Halilagic |1

Assignment 3
Chapter 17
3. In mid-1978, Wiggley S&L issued a standard 30-year fixed rate mortgage at 7.8% for $150,000. 36 months later, mortgage rates jumped to 13%. If the S&L sells the mortgage, how much of a loss is expected? Solution: When issued, the required payment is: PV $150,000, I 7.8/12, N 360, FV 0 Compute PMT. PMT $1,079.81 After 36 months, the mortgage balance is: PMT $1,079.81, I 7.8/12, N 324, FV 0 Compute PV. PV $145,764.43 However, at current rates, the remaining cash flows are worth: PMT $1,079.81, I 13/12, N 324, FV 0 Compute PV. PV $96,637.64 Wiggley S&L expects to take a loss of $49,126 if it sells the mortgage. 4. Refer to the previous question. In 1981 Congress allowed S&Ls to sell mortgages at a loss and to amortize the loss over the remaining life of the mortgage. If this were used for the previous question, how would the transaction have been recorded? What would be the annual adjustment? When would that end? Solution: The sale would be recorded as: Debit Cash Capitalized Loss $96,638 $49,126 Mortgage Credit $145,764

Then, each year for the next 27 years (ending in 2007!), the loss would be written off: Debit Loss Expense $1,819.48 Credit Capitalized Loss $1,819.48

Chapter 19

Halilagic |2 11. True. Higher inflation helped raise interest rates which caused the disintermediation process to occur and which helped create money market mutual funds. As a result banks lost cost advantages on the liabilities side of their balance sheets and this has led to a less healthy banking industry. However, improved information technology would still have eroded the banks income advantages on the assets side of their balance sheet, so the decline in the banking industry would still have occurred.

Chapter 20
6. On January 1st, a mutual fund has the following assets and prices at 4:00 p.m.: Stock 1 2 3 4 5 Shares owned 1,000 5,000 1,000 10,000 3,000 Price $ 1.97 $48.26 $26.44 $67.49 $ 2.59

Calculate the net asset value (NAV) for the fund. Assume that 8,000 shares are outstanding for the fund. Solution:
NAV $1,970 $241,300 $26,440 $674,900 $7,770 $119.05/share 8,000

7. An investor sends the fund a check for $50,000. If there is no front-end load, calculate the new number of shares and price/share. Assume the manager purchases 1,800 shares of stock 3, and the rest is held as cash. Solution: With the $50,000, the value of the fund is now $952,380 50,000 $1,002,380. Shares are sold at a price of $119.05, or 420 new shares. There are now 8,420 shares outstanding. The new fund looks like: Stock 1 2 3 4 5 cash Shares owned 1,000 5,000 2,800 10,000 3,000 n.a. Price $ 1.97 $48.26 $26.44 $67.49 $ 2.59 $ 2408

8. On January 2nd, the prices at 4:00 PM are: Stock 1 2 3 4 Shares owned 1,000 5,000 2,800 10,000 Price $ 2.03 $51.37 $29.08 $67.19

Halilagic |3 5 cash 3,000 n.a. $ 4.42 $ 2408

Calculate the net asset value (NAV) for the fund. Solution:
NAV $2,030 $256,850 $81,424 $671,900 $13,260 2,408 $122.08/share 8,420

9. Assume the new investor then sells the 420 shares. What is his profit? What is the annualized return? The fund sells 800 shares of stock 4 to raise the needed funds. Solution: The 420 shares are worth 420 $122.08 $51,273.60, for a profit of $1,273.60. The one day return is $1,273.60/50,000 2.54%. Annualized, this is 637% in nominal terms, assuming 250 trading days. The new fund is: Stock 1 2 3 4 5 cash Shares owned 1,000 5,000 2,800 9,200 3,000 n.a. Price $ 2.03 $ 51.37 $ 29.08 $ 67.19 $ 4.42 $4,886.40

10. To discourage short-term investing in its fund, the fund now charges a 5% upfront load and a 2% backend load. The same investor decides to put $50,000 back into the fund. Calculate the new number of shares outstanding. Assume the fund manager buys back as many round-lot shares of stock 4 with the cash. Solution: With the upfront load, 5% is charged as a commission. The actual funds invested are $50,000 0.95 $47,500. This represents $47,500/122.08 389.09 new shares. The manager purchases 700 shares of stock 4. 11. On January 3rd, the prices at 4:00 PM are: Stock 1 2 3 4 5 cash Shares owned 1,000 5,000 2,800 9,900 3,000 n.a. Price $ 1.92 $ 51.18 $ 29.08 $ 67.19 $ 4.51 $5,353.40

Calculate the new NAV.

Halilagic |4 Solution:
NAV $1,920 $255,900 $81,424 $665,181 $13,530 $5,353.40 $121.98/share 8,389.09

12. Unhappy with the results, the new investor then sells the 389.09 shares. What is his profit? What is the new fund value? Solution: The 389.09 shares are worth 389.09 $121.98 $47,461.20. This amount comes out of the fund, leaving the fund with $975,847.20. The investor must then pay the 2% back-end fee, leaving $47,461.20 0.98 $46,511.98. This represents a loss of $3,488.02, mostly due to fees.

Chapter 21
1. People carry insurance because they are risk-averse and prefer to know their wealth with certainty.

Chapter 14
1. Securities in the mortgage markets are collateralized by real estate. 9. The Veterans Administration and the Federal Housing Administration guarantee lenders against losses from loans insured by them. Conventional loans do not have this guarantee, so the lender usually requires private mortgage insurance.