Federal Reserve System report

Question 1(a) 

As per Federal Reserve System report, the average interest rates charged by commercial banks were as follows. On new automobiles, the commercial banks advanced loans at an average interest rate of around 4.3% towards the end of the year 2016 if the loan was to be repaid within a four years term and the rate of 4.14 percent where the loan agreement made is for a five years term. Personal loans advanced through the commercial banks towards the end of the year 2016 were charged an average interest rate of 9.7 percent for a two years term agreement. Further, credit card plans advanced through commercial banks as of the year 2016 were charged an average interest rate of 12.35 percent for all accounts and 13.56 percent for accounts assessed interest. Therefore, based on Federal Reserve data on consumer information, loans advanced by commercial banks on new automobiles has the lowest interest rate compared to other loan types. However, the credit card plans have the highest loan interest rate. 

b. 

Consumer credit is continually changing in each year. As at the start of the year 2014, the annual rate of consumer credit was 7.2 percent which changed to 7 percent in 2015 and reduced to 6.4 % in 2016.However, the annual revolving rate increased throughout the period of three years from 3.9% in 2014 to 6.1% as at the end of 2016. The annual non-revolving rate, however, decreased from 8.4% in 2014 to 6.5% in 2016. Therefore, the total consumer credit flow over the analysis period increased from 221.8 billion dollars in 2014 to 227.2 billion dollars at the end of 2016. Also, the total outstanding consumer credit increased from 3,318 billion dollars in 2014 to 3,762.9 billion dollars at the end of 2016. 

Future value problems 

Question 2 

a. Future value using simple interest rate 

Future value (FV) = principle + interest 

Principle = $10,000 

Interest = ($10,000*5*8)/100 =$ 4,000 

Amount = $10,000+$4,000 = $14,000 

b. Future value using compound interest rate 

Future value = principle + interest 

Amount = [$10,000* (1+8/100) 5 ] = $14,693 

Question 3 

a. 5 percent for 10 years 

Simple interest: $ 5,000 + [$5,000*5% *10] = $7,500 

Compound interest: $5,000* (1+5%) 10 = $ 8,144 

b. 7 percent for 7 years 

Simple interest: $ 5,000 + [$5,000*7% *7] = $7,450 

Compound interest: $5,000* (1+7%) 7 = $ 8,028.9 

c. 9 percent for 4 years 

Simple interest: $ 5,000 + [$5,000*9% *4] = $6,800 

Compound interest: $5,000* (1+9%) 4 = $ 7,057.9 

Question 4 

a. Future value of the investment 

Future value = $2,500*(1+9%) 3 = $ 3,237.6 

b. Future value in terms of purchasing power 

Compounding interest rate = 9%-3% = 6% 

Future value = $2,500* (1+6%) 3 = $2,977.5 

c. Future value in case inflation is 9% each year 

Compounding interest rate = 9%-9% =0% 

Future value = $2,500*(1+0%) 3 = $ 2,500 

The purchasing power of $2,500 will be the same throughout the three years period 

Question 5 

a. Present value in case of 3% interest rate for one year 

Discounting rate = (1+3%) 1= 1.03 

Present value = $7,000/ 1.03 = $6,796 

b. Present value after two years 

Discounting rate = (1+3%) 2 = 1.0609 

Present value = $ 7,000/1.0609 = $6,598 

Question 7 

Present value after end of 8 years using 9% discount rate 

Present value factor from the table = 0.502 

PV = $ 15,000* 0.502 = $ 7,530 

Present value after the end of 6 years 

Discounting rate = 0.596 

PV = $15,000*0.596 = $8,940 

Question 16 

a. Future value = $15,555*(1+14.5%) 7 = $40,133.6 

b. Future value = $19,738*(1+18%) 8 = $ 74,192.4 

Question 17 

a. Present value =$359,000/ (1+11) 23 = $32,558.62 

b. Present value = $359,000/ (1+11) 20 = $ 44,528.17 

Question 19 

a. Compounding semi-annually 

Future value = $19,378*(1+9%) 16 = $76,936.6 

b. Compounding quarterly 

Future value = $ 19,738* (1+4.5%) 32 = $80,728 

Discussion Questions 

Question 1 

Investment bankers are the individuals who work in large banks and corporations with the sole objective of raising capital. Therefore, many organizations engage investment bankers since they have the required expertise and knowledge necessary for the handling of securities mainly shares. Securities expertise help the investment banker to perform functions such as securities underwriting, buying, and selling of securities among others. Corporations will, therefore, hire them due to their in-depth expertise on securities, thus, mitigating any securities risks as they are under the care of an expert. 

Question 2 

Investment bankers usually perform various tasks for the investment companies. However, the primary function of the investment bankers is originating. Originate function is a function where an investment banker identifies prospective growing firms to whom company securities may be offered, thus, helping to raise capital for the company. Investment bankers also carry out the underwriting function. Underwriting is where the investment banker uses his/her capital to purchase securities from issuers and then to sell the same to investors hence reducing risk. Further, investment bankers’ helps in selling firms privately placed securities. 

Question 3 

While marketing corporation’s securities, investment bankers assume the securities selling risk via their underwriting function. In this case, investment bankers purchase the risky securities using their own capital and later sell them to their corporation. Therefore, in case the security price falls below the firm's price, the investment banker bears the risk on behalf of the corporation which has engaged them as per the corporation’s underwriting agreement. To mitigate the risk, the investment bankers are usually allowed to execute market stabilization actions which allow them to insure against the risk of loss. 

Question 4 

Competitive bidding refers to a public offering process where an underwriter submits a bid to a firm which is issuing its first stock. First, the firm decides which type of security it will offer while the investment bank enters into actual bidding so as to obtain the offering underwriting rights. The banks will allow time so as to get the necessary advice from its investment bankers. The bank which is offering the highest bid price will normally get the business. The competitive bidding process is advantageous since it allows the security issuers to obtain higher bidding price for their securities. 

Question 7 

Investment banking refers to financial and other related services such as raising capital offered by a private investment bank to individuals, corporations, and governments. The investment banks are administered under Securities provision Act. The major purpose of the act is to provide overall disclosure about the newly issued securities which are being offered for sale and also prevent fraud in the sale of such securities. Therefore, corporations issuing securities are required to file the registration statement with the Securities and Exchange Commission (SEC) and also issue prospectus to prospective investors. Therefore, security investors have an obligation to register with Securities and Exchange Commission since it has the overall stock market authority. Also, a majority of states have the blue-sky law which protects investors against fraudulent security offerings. Commercial banks are also denied the ability to act as underwriters while new securities are being issued by the Glass-Steagall Act. 

Question 10 

The initial public offering for Facebook was held on 18th May 2012. Though the IPO was seen as the biggest in technology history, with over $104 billion in market capitalization, the share price fell by at least 50% within a few months. Therefore, the reasons besides the decline in Facebook stock price IPO are: 

1. There was a delay in share issue due to the heavy trading in the first days of IPO trading. 

2. There were also some technical problems with their computers during the first trading days. 

3. The underwriters had made a late decision to increase IPO by 25% two days before first trading day. 

4. The lock-up limit expired with IPO having increased by 271 million shares which allowed early investors to sell their stocks and which increased share supply without changing their demand. 

Question 11 

Organized securities exchange is usually characterized by the following: 

1. Organized securities exchange uses modern communication means to reach their potential public investors and, thus, facilitating trade. 

2. Trading for these institutions is normally executed in a physical location where investors meet for a free and transparent trade. 

3. They carry out their operations under the guidelines set by Securities and Exchange Commission. 

Question 12 

The New York Security Exchange (NYSE) is the oldest and leading security exchange in the United States. Therefore, the New York Stock Exchange has various membership groups as follows: 

1. House brokers: These members act as customers agents, thus, they conduct securities trade on behalf of their clients. 

2. Independent brokers: The members act as a reserve unit and will thus help the house brokers in handling customers in case the customers are many. 

3. Registered traders: The members usually buy and sell securities for personal accounts. 

4. Specialist members: The members specifically deal with ensuring that some specific securities liquidity is maintained. 

Question 13 

Security trade is deemed to have taken place the moment the buyer and the seller agree/settle on the price to sell or buy the underlying stock. Therefore, in the security market, the bid price represent the highest price that the buyer of a particular underlying stock is willing to pay for that security. On the other hand, the ask price represents the lowest/minimum price that a security seller is willing to receive for him to sell the security. Therefore, the major difference between the bid and ask price of security is the profit which the dealer is bound to realize/security liquidity. In general, the bid-ask difference is smaller in the stocks which are more frequently traded. 

Question 14 

A market order is the modest order type and refers to the buy or sell order that is exercised immediately and at the prevailing market prices. In the presence of willing buyers and willing sellers, the market orders are filled. Therefore, market orders are utilized when the certainty of order execution is a priority over the execution price. However, a stop-loss order refers to the order requiring stocks to be sold as soon as possible at the market price in the vent the stock price falls to a specified level.