FIN 564 Week 8 Final Exam

FIN 564 Week 8 Final Exam: Answer 14 of the 15 questions in the space provided. Mark the one that you want to omit by putting an “X” through the question.
  1. Should countries forgo using their own currency and adopt as legal tender a stable foreign currency? Address the following in your answer:
    a. Give two advantages and two disadvantages of dollarization
    b. Does a country need permission to dollarize?
    c. Would dollarization be reversible?
  2. What are the differences in the structures of the New York and Nasdaq exchanges? How are stocks traded on each? What role (or roles) does a specialist or market maker play in the two exchanges?
  3. Barr Bank has just purchased bonds for $106 million that have a par value of $100 million, three years remaining to maturity, and an annual coupon rate of 14 percent. It expects the required rate of return on these bonds to be 12 percent one year from now.
    a. At what price could Barr sell these bonds one year from now?
    b. What will be the duration of the bonds in one year?
    c. What is the bond’s current yield today?
  4. Define the term “duration” in the context of fixed income securities. What is meant by the terms “price risk” or “interest rate risk”? What is the relationship between “interest rate risk” and duration?
  5. “Municipal-Bond Fans Get a Rude Awakening” (WSJ 2/8/05) Summary: Last week brought losses of 15% or more for a group of bonds with a solid triple-A rating. The losses occurred when New York City exercised the call feature on some of their municipal bonds. A call feature allows the issuer to redeem the bond early at a set price (usually a few percentage points above par value).
    a. What is a municipal bond? Why would an investor prefer a municipal bond to a non-municipal one?
    b. What is a “call option”? How does a callable bond differ from a non-callable bond? Who holds the call option in a callable bond
    c. All else equal, should a callable bond have a higher or lower yield to maturity than an otherwise equivalent non-callable bond? Support your answer.
  6. Explain the government bond quotes below. If you wanted to buy the 2nd bond listed, what price would you pay? Why are the bonds selling at different prices? What is the asked yield? Why do the bonds have the same asked yield when their prices are different?
  7. You have taken a long position in a call option on IBM common stock. The option has an exercise price of $136 and IBM’s stock currently trades at $140. The option premium is $5 per contract.
    a. What is your net profit on the option if IBM’s stock price increases to $150 at the expiration of the option and you exercise the option?
    b. What is your net profit if IBM’s stock price decreases to $130?
  8. What is an ECN? Give two advantages of ECNs in the U.S. equity markets. What is a limit order?
  9. Given the options data below, answer the following questions.
    a. Why do the three April call options sell at such different prices?
    b. Which of the call options are “out-of-the-money”?
    c. What is meant by “Open Interest”?
  10. The treasurer of a major US firm has $5 million to invest for 3 months. The annual interest rate in the US is 12%. The annual interest rate in the UK is 9%. The spot exchange rate is $2/£. The 3-month forward rate is $2.015/£. Ignoring transactions costs, in which country would the treasurer want to invest the company’s capital. What would be his return?
  11. The price of Microsoft is $25.26 and the July 2005 call options with a strike price of 27.50 sell for $0.24. You have $1,000 to invest. Describe in words (you don’t need to do calculations) the risks and returns of buying the stock outright, buying the stock on margin or buying the call options.
  12. If you wanted to buy the T-bill below, what is the price that you would pay? Assume a face value of $1,000. What would be the yield to maturity or coupon equivalent yield on the T-bill?
  13. Given the data on the Euro futures contract ($/Euro quote), answer the questions below.
    a. Describe the rights and/or obligations of the buyer and the seller of the Sep ’05 contract.
    b. Based on the data above, what do you think is going to happen to the Euro/$ exchange rate in the future – is the dollar expected to appreciate or depreciate? .
    c. What is the difference between a forward market and a futures market?
  14. “Japanese Officials Vow to Fight Any Excessive Surge in the Yen” (WSJ 1/7/04)
    a. Describe how Japanese officials intervene directly in foreign markets to stop the dollar’s fall. What specifically would they do?
    b. The March 2005 yen/dollar exchange rate is $1 to 104.04 yen. Has the dollar appreciated or depreciated since April 2, 2001, when $1 equaled 126.68 yen?
  15. When the Federal Reserve raises interest rates, exactly which rate are they “raising”? How does the Fed cause rates to rise? What U.S. Government security do they use to change this rate? Be specific.

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