Chapter 9

Question 1

It what conditions are money market instruments and cash on deposits attractive to investors?

Answer 1

• If the investor is concerned about liquidity
• General economic uncertainty
• Investor is risk-averse
• Depreciation of domestic currency
• Before the start of a recession
• Anticipation of rising interest rates
• Investor has known short-term commitments

Question 2

Nominal yield calc

Answer 2

Nominal yield= risk-free real yield + E(future inflation) + inflation risk premium
Real yield = (1+ Nom)/(1+inflation)-1

Question 3

What could reduce the risk of index-linked bonds?

Answer 3

The bond would be less risky if it had lower default risk. This could be a result of:
* the type of debt, i.e. higher ranking debt (e.g. debentures) rather than lower ranking debt (e.g. unsecured debt or subordinated debt)
*the existence of fixed or floating charges
* higher levels of income / capital cover
* restrictions on further corporate borrowing
* a lack of prior ranking debt
* parent company guarantees being placed where the loan has been issued by a subsidiary
* third party guarantees, for example, insurance provision
* registering any security and ensuring that investors can enforce that security on default a shorter-term issue

Marketability would be increased, and hence risk reduced, if the bond had the following features:
* a larger issue size
* no options set against the investor, e.g. option for early redemption options for the investor, e.g. convertible debt
* a stock exchange listing (rather than a private placement).