.