Babes n Toyland case study
Directions are as follows (case is attached as PDF)
Answer the following questions as per these instructions not the one in the PDF.
This is a case about interest rate forecasting.
On the first page it mentions Wally, who when facing falling sales, sees a memo from his boss.
She is concerned (see next page) about the declining operating margin from 14 percent to 10 percent. She has asked Wally for yield curve data showing the stability of interest rates over the past few years, the stability of current prices, and inflation rates. She also wishes to evaluate whether Babes should issue debt.
Towards the bottom of the page she states, I think we can currently issue 3-year bonds priced to yield 6.4 percent, 5-year bonds priced to yield 7.3 percent, and 10-year bonds priced to yield 8.4 percent.
See the next page, 792. We are just reading through the case at this point. This is the information you need to forecast interest rates.
See Table 1. Treasury securities are issued by the government, they are called Treasury securities. There are 3 periods of information for August 1991, August 1992, November 1992.
They have varying maturities, meaning they come due in 3 months, 6 months, etc. You notice that yields (returns) rise with maturity, which is what you would expect. If you were tying your money in an investment for a long period of time, your yield would be higher than it would be for a short period of time.
Table 2 includes information about corporate bonds, see the section on Default risk premia.
Corporate bonds may default, if debt is issued by a firm, the firm may not pay the debt, the risk of nonpayment is a percentage that is added to the return.
Riskier bonds like C-rated bonds have higher risk of default, or higher default risk than AAA bonds.
Using the data provided in Table 1, construct the yield curves for August 1991, August 1992, and November 1992. Yes, T-bills are risk-free.
The yield curve is a graph of interest rates and time to maturity.
Draw a graph in Excel. Create a table of values first.
In the first column, list the maturities from Table 1.
Second column: list the yields for August 1992 Third column: list the yields for November 1992.
Insert Line Chart.
Highlight maturities 1 – 10 and the second and third columns to get the graph.
2. is descriptive. Evaluate the change in shape of the yield curve using expectations and market segmentation. Look them up in the book and write a paragraph.
We use 1-10 just because of ease of comparability, which does not exist for 30 years. We’ll do 1-10, as 3 months and 6 months are of a different duration than the annual maturities for years 1 – 10.
3. Calculate the one-year forward rates of interest implied by the November 1992 yield curve over the period 1993-2002.
We need a starting point. Use 1993 as 3.8% 4.65 = 2 year rate = (3.8+x)/2.
According to the expectations theory, the 2 year rate = sum of the previous year’s rate and the year before that, or the 2 previous 1 year rates.
x = 5.5 %
That is your answer for 1994.
Next, for 1995, you have a 3-year rate = 5.23 = (3.8+5.5+x)/3
x = 6.39 %
Complete the rest by yourselves.
4. Using these 1 year forward rates, calculate the expected annual inflation rate in each of the next 10 years, and use this rate to obtain the average rate of price appreciation over the 1993 to 2002 period. Assume expectations, knominal = kreal + expected inflation premium
expected inflation premium = knominal – kreal = 1993-1994 = 5.5-3.8 = 1.7%
5.5 was the first answer we computed, that is the nominal quoted interest rate.
The real rate, according to expectations, is the nominal rate for the year before, or 3.8%
For 1994-1995, 6.39 -5.5 = 0.89% is the expected inflation premium. knominal = 6.39 – kreal of 5.5 Complete the rest.
5. Examine the information provided in Table 2. Do these data lead you to believe that the annual inflation rate you calculated in Q 4 might be incorrect ? Why or why not ?
See Table 2, the second and third columns list maturity and liquidity risk premia which were omitted from the strict expectations theory computation.
6. Using the data provided in Tables 1 and 2 prepare a revised estimate of (a) the one-year forward interest rates implied by the November 1992 yield curve over the 1993-2002 period, and the expected inflation rate in each of these years.
Originally, we were using the expectations theory, now we are using liquidity preference.
1993, one year forward rate = 3.8%
1994, 4.65 + 0.2 + 0, take the figure for 2 years from the last column of Table 1, add the maturity risk premium and the liquidity risk premium
3 years, 1995, 5.23 + .3 + .1 = 5.63%. This is 6a.
6b. Find the inflation rates as the difference between the nominal rates (answers) to 6a.
We are using the liquidity preference theory, so inflation = sum of maturity and liquidity risk premia
1 year = 0%
2 years = .2 + 0 = .2
3 years, .3 + .1 = .4
7. How would the yield curve for an AAA rated firm, a B-rated firm, and a C-rated firm, differ from the Treasury security yield curve you constructed in # 1 ?
You have to draw yield curves – 3 lines for the 3 types of bonds using the same procedure as problem 1.
Year 1, nominal rate = T-bill rate + Maturity risk premium + liquidity risk premium + default risk premium for an AAA bond
3.8 + 0 +0 +.9 = 4.7
3 years, 5.23 + .3 + .1 + .9
We are taking the lowest risk free rate on a Treasury security and adjusting it to the rate on an AAA bond.
Do the rest of the AAA bonds, then all of the B rated bonds-just use a different column for default risk, and then the C-rated bonds.
Also, compare the shape of the yield curve in question 7, and compare the 2 methods used.
9. Can you use the information in the case to estimate Babes-N-Toyland’s bond rating ?
See the yields on the second page. 3 year bonds priced to yield 6.4% per annum. 5-year bonds priced to yield 7.3 percent per annum, 10 year bonds priced to yield 8.4 percent. Look at the yields on the AAA. B, and C bonds and see if any bond has a maturity and yield similar to these figures. That will be Babes’s bond rating.
10. Think through this one. It uses a result from 5080.
AAA are the least risky and C the most risky.
Try it now!
How it works?
Follow these simple steps to get your paper done
Place your order
Fill in the order form and provide all details of your assignment.
Proceed with the payment
Choose the payment system that suits you most.
Receive the final file
Once your paper is ready, we will email it to you.
Paper Helper has assembled a team of highly skilled writers with diverse experience in the online writing circles. Our aim is to become a one stop shop for all your Academic/ online writing. Check out below our amazing service!
At Paper Helper, we prioritize on all aspects that creates a good grade such as impeccable grammar, proper structure, zero-plagiarism, and conformance to guidelines. The principal purpose of essay writing is to present the author's evaluation concerning a singular subject about which they have made. Since Professionalism is the mother of every success, try our team of experienced writers in helping you complete your essays and other assignments.
You have been trying to join that prestigious institution you long yearned for, but the hurdle of an admission essay has become a stumbling block. We have your back, with our proven team that has gained invaluable experience over time, your chance of joining that institution is now! Just let us work on that essay.How do you write an admission essay? How do you begin the essay? For answers, try Quality Custom Writers Now!
Editing and Proofreading
Regardless of whether you're pleased with your composing abilities, it's never an impractical notion to have a second eye go through your work. The best editing services leaves no mistake untouched. We recognize the stuff needed to polish up a writing; as a component of our editing and proofreading, we'll change and refine your write up to guarantee it's amazing, and blunder free. Our group of expert editors will examine your work, giving an impeccable touch of English while ensuring your punctuation and sentence structures are top-notch.
We pride ourselves in having a team of clinical writers. The stringent and rigorous vetting process ensures that only the best persons for job. We hire qualified PhD and MA writers only. We equally offer our team of writers bonuses and incentives to motivate their working spirit in terms of delivering original, unique, and informative content. They are our resources drawn from diverse fields. Therefore your technical paper is in the right hands. Every paper is assessed and only the writers with the technical know-how in that field get to work on it.
College Essay Writing
If all along you have been looking for a trustworthy college essay service provider that provides superb academic papers at reasonable prices, then be glad that you search has ended with us. We are your best choice! Get high-quality college essay writing from our magnificent team of knowledgeable and dedicated writers right now!
Quality Assignment/Homework Help
We give the students premium quality assignments, without alarming them with plagiarism and referencing issues. We ensure that the assignments stick to the rules given by the tutors. We are specific about the deadlines you give us. We assure you that you will get your papers well in advance, knowing that you will review and return it if there are any changes, which should be incorporated.