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Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy? a. Households start saving a larger percentage of their income. b. The economy moves from a boom to a recession. c. The level of inflation begins to decline. d. Corporations step up their expansion plans and thus increase their demand for capital. e. The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

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Collen Von
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2 Nov 2018

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Compose a 4-6 page report, double-spaced, on the following topic. Be sure to illustrate your report with relevant financial numbers and data, and to explain the significance of this data. ** DUE: Friday, April 29th 11:59PM EST ** BACKGROUND INFORMATION: During the Carter administration, long-term US Treasury yields exceeded 15%, and short-term T-Bills yielded near 20%. After Reagan's inauguration, interest rates began to fall as Fed Chairman Volcker's restrictive monetary policy succeeded in containing inflation. Over the past 25 years, US rates have steadily declined: T-Bills are hovering under 1% and the long bond is yielding about 4%. Lately, though, rising oil prices have incited inflationary forces. China and other developing nations have increased their consumption for oil, metals, materials, and food. Thus, both foreign and domestic factors have spurred demand and are contributing to rising prices on a global scale. In addition to this commodity-induced inflation, US consumers are faced with rising costs for essential services such as healthcare and education. The Chairman of the Federal Reserve, Ben Bernanke, is faced with a dilemma. Should the Fed increase rates to contain inflation; or, should the Fed keep rates very low to spur the US economy which is beset by a collapse in home values, an extensive banking crisis, and a faltering stock market ? YOUR ASSIGNMENT: Given this economic background...Compose a 4-6 page report, double-spaced, on the following topic: If the Fed decides to raise interest rates next year, what effect would rising rates have upon the following: (1) Consumer financing for big-ticket items such as autos and homes; (2) the present and future values of annuities; (3) the NPV calculation; (4) the WACC; (5) corporate earnings ? Be sure to illustrate your report with relevant financial numbers. Hint: for topic (3), above, one approach you might adopt is to cite the NPV calculation from previous case problems, then to contrast it against a new calculation performed with a higher interest rate. Cite the numeric effect upon the NPV, and then explain its rationale and its significance. This is the kind of "numeric illustration" that you should provide for each of the five topic sections.

Many Fedwatchers are convinced the central bank is just hours away from announcing the first increase to its benchmark federal-funds rate in nearly a decade. If that happens, there will be repercussions for stocks and bonds, on Main Street and Wall Street, and for economies in all corners of the world. For some, the impact could be felt right away, and for others, the shakeout may be felt more acutely over time, especially if the Fed follows the first rate hike with sustained tightening.

Here’s a roundup from Journal staffers about who wins and who loses when rates rise.

Banks. Banks have been yearning for the Federal Reserve to start raising rates for years to stem the decline in their net interest margin, an important measure of banks’ profitability. The interest rates banks charge on many loans are directly tied to the Fed’s target rate, meaning they immediately earn more interest on those items, while deposit rates move more gradually. Goldman Sachs Group Inc. analysts recommends owning the stocks of banks whose depositors are likely to stick around: Bank of America Corp., J.P. Morgan Chase & Co., Wells Fargo & Co., PNC Financial Services Group, Inc. and E*Trade Financial Corp. –Peter Rudegeair

Corporate bonds. Corporate bonds could take a hit if the Fed raises rates, but should outperform benchmark U.S. Treasury debt, analysts say. Part of the reason is bond math: When rates rise, prices fall. But corporate bonds carry higher interest rates than Treasurys, to compensate investors for the added risk of default, so these bonds have more cushion to absorb a rate increase. After a major selloff in the market for higher-yielding junk debt in recent weeks, some analysts now expect that junk bonds–excluding the hardest hit energy and commodity sectors–will perform better than investment-grade debt should the Fed make a move. “As long as we’re selective about credits, [high-yield bonds] probably offers us a better opportunity in a rising-rate environment,” said Priscilla Hancock, global fixed income strategist at J.P. Morgan Asset Management. “When the Fed raises rates, it’s supposed to suggest the economy is strengthening.” –Mike Cherney

Dollar. Most investors and analysts say the dollar’s nearing the end of its bull run, even if the Federal Reserve raises rates Wednesday or early in 2016. The greenback’s risen ahead of past tightening cycles, and then sold off before interest rates reached their apex. “The European Central Bank probably has to step up and ease policy again in 2016, and the Fed will likely have more than one interest-rate move next year; add those up and yield spreads still are generally moving in the dollar’s favor,” said Westpac Bank’s Richard Franulovich. “The dollar’s rally is hitting its mature phase, but it’s definitely got further to run.” The dollar has already strengthened 24% against other currencies since June 2014. Many investors predict that uneven U.S. growth or volatile global markets would discourage the Fed from raising rates as rapidly as in previous tightening cycles, limiting further upside. –James Ramage

Emerging markets. A rise in U.S. interest rates could provide a litmus test for many emerging economies and show how prepared they are to withstand the potential capital outflows triggered by higher U.S. yields and a stronger dollar. Retaining foreign capital has already been challenging for emerging countries, many of which are struggling with slowing growth and substantial debt. So far, emerging-market currencies have absorbed most of the pains, losing 18% against the dollar this year through last week. Stocks, which are priced in local currencies, were down 17%, but dollar-denominated EM bonds have fared better, still managing to hold on to single-digit gains this year. “Given how much EM currencies have already fallen this year, we don’t expect much turmoil in the near term,” if the Fed begins to tighten as expected, said Jorge Mariscal, chief investment officer of emerging markets at UBS Wealth Management, which oversees $1.9 trillion in invested assets. “What matters is the path of the interest rates in the U.S. going forward.” UBS expects four more rate increases next year, which will be problematic for a number of vulnerable emerging countries, including Brazil, Turkey, South Africa and Indonesia. –Carolyn Cui

Euro. Expectations for higher U.S. interest rates and easier monetary policy in the eurozone drove the euro down 22% against the dollar since May 2014. In theory, a Fed rate increase should push the euro even lower. But the common currency’s future has been complicated by investors’ penchant for using euros to fund trades for higher-yielding assets. Thus, the euro stands to gain whenever investors grow risk-averse and trim or exit those bets. In addition, euro-bears have proven particularly sensitive to central-bank expectations. The euro isn’t likely to reach parity with the dollar anytime soon, says Mizuho Bank’s Sireen Harajli. “Fundamentals would call for a weaker euro,” she says. “But unless the ECB asks for more stimulus, it would be difficult for the euro to weaken significantly from here.” However, few investors foresee a substantial euro rally in the coming weeks, either. –James Ramage

Gold. Prices slumped to five-year lows in recent weeks as expectations of higher rates from the Fed hit fever-pitch. Bets that benefit if gold prices fall outpaced wagers that gold will rally by a record margin of 17,949 contracts on Dec. 1, according to CFTC data. Tighter monetary policy is likely to make it harder for gold, which doesn’t pay interest, to compete with yield-bearing assets like Treasury bonds. However, some market watchers say the policy shift is already reflected in low gold prices, and the market could pop higher if the Fed reiterates that subsequent rate increases will be spread out. –Tatyana Shumsky

High-quality stocks. Stocks with healthy balance sheets, high returns on capital, muted volatility, elevated margins and track records of stable sales and earnings growth stand to benefit when rates are rising. Per data compiled by Goldman Sachs Group Inc., these names have a history of outperforming their lesser-quality counterparts in the three months following an initial rate rise. Companies with strong balance sheets, for instance, typically outperform those with weak ones by an average 5% three months after liftoff, according to Goldman. –Kristen Scholer

Housing market. Higher short-term interest rates won’t wreck housing, and in the near-term might have hardly any impact at all. For one, the rate of mortgages, as with those of other long-term loans, have only an indirect relationship with short-term rates and are influenced more heavily by factors such as inflation expectations and economic growth. The rate on a 30-year fixed-rate mortgage–which last week was at 3.95% according to Freddie Mac–almost surely is already pricing in expectations of a Fed move on Wednesday. That said, over the next year, some economists expect mortgage rates to rise about half a percentage point. All else being equal, that would hurt home prices as borrowers would need to buy a cheaper house to keep the same monthly payment. A recent poll of home buyers by real-estate broker Redfin Corp. said that higher mortgage rates would have the biggest impact on the lower-end of the housing market. –Joe Light

Life insurers. Few companies are rooting for a sustained rise in interest rates as loudly as U.S. insurers are, and life insurers are leading the cheers. Most insurers earn substantial income from investing premiums, and they typically favor high-quality bonds, whose yields have plummeted in recent years amid the sustained low interest-rate environment. Life insurers depend more heavily on investment income than do car, home and some sorts of business insurers. That’s because life insurers can collect premiums for decades before paying out a claim, and rely on that investment income to make a policy profitable. For many older policies on life insurers’ books, the companies expected to earn far-higher yields than newly invested cash fetches today. MetLife Inc. Chief Executive Steve Kandarian argues that life-insurance buyers will benefit too, as low rates make the cost of the coverage “much more expensive than it needs to be.” Low rates also raise the cost of running risk-management programs. Such hedging programs are important for those life insurers selling certain types of income-stream guarantees. –Leslie Scism

Money-market funds. The Fed’s 0.25% interest-rate increase will begin showing up in the yields of money-market mutual funds within days, welcome news for investors. Funds for individual investors that invest in both corporate and government debt currently yield just 0.01% on average, according to researcher iMoneyNet Inc. The higher rates should be fully reflected in just over a month, but investors in some money funds may not see the full increase, says Peter Crane, president of Crane Data LLC. Fund managers have temporarily trimmed fees to keep expenses from eating up the funds’ paltry yields and taking a bite out of investors’ principal. As interest rates rise, some part of the increase is likely to go toward increasing funds’ fee charges, Mr. Crane says. Across the industry, “my wild guess is that half of the first rate hike might flow through to investors, but it could be more,” he says. –Daisy Maxey

Oil. The latest plunge in oil prices has pummeled the stock and bond prices of some U.S. energy producers and raised fears of a spate of defaults across the sector. Increased interest rates could hurt producers that are already struggling to pay debts amid sharply lower cash flow. That could be positive for oil prices in the long run, if U.S. producers are forced out of business and domestic production declines as a result, reducing the global glut of crude. But in the near-term, the most direct effect on oil prices would probably come from the dollar. If the dollar still has room to run in the wake of a rate hike, the rising dollar could weigh on oil prices by making dollar-traded oil more expensive for buyers using foreign currencies. –Nicole Friedman

Rate-sensitive stocks. Companies considered rate-sensitive are those that have high dividend yields. Consumer staples, telecoms and utilities fall into this category, as all three sectors yield more than the S&P 500. They have been attractive investments amid the low-yield environment the past several years. But, as rates rise, bonds are poised to become more attractive than their current state, which could steal some of the thunder away from high-dividend yielding shares. –Kristen Scholer

Stocks with a large portion of floating-rate debt. Firms that have a decent amount of variable debt–where interest payments adjust as market rates rise or fall–stand to take a hit. As rates rise, so too will the cost of floating-rate debt. “When the tightening cycle finally starts, the immediate impact will be felt by firms with high proportions of variable rate borrowing,” wrote Goldman. Among the 10 S&P 500 sectors, financials and industrials have the greatest portion of floating-rate debt with it accounting for 16% and 10%, respectively, of all debt for those sectors. –Kristen Scholer

Treasurys. The Fed’s policy has a more direct impact on short-term government debt whose yields are highly sensitive to changes in the fed-fund rate. The yield on the two-year note recently traded near 1%, headed for the highest closing since May 2010. Many investors expect the yield to rise if the Fed raises interest rates on Wednesday. But some argue the yield has nearly doubled in the past two months and if the Fed signals that further tightening will happen at a very slow pace, some may book profit from their short bets on the two-year notes.

The Fed’s impact on long-term bonds is more subdued. The value of those bonds are influenced by a broad basket of factors, including the global growth and inflation outlook. A rate increase by the Fed may drive some investors to sell long-term bonds. But given concerns about the global economic outlook, there likely plenty of investors who could seek safety in long-term Treasury debt, especially with many focusing on the recent stress from the junk debt market. Any signal of a slow tightening path would keep a lid on long-term bond yields.

One way an interest-rate increase could weigh on the U.S. government debt market is by making newly-minted bonds more attractive to buy, thus dragging down the value of outstanding bonds. –Min Zeng

In the discussion of "housing market," if we keep the same monthly payment (note: these are future cash outflows), will mortgage borrowers be able to buy a cheaper or more expansive house with the rate hike (note: the mortgage loan the borrower takes out to buy the house is the present value)? Explain briefly please.

Question 25

1. What does the efficient market hypothesis require?

1. Financial markets to be competitive.

2. Prices to adjust rapidly.

3. Prices of undervalued securities to fall.

a.

1 and 2.

b.

1 and 3.

c.

2 and 3.

d.

All of these choices.

3 points

Question 26

1. Which of the following does the strong form of the efficient market hypothesis suggest?

1. Inside information will not lead to superior investment results.

2. Inside information will lead to superior investment results.

3. Studying financial statements will not lead to superior investment results.

4. Studying financial statements will lead to superior investment results.

a.

1 and 3.

b.

1 and 4.

c.

2 and 3.

d.

2 and 4.

3 points

Question 27

1. Which of the following is the least broad-based measure of stock prices?

a.

NASDAQ market index.

b.

Dow Jones industrial average.

c.

S&P 500 stock index.

d.

AMEX market value index.

3 points

Question 28

1. What is dollar-cost averaging?

a.

Periodically buying a round lot of stock.

b.

Periodically investing a specified dollar amount in a stock.

c.

A means to increase the average cost basis.

d.

A means to ensure a positive return.

2 points

Question 29

1. Stock dividends cause:

a.

The price of a share of stock to rise.

b.

The price of a share of stock to fall.

c.

The value of the firm to rise.

d.

The value of the firm to fall.

2 points

Question 30

1. Which of the following occurs when a stock has a two-for-one split?

a.

The price of the stock doubles.

b.

The firm's assets increase.

c.

The firm's liabilities decrease.

d.

The par value of the stock is reduced.

3 points

Question 31

1. Dividend reinvestment plans offer which of the following advantages?

1. Deferment of federal income taxes.

2. A convenient means to accumulate shares.

3. Dollar-cost averaging.

a.

1 and 2.

b.

1 and 3.

c.

2 and 3.

d.

2.

3 points

Question 32

1. When the Federal Reserve seeks to expand the money supply, it:

a.

Sells securities.

b.

Buy securities.

c.

Runs a deficit.

d.

Runs a surplus.

2 points

Question 33

1. The sum of cash, currency, and demand deposits is:

a.

M1.

b.

M2.

c.

M3.

d.

M4.


3 points

Question 34

1. If the Federal Reserve lowers the target federal funds rate:

a.

The discount rate rises.

b.

Liquidity in the banking system is increased.

c.

Security prices fall.

d.

Required reserves are also decreased.

3 points

Question 35

1. The anticipation of inflation suggests that the investor should:

a.

Buy bonds.

b.

Anticipate higher interest rates.

c.

Avoid real estate investments.

d.

Sell stocks of gold companies.

3 points

Question 36

1. The current ratio is unaffected by:

a.

Using cash to pay a dividend.

b.

The collection of an account receivable.

c.

Selling inventory for a profit.

d.

Selling bonds and using the funds to finance inventory.

2 points

Question 37

1. Which of the following are true as the debt ratio increases?

1. Fewer assets are debt financed.

2. More assets are debt financed.

3. The ratio of debt equity increases.

4. The ratio of debt equity decreases.

a.

1 and 3.

b.

1 and 4.

c.

2 and 3.

d.

2 and 4.

2 points

Question 38

1. The technical approach suggests that future stock prices are forecasted by:

a.

Past stock rates.

b.

Financial ratios.

c.

Accounting statements.

d.

Monetary policy.

2 points

Question 39

1. The Dogs of the Dow strategy:

a.

Forecasts the direction of the Dow Jones averages.

b.

Suggests buying the Dow stocks with the highest dividend yields.

c.

Outperforms the S&P 500.

d.

Suggests buying the lowest-priced Dow stocks.

3 points

Question 40

1. Behavioral finance combines aspects from which two fields in an attempt to identify human traits that affect investment decisions?

a.

Accounting and finance.

b.

Finance and psychology.

c.

Physics and finance.

d.

Finance and marketing.

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