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ECON1239-Assessement Task 2 S2 2020 1 ECON1239 (Principles of Finance) Assessment Task 2 – “Web-based Assignment” (Individual Assignment) 1. General Information Assessment Task 2 comprises a paper of about 2,000 - 2,500 words (or 8-10 pages double- spaced, 12 pts Time New Roman font type). Students are asked to prepare a report setting out a basic analysis of the bond market in TWO selected countries. The focus of this assessment task is to test the students’ understanding of CLOs 1, 2, 3, and 4. The due date for this assessment task is specified on the Canvas course site. Task in Brief: “You are a bond analyst working for a securities firm. Prepare a report which sets out an analysis of the bond market in two selected countries using the real-world, recent bond data you have collected from reliable sources and the forecasting techniques and concepts covered in the course to replicate realistic predictions for future inflation and interest rates. It is not sufficient to simply present typed or spreadsheet solutions. You are required to demonstrate and explain your assumptions and detailed workings to obtain your solutions, conclusions, arguments, and statements.” You are reminded that it is an INDIVIDUAL assignment and hence, the analysis for the assignment should be done separately. Materials: Bond market data and other relevant data from reliable sources: - central banks, Bloomberg, Thomson-Reuter, IMF, - financial websites, eg. www.investing.com www.worldgovernmentbonds.com - subscribed databases. Marks: Assessment 2 constitutes 40% of the total marks for ECON1239. Students are required to complete this assignment, which will contribute 40% towards the final assessment. Assessment: This Assignment will be marked out of 100 and will comprise 40% of the final ECON1239 grade. The allocation of marks will be divided among the following areas: (1) General and Presentation, (2) Range and accuracy of calculations and collected data, (3) Economic analysis and interpretation of results and findings, including original contribution. 2 A Rubric Marking: Marking Guide lists specific points under each of these three categories is provided on Canvas for the assessment of your assignment. This should be used as a guidance in the preparation of your assignment. Further instructions and tips for completing this assignment will be discussed during Week 5, 6 & 7, and be provided on Canvas. World Limit: 2,000 - 2,500 words, typed 12 pts, Times New Roman font type, A4-sized pages. Submission & Due date: Submit your Assessment Task 2 to “Assignments” via Canvas by the end of Week 9. 3 2. Assignment Requirements Please consult the Appendix (see the below) to this document for an example of how to analyse the bond data within the context of your course. The core elements of this assignment contain eight (8) Parts, each carrying an equal weight. Discussions of the assignment will be held during the lectures in Week 5/6/7. Please read carefully the following. IMPORTANT: You are required to choose TWO countries: the USA and ONE other country of your own choosing. Part 1: You are required to collect the most recent bond market data, namely, yields to maturity, over the periods for which you have the data. (Your data must be from reliable sources, e.g., you should not collect the data from personal blogs. Also, it should not be from too generic sources, i.e., you should not collect data from Wikipedia). Part 1A: Collect the Yields to maturity and other relevant data, if any, for the maturities of 1, 2, 5, 10, 20, and 30 years. Present your data clearly and neatly in a properly formatted table. Part 1B: Consult the Appendix to this Assignment to gain a basic understanding of the Approximate Method for predicting future interest rates. Use the Approximate Method to calculate the Discount Rate (“DR”) (future interest rates) that the bond markets appear to consider appropriate over the following periods (see the Appendix): - For 1-year - Averaged over 1 – 2 years - Averaged over 3 – 5 years - Averaged over 6 – 10 years - Averaged over 11 – 20 years - Averaged over 21 – 30 years Show all your detailed workings for at least one country, i.e., either for the US or for the country of your own choosing, or both (to be included in the Appendix of your submission). Present your calculated DRs clearly and neatly in a properly formatted table. Part 2: Use the reliable internet sources to collect the predicted rates of inflation for all the periods for which you have forecasted the Discount rates. Use your calculated DRs and these inflation rates to predict the REAL rates of interests for those periods based on the following formula: 4 ���������� ������ = 1 + ���� ������ 1 + ������ ���� − 1 For the future periods in which there are no predicted inflation rates, you can assume either that the last predicted inflation rate will stay constant for such periods or that the last real rate of interest as calculated will stay constant or that the predicted inflation rates are calculated based on historical rates. You are required to JUSTIFY your assumptions. Show all your detailed workings in an Appendix. Part 3: Use your results to compare the predicted future interest rates (DRs) between the USA and your selected country. Make sure that you use your own economic analysis of your results and/or findings. (For example, stating that one rate is higher than the other without any further comment on the reasons for it does not constitute economic analysis). (If you use any other expert opinions from such sources as financial newspapers or statements by some central banks, make sure to quote the source properly). Part 4: Use your forecasting results in previous parts to make comments on the US market and the rates on TIPS (Treasury Inflation-Protected Securities). Part 5: Comment on how the YTMs of Treasury bonds have changed since July 30th 2019 as below, eg. how does the bond market appear to have changed its predictions? Yields as shown below were collected in July 2019. Year-bond US US TIPS Australia Japan Germany UK Cash 2.25% - 1.50% 0.10% 0.00% 0.75% 3-month 2.31% - - - - - 6-month 2.28% - - - - - 12-month 2.10% - 1.20% -0.15% -0.58% 0.62% 2-year 1.84% - 1.11% -0.19% -0.67% 0.56% 5-year 1.85% 0.28% 1.17% -0.21% -0.57% 0.61% 10-year 2.08% 0.35% 1.48% -0.10% -0.20% 0.86% 20-year 2.61% 0.42% 1.95% 0.29% 0.21% 1.33% 30-year 2.55% 0.73% 3.15% 0.45% 0.41% 1.45% Part 6: Use the relevant theories of the term structure of interest rates to discuss how they affect your interpretation/results/findings. 5 Part 7: In the light of your findings, comment on the excerpt below from The Economist: Buttonwood 4-10 March 2017. “If there is one aspect of the current era sure to obsess the financial historians of tomorrow, it is the unprecedented low level of interest rates. Never before have deposit rates or bond yields been so depressed in nominal terms, with some governments even able to borrow at negative rates. It is taking a long time for investors to adjust their assumptions accordingly. Real interest rates (i.e., allowing for inflation) are also low. As measured by inflation-linked bonds, they are around minus 1 % in big rich economies.” Part 8: Discuss how you see the implications of your findings for the equity markets. 6 APPENDIX – APPROXIMATE METHOD. Example 1: Expected Interest Rates & Inflation Rates. According to the expectations hypothesis, a bond’s yield to maturity (YTM), which represents investors’ required rate of return on the bond, is directly related to expectations of inflation and prevailing interest rates. Thus, consider the following: 1. Expected Interest Rate: A Treasury bond with a face value of $100 and a coupon payment of 7.1% has one year to maturity. Thus, 1 year from now, the bond is scheduled to make a payment of $100 together with a final coupon payment of $100 * 0.071 = $7.1. If the bond is currently priced at $102.00, the YTM for the bond is $102.00 = $107.1 1 + ��� So, YTM = 0.05, or 5.0%. Therefore, we determine 5.0% as the prevailing 1-year interest rate on Treasury bonds. Since Treasury bonds can be considered effectively free from default risk, they provide a useful benchmark for interest rates. For instance, if inflation is running at, say, 2.4% per annum, we might deduce that bondholders require a risk-free real rate of interest per annum of approximately 2.6% per annum (≈0.05 – 0.024), or more precisely, Realrateofinterest = 1 + nominalinterestrate 1 + inflationrate − 1 = ).*+ ).*,- − 1 = 1.0254 − 1 = 0.0254 = 2.54% 2. Expected Inflation Rate: Now suppose that at the same time, a 2-year Treasury bond with a face value of $100 is scheduled to make a coupon payment of 7.1% both 1 year and 2 years from now, and that it is currently priced at $102.99. To determine bond investors’ required rate of return on this bond in Year 2, that is, YTM12, we solve the following equation: $102.99 = $7.1 1 + ���) + $107.1 (1 + ���))(1 + ���),) , where YTM1 is the YTM in Year 1 (determined for one-year Treasury bonds as above = 5.0%) and YTM12 is the YTM in Year 2. Hence, $102.99 = $7.1 1 + 0.05 + $107.1 (1 + 0.05)(1 + ���),) , 7 which yields YTM12 (in Year 2) = 0.06 (6.0%). Therefore, it appears that the market anticipates an