University of the West Indies

Department of Management Studies

MS28D Financial Management I

 

Tutorial #2 - The Financial Environment - Chapter 4

     

  1. Differentiate between the money market and the capital market

  2. Differentiate between the primary market and the secondary market. If WebMax.com decided to issue additional common stock, and Vera Goode purchased 1,000 shares of this stock from AB&M Investment Bank, the underwriter, would this transaction be a primary market transaction or a secondary market transaction? Would it make a difference if Goode purchased previously outstanding WebMax stock in the over-the-counter market? Explain.  

  3. Securities can be traded on the organized exchanges or in the over-the-counter market. Define each of these markets, and describe how stocks are traded in each of them.

  4. What do we call the price that a borrower must pay for debt? What is the price of equity capital called? What are the four fundamental factors that affect the cost of money?

  5. How does the real risk-free rate of interest (K*) differ from the nominal risk-free rate (krf)? How are these two rates measured?  

  6. Define the terms:- 

                     a.     Inflation Premium (IP)
                     b.     Default Risk Premium (DRP)
                     c.     Liquidity Premium (LP)
                     d.    Maturity Risk Premium (MRP)

  1. What premiums would be included in the following securities when determining interest rates?

a.            Short-term GOJ (Government of Jamaica) securities

b.            Long-term GOJ securities

c.            Short-term corporate securities

d.            Long-term corporate securities

  1. 4-6 (Change 0.0005 to 0.05%)

  2. 4-13

  3. What is the term structure of interest rates? What is a yield curve? 

  4. 4-15

  5. 4-14

  6.  It is expected that the rate of inflation will be 6% next year, 7% the following year and 9% thereafter. The real risk-free rate is 4%. The maturity risk premium (MRP) is zero for bonds that mature in 1 year or less, 0.2% for 2-year bonds, and then the MRP increases by 0.2% per year thereafter for 15 years, after which it is stable.

    a. What is the interest rate on 1-year, 5-year, and 15-year GOJ bonds?

          b. Draw a yield curve with this data. 
  1. 4-17