Money, Financial Market and Banking

1. Please explain whether the following statement is true, false or uncertain. All your credit comes from your explanation, which should be thorough, brief, and accurate. One to two sentences should suffice: Steeply inverted yield curves are useful for forecasting economic downturns. 

I.2. How might you know whether a stock market is in a bubble? List and justify at least three different signs (more is better).

I.3. Consider a bond paying an 8% coupon on a face value of $100. If yields are 4%, is the bond selling for more or less than par value (par value = $100)? Explain.

I.4. Purchasing power parity does not always hold empirically. Explain why.

II.1. Snooker Arnovich buys on margin 1,000 shares of Rickford Systems at $50 per share. The initial margin requirement is 60% and the maintenance margin requirement is 50%. If the Rockford stock falls to $38, will Snooker receive a margin call? Explain your answer numerically

II.2. Rank the duration of the following bonds as accurately as you can (it may not be possible to provide a completely clear ranking). Please explain your ranking.

                                                           Maturity                        Coupon                    

            Bond 1                                    15 years                       10 percent

            Bond 2                                    10 years                       10 percent

            Bond 3                                    15 years                        0 percent

            Bond 4                                    10 years                        0 percent

Question II.3 Setup:

(15 Points).

Roberts Roofing currently earns $3 per share. Its return on equity is 20% and it pays out 50% of its earnings as dividends (both figures are expected to be maintained indefinitely). Stocks of similar risk are priced to return 15%.

Earnings Per Share (E)


Return on Equity (ROE)


Plowback Ratio (pb)


Dividends (D = pb* E)


Similar Stocks priced to return      

(Discount Rate, k)


II.3(a). What should Roberts Roofing’s price per share be if it equals the firm’s true value per share?

II.3(b). How much of Roberts Roofing’s true value is the present value of growth opportunities?


II.3(c). Suppose the roofing industry becomes more cyclical (and there are reasons to believe it might). How would the firm’s beta be affected? How would the firm’s price-earnings ratio be affected? Explain intuitively and mathematically.

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