QUESTION 1

(the interest rates)

You are a senior financial analyst and have been asked to analyse recent developments in the Euro era and the U.S markets and advise the top management on the economic conditions in both markets. You have collected data on the euro area yields of the central government bonds and the U.S. treasury bond yields. For this purpose, you have downloaded the following data from the European Central Bank and the U.S Federal Reserve Bank on 24^th September 2020 (Mo = month, Yr = Year):

REQUIRED:

1. Considering both yield rates on 24^th September 2020, depict the yield curves charts and describe the implied market outlook in the Euro area and the U.S. market to the top management.

[4 marks].

QUESTION 1 (continued)

2. Calculate the market price of each bond on 24^th September 2020 that issued by North Polar Ltd., a European company specialises in manufacturing semiconductors, using the yield curve data provided in the table above. What is the current total value of minimum application?

[4 marks]

3. Suppose the Australian government has announced tax cuts for the business sector. Using the loanable funds model, explain how this will impact the supply of and demand for loanable funds and the interest rate in Australia. (Explain your answer using diagrams).

In 2007, Consumer Report published a report of bacterial contamination of chicken sold in the US. They purchased 523 broiler chickens from various kinds of food stores, and tested them for bacteria that causes food-borne illnesses. Results indicated that 83% of chickens were infected with Campylobacter.

1. Construct a 95% confidence interval.

2. Explain what your confidence interval says about chicken sold in the US.

3. A spokesperson for the US Department of Agriculture dismissed the report, saying, “That’s 500 samples out of 9 billion chickens slaughtered a year…With the small numbers they tested, I don’t know that one would want to change one’s buying habits.” Is this criticism valid? Explain.

b. Find one aspect of this week’s material that is relevant to college, career, or everyday life. Provide some detail on how it could be important.

Your firm has a $10,000 par value U.S. Treasury bond with 30 years to maturity, annual coupon rate of 3.00% with semiannual coupon payments. Assume that the market annual yield to maturity on 30-year “T” bonds, found in the US Treasury Yield curve, is 3.04%.

What should the asked price (price you would pay) be for the bond?

Assume: YTM from US Treasury Yield Curve = 3.04% or semiannual rate = 1.52%

         Hint:

V_B =

If the 30 US Treasury Bond rate jumps immediately to 4.5%, what is the new price for the 30-year “T” bond? How much, in percent, would you lose or gain if you had purchased the bond in part A.

V_B = 150 (32.748953) + 10,000(0.263149)

      =$4,912.34 + 2,631.49= $7,543.83

Gain/Loss%=(price@ r= 4.5%) - (price@ r= 3.14%)/(p

The United States claims that Canada subsidizes the production of softwood lumber and that imports of lumber damage the interests of US producers.  The United States has imposed a high tariff on Canadian imports to counter the subsidy.  Canada is thinking of retaliating by refusing to export water to California.  The following table shows the payoff matrix for the simultaneous game that Canada and the US are playing

a.       What is the US’ optimal strategy? Why?

b.       What is Canada’s optimal strategy? Why?

c.       What is the outcome of the game? Explain.

d.       Is this game like a Prisoner’s Dilemma game or different in some crucial way? Explain.

e.       Which country would benefit more from a free trade agreement (where only the strategy of “no tariff” is allowed)?

Shipping R US (LESSEE) leased an ocean-liner freighter from Viking Ships (LESSOR). The lease is non-cancelable, requires beginning of the year (annuity due) payments for three years and at the end of the lease lessee returns the ship to the lessor. Shipping R US's incremental borrowing rate is 6%, but knows that Viking Ships used a 3.5% present value discount rate in determining the present value of the three annual lease payments, which total $6,000,000. Viking Ships manufactured the ocean-liner freighter, the freighter's fair value at the beginning of the lease is $5,500,000 and its estimated useful life is 10 years. Shipping R US is required to pay all executor costs, such as insurance, maintenance and taxes and did not guarantee the residual value of the ocean-liner freighter. Shipping R US uses the straight-line depreciation method for all of its depreciable assets.

Sax Company signs a lease agreement dated January 1, 2019, that provides for it to lease computers from Appleton Company beginning January 1, 2019. The lease terms, provisions, and related events are as follows:

Required:

A mature company on Beverage and Food Industry, with stable earnings expects to have earnings per share (EPS) of 30 AED in the coming year and its current stock price is 280 AED. The management must decide between the following alternatives: Pay all of its earnings as dividends and abandon the new investment in Dubai or Cut its dividend payout rate to 75% and implement the Dubai Project. If the second policy is followed there is a divergence in the estimation of the Return on New Investment.

(i). Pay all of its earnings as dividends. Because of the status of the company and its strength in the market, the CEO believes that cash flow from operations is sufficient to continue to reinvest in growth, though has to abandon Dubai Project for next year, and decided to pay out all of its earnings to investors. Besides that, current economic conditions are weak due to the crisis, and the CEO is more willing to pay dividends than to enter a program of share buybacks.

(ii). Cut its dividend payout rate to 75%. On the other hand, the company’s manager has negative expectations regarding the recent financial crisis and advise to cut dividends even if this is not consistent with its long-run growth in earnings. He believes that it is better to reinvest some of the earnings to open new stores in Dubai, a project that will last 2 years and hence, it is advisable to safeguard its financial reserves for future expenses. If the firm follows this program the return on investment is expected to be 17%. Suppose that the required rate of return is the same as calculated in Question (2) above.

(iii). Expected return on New investment is 9% rather than 17%. Financial crisis is severe and persist. The manager of the company estimates that in this case the return on the new investment will be 9% rather than 17%.

Questions:

(9) What do you advise the firm given the above scenarios, firm’s conditions, and economic situation?

(iv). Taking into consideration the market’s systematic risk. Our firm has a beta factor (systematic risk) quite low, equal to 0.67. This is expected as our firm belongs to Beverage and Food industry. The economy’s risk-free rate is 6% and the market’s return is 10%.

Questions:

(10) Estimate the risk premium.

(11) Estimate the required rate of return using CAPM.

(12) Estimate the price of the stock under alternative (ii) using your answer to Q (7). How do you explain the difference in price found in Question (4)?

(13). What should be your final estimation of the firm’s stock price?

Profit center responsibility reporting for a service company

Red Line Railroad Inc. has three regional divisions organized as profit centers. The chief executive officer (CEO) evaluates divisional performance, using operating income as a percent of revenues. The following quarterly income and expense accounts were provided from the trial balance as of December 31:

The company operates three support departments: Shareholder Relations, Customer Support, and Legal. The Shareholder Relations Department conducts a variety of services for shareholders of the company. The Customer Support Department is the company’s point of contact for new service, complaints, and requests for repair. The department believes that the number of customer contacts is a cost driver for this work. The Legal Department provides legal services for division management. The department believes that the number of hours billed is a cost driver for this work. The following additional information has been gathered:

Required:

1. Prepare quarterly income statements showing operating income for the three divisions. Use three column headings: East, West, and Central.

2. What is the profit margin of each region? Round percentages to the nearest whole number.

Identify the most successful region according to the profit margin.

3. What would you include in a recommendation to the CEO for a better method for evaluating the performance of the regions?

1. A better divisional performance measure would be return on investment, residual income as these methods consider the assets used by the division.
2. The current performance measures are based on the operating income per dollar of earned revenue. This method meets the requirement.
3. A better divisional performance measure would be return on investment, and residual income as these methods consider the dollar revenue earned by the division.

Consider the following situation as if you were Ian.

Ian was a senior analyst at a major hotel company. Although Ian worked mostly in corporate headquarters, he would occasionally travel to the field where he met with front-line employees and learned what was on their minds.

On a trip to Portland, Ian had the chance to speak with two people working at the front desk about what it was like to work at the hotel. Daniel, the younger of the two had joined the staff recently; Ellen, the other employee (and Daniel’s supervisor), had been with the company for almost 15 years. Both employees seemed particularly interested in talking with Ian because they rarely got a chance to talk directly to anyone from headquarters.

As the three discussed changes in the hospitality industry, Ellen and Daniel complained about their company’s aggressive cost control initiatives, spearheaded by the charismatic but frugal CEO, whose policies were occasionally unpopular. After a few more minutes of conversation, Ellen casually said, “The CEO is so tight with a buck, I wonder if he is Jewish.”

As a Jewish person, Ian did not know how to react. He had never actually experienced anything like this before, especially in a professional setting. Ian’s instinct was not to be combative or hostile, but he felt a bit like a deer caught in the headlights. Daniel looked a little surprised at his supervisor’s remark, but, laughing, he quickly changed the subject. Smiling, Ian made an excuse to end or discussion and walk away.

The next day Ian woke up still bothered by Ellen’s remark. While checking out, he saw Daniel at the front desk. Ian mentioned to him that he may want to tell his supervisor to watch her remarks about other peoples’ ethnicity, to which Daniel replied, “I know what you mean because I am Puerto Rican, but I think that she meant it as a joke.” Ian could see that Daniel just wanted to smooth the issue over.

On the ride to the airport, Ian kept thinking about what he might do. Should he report Ellen to Human Resources? The company had a process in place for such matters, but he was worried. Ian did not know who he was dealing with; maybe Ellen would retaliate if he said something, especially since she would know who filed the complaint. Plus, Ian was not sure what the consequences would be – he didn’t want to get her fired. Ian only wanted Ellen to know how offensive the comments were.

As a team, consider what steps Ian should take.

What are the concerns facing Ian?

Please write a short paragraph about your interest in pursuing a M.B.A. degree at XYZ UNIVERSITY.