Q1. Describe the factors that determine the level and shape of the yield curve.

Question

Q1. Describe the factors that determine the level and shape of the yield curve.

Q2. Explain how valuing preferred stock with a stated maturity differs from valuing preferred stock with no maturity and calculate the price of a share of preferred stock under both conditions.

Q3. Describe how distinguishing between variable and fixed costs can be useful in forecasting operating expenses. (2 Marks)

Q4. What is the effective annual yield of a bond that promised an annual yield of 7.5% if this bond pays coupons twice a year?

Q5. What is the EAC of two projects: project A, which costs $230 and is expected to last two years, and project B, which costs $300 and is expected to last three years? The cost of capital is 12%.

Explanation / Answer

Only Q1)

Factors affeting the shape and level of yield curve are as follows:

1) The real rate of interest: It affects only the level of yield curve and not its shape.

2) The expected rate of inflation: It affects only the shape of yield curve. Increasing inflation in future will make the yield curve upward sloping.

3) The interest rate risk: It increases with a securty's maturity and adds an upward bias to the slope of the yield curve.

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