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Financial Analysis Assignment: Interest Rates, Time Value of Money and Derivative Securities

## Question 1: Yield Curves Analysis and Bond Valuation

There are 4 questions for this assignment. Please provide the answer on a separate word docs.

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 24th September 2020 (Mo = month, Yr = Year):

 Time to Maturity Euro area Central Government Bond Yield Rates U.S. Treasury Bond Yield Rates 1 Mo - 0.08% 3 Mo -0.60% 0.10% 6 Mo -0.62% 0.11% 1 Yr -0.66% 0.12% 2 Yr -0.71% 0.14% 3 Yr -0.74% 0.16% 4 Yr -0.74% - 5 Yr -0.72% 0.27% 7 Yr -0.63% 0.46% 10 Yr -0.49% 0.67% 20 Yr -0.17% 1.19% 30 Yr -0.05% 1.40%

Considering both yield rates on 24th 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.

Calculate the market price of each bond on 24th 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?

 Issuer North Polar Ltd. Issuing date 24th September 2020 Bond expiration date 24th September 2025 Face value € 1000 per bond. Minimum application 50 Bonds (€ 50,000) Interest rate Floating Interest Rate. The Interest Rate is the sum of the Market Rate plus the Margin. Coupon rate (annual) Central Government Bond Yield + 1.86% p.a. Coupon payment Annually (coupon payment is paid on 10th July every year) Market Yield 4.5%

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).

You have just received a bonus of \$15,750 and are looking to deposit the money in a bank for 5 years. You have investigated the annual deposit rate of several Australian banks and collected the following information:

 Commonwealth Bank of Australia 0.85% Monthly Westpac Banking Corporation 0.89% Quarterly Australia and New Zealand Banking Group 0.77% Daily National Australia Bank 0.82% Annually

To determine which bank you should deposit your money in, calculate how much money you will earn at the end of 5 years at each bank. (round your answer to 2 decimal places).

You understand that the more frequently interest is earned in each year, the more you will have at the end of your investment horizon. Is this always true? Discuss this statement considering your answer from the previous part.

A professional footy player and his agent are evaluating three contract options to play in the Australian Football League (AFL). Each option offers a signing bonus and a series of payments over the life of the contract. The player uses 7.25% rate of return (compounded annually) to evaluate the options.

 0 signing bonus \$3,500,000 \$3,500,000 \$3,500,000 1 Annual Salary \$700,000 \$850,000 \$775,000 2 Annual Salary \$750,000 \$800,000 \$775,000 3 Annual Salary \$800,000 \$750,000 \$775,000 4 Annual Salary \$850,000 \$700,000 \$775,000

Using the information provided above, which contract should be chosen? (Show your calculations).

Explain the phrase “a dollar today is worth more than a dollar tomorrow”

Melbourne Capital Ltd considers selling European call options on ANZ Bank Ltd for \$1.50 per option. The current market price is \$17.70 on 28th September 2020, the exercise price is \$20, and the maturity of each call option is 6 months.

Under what circumstances does the investor make a profit?

Under what circumstances will the option be exercised?

How many call options should the investor sell to raise a total capital of \$1,260,000?

Company A agrees to enter into an FRA agreement with Company B in which Company A borrows \$ 40,000,000 in 6-month time for a period of 9 months, and Company B invests \$ 40,000,000 in 6-month time for a period of 9 months. The 6-month interest rate is 0.77% per annum and the 9-month interest rate is 0.89% per annum.

What is the interest rate that both companies agreed upon?

Suppose that at the expiry date of the FRA, the 6-month interest rate is 0.81% per annum and the 9-month interest rate is 0.96% per annum, calculate the compensatory payment and which party receives it?

Suppose that at the expiry date of the FRA, the 6-month interest rate is 0.79% per annum and the 9-month interest rate is 0.86% per annum, calculate the compensatory payment and which party receives it?

A mining company in Australia has entered into a contract to export iron ore into China with delivery in three months’ time. The contract is denominated in Chinese Yuan, CNY and is valued at CNY 500 million. The current spot exchange rate is AUD/CNY 5.18. Assume that the expected spot rate in three months’ time is AUD/CNY 5.13. The three-month futures contract for Australian dollar and Chinese Yuan is trading at AUD/CNY 5.09. Should the mining company use the futures market to hedge the exchange rate exposure? Explain why or why not?

In response to the COVID-19 pandemic, Australian government implements numerous policies to provide economic support to the Australian economy. Briefly discuss the role played by the Australian government to rescue the economy.

On April 7th, 2020, Fitch Ratings Inc. downgrades Australia's four biggest banks credit ratings. How does this affect borrowers, lenders, and financial institutions? What are the implications of this downgrade to the health of the financial system?