Financial Market & Institutions Exam

8/10/2019 Financial Market & Institutions Exam

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UNIVERSITYOFWESTMINSTERWESTMINSTERBUSINESSSCHOOL

EXAMINATION PAPERSEMESTER NINE

January 2012

MODULE CODE !FIN"E2

MODULE TITLE FINANCIAL MAR#ETS $ INSTITUTIONS

DATE January 11%&2012

TIME 10'00 a(

INSTRUCTIONS TO CANDIDATES

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C/.)+87..3 +9a('

TIME ALLOWED : HOURS

PLEASE DO NOT TURN OVER THIS PA;E UNTIL

INSTRUCTED TO DO SO BY THE INVI;ILATOR

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S+%-.n A = >An)*+r a% /+a)% .n+ ,u+)%-.n r.( %&-) )+%-.n?

@u+)%-.n 1' An)*+r a// 4ar%)' U)+ 6ra4&) *&+n n++))ary'

a) Under the expectations hypothesis, if the yield curve is upward sloping,the market must expect an increase in short term interest rates.True/False/Uncertain? hy?

!" marks)

#) Under the li$uidity preference theory, if inflation is expected to #e fallingover the next years, long%term interest rates will #e higher than short terminterest rates. True/False/Uncertain? hy?

!" marks)

c) &f the segmented markets theory causes an upward%sloping yield curve,

what does this imply? &f markets are not completely segmented, should wedismiss the segmented markets theory as even a partial explanation forthe term structure of interest rates? 'xplain.

!" marks)

d) The yield to maturity of one year (ero coupon #ond is *. The yield tomaturity on two year (ero coupon #ond is +*.

i) hat is the forward rate of interest for the second year?ii) &f you #elieve in the expectations hypothesis, what is the #est guess

as to the expected value of the short term interest rate next year?iii) &f you #elieve in the li$uidity preference theory, is your #est guess at

to next years short term interest rate higher or lower than in !ii)?

!- marks)

!T.%a/ :: (ar3)

@u+)%-.n 2' An)*+r a// 4ar%)' U)+ 6ra4&) *&+n n++))ary'

a) ou are the treasurer of a U0 manufacturing company and you plan to

#orrow funds and may use the forecast of interest rates to determinewhether you should o#tain a loan with a fixed interest rate or a floatinginterest rate. The following information from the 1ank of 'ngland !1o')&nflation 2eport can #e considered when assessing the future direction ofinterest rates3

'conomic growth has #een very low3 The U0 grew #y 4.5* in the first$uarter of 4-- and #y 4.-* in the second $uarter and there are fears ofdou#le deep recession.

The 67& inflation rate is likely to pick up to #etween 5* and * in thenear term and to remain well a#ove the 1o's * target over the next

year.

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The 8onetary 7olicy 6ommittee !876) of the 1o' has maintained the1ank 2ate at 4.* and it has announced a new program of 9uantitative'asing #y e:ecting ;


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S+%-.n B = >An)*+r a% /+a)% .n+ ,u+)%-.n r.( %&-) )+%-.n?

@u+)%-.n !' An)*+r a// 4ar%)'

a) ankla 6ompany plans to purchase either !-) (ero%coupon #onds that

have ten years to maturity, a par value of A-44 million, and a purchaseprice of A54 million, or !) #onds with similar default risk that have fiveyears to maturity, a B percent coupon rate, a par value of A54 million, anda purchase price of A54 million. ankla can invest A54 million for fiveyears. >ssume that the markets re$uired return in five years is forecastedto #e -- percent. hich alternative would offer ankla a higher expectedreturn !or yield) over the five%year investment hori(on?

!- marks)

#) > -4%year #ond has a par value of A-,444 and a coupon rate of percent.@uring the first six months after the #ond was issued, the inflation ratewas 5. percent. 1y how much does the principal of the #ond increase?hat is the coupon payment after six months?

! marks)

c) The re$uired rate of return on a #ond is primarily determined #y theprevailing risk free rate and the credit risk premium on the #ond. hichare the factors that affect the risk free rate ? @iscuss each one of themseparately and how they affect the re$uired rate of return and the price ofthe #ond

!-" marks)

!T.%a/ :: (ar3)

@u+)%-.n ' An)*+r a// 4ar%)'

a) @escri#e the 6apital >sset 7ricing 8odel !6>78) as a model used toderive the re$uired rate of return for stocks and its limitations.

!-< marks)

#) >T company :ust paid a dividend of A. per share on its stock and thatthe dividend will continue to grow at a rate of + percent per year. &f the

re$uired return on this stock is percent, what is the current share price?!C marks)

c) &18 has a #eta of -.--.i) &f you assume that the stock market has a maximum expected loss

of D. percent on a daily #asis !#ased on a B percent confidencelevel), what is the maximum daily loss for the &18 stock?

ii) &f you have A4,444 invested in &18 stock, what is your maximumdaily dollar loss?

!C marks)

!T.%a/ :: (ar3)

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@u+)%-.n ' An)*+r a// 4ar%)'

a) Epen%end Fund > has -44 shares of >TT valued at A-44 each and 4shares of Toro valued at A4 each. 6losed Dend Fund 1 has TT and -44 shares of Toro. 1oth funds have -44 shares outstanding.

i) @etermine the >G of each fund.ii) >ssume another -44 shares of >TT valued at A-44 are added to

Fund >. @etermine the >G of the fund if the underlying shareprices remain unchanged?

iii) &f the price of >TT rises to A--4 and price of TE2E falls to A54, howdoes this impact on the >G of #oth funds. >ssume Fund > only has-44 shares on >TT.

!- marks)

#) > hedge fund charges plus +4*. &nvestors re$uire a return of *. owmuch the hedge fund must earn #efore fees to provide investors with

these fees?!" marks)

c) @escri#e a defined #enefit pension plan. @escri#e a defined%contri#utionplan, and explain how it differs from a defined%#enefit plan.

!- marks)

T.%a/ :: (ar3))

[End of Examination Paper]

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Financial Market & Institutions Exam

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