(BQ) Part 2 book "Quantitative investment analysis workbook" has contents: The time value of money, discounted cash flow applications, statistical concepts and market returns, probability concepts, portfolio concepts, time series analysis,.and other contents. | PART SOLUTIONS II CHAPTER 1 THE TIME VALUE OF MONEY SOLUTIONS 1. A. Investment 2 is identical to Investment 1 except that Investment 2 has low liquidity. The difference between the interest rate on Investment 2 and Investment 1 is percentage point. This amount represents the liquidity premium, which represents compensation for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly. B. To estimate the default risk premium, find the two investments that have the same maturity but different levels of default risk. Both Investments 4 and 5 have a maturity of eight years. Investment 5, however, has low liquidity and thus bears a liquidity premium. The difference between the interest rates of Investments 5 and 4 is percentage points. The liquidity premium is percentage point (from Part A). This leaves − = percentage points that must represent a default risk premium reflecting Investment 5’s high default risk. C. Investment 3 has liquidity risk and default risk comparable to Investment 2, but with its longer time to maturity, Investment 3 should have a higher maturity premium. The interest rate on Investment 3, r3 , should thus be above percent (the interest rate on Investment 2). If the liquidity of Investment 3 were high, Investment 3 would match Investment 4 except for Investment 3’s shorter maturity. We would then conclude that Investment 3’s interest rate should be less than the interest rate on Investment 4, which is 4 percent. In contrast to Investment 4, however, Investment 3 has low liquidity. It is possible that the interest rate on Investment 3 exceeds that of Investment 4 despite 3’s shorter maturity, depending on the relative size of the liquidity and maturity premiums. However, we expect r3 to be less than percent, the expected interest rate on Investment 4 if it had low liquidity. Thus percent < r3 < percent. 2. i. Draw a time line. ii. Identify the .
