826Fall2001midterm - Midterm Finance 826 Professor Helwege...

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1 Midterm Professor Helwege Finance 826 Fall 2001 You have the entire class period to answer these questions. You may use scrap paper, a calculator, and a writing implement. If you think certain assumptions are important in determining the answer and those assumptions are not made clear in the question, feel free to write them down, as it may affect the extent to which you receive partial credit. Total points = 100. PART I. Answer every question in this section to receive full credit (80 points possible). (9 pts) 1. Wheeling Savings and Loan has assets of $100 million, which are split evenly between 8% fixed rate home mortgages due in 30 years and 7% auto loans due in 5 years. This S&L funds all of its loans with certificates of deposit that are due in 2003. (2 pts) a. What is the maturity gap of this institution? _ [.5(30)+.5(5)]- 2= 17.5-2=15.5__ (2 pts) b. If you were a Wheeling shareholder, would you prefer to see the yield curve shift up or shift down? _ down (long assets would gain a lot while CDs would gain little) (4 pts) c. Which of the following strategies could Wheeling use to protect itself from interest rate risk? (Circle ALL strategies that apply.) 1. Enter a plain vanilla swap and agree to pay floating. 2. Write a call option on Treasury securities. 3. Sell some of the mortgage loans to Fannie Mae and use the cash to make more auto loans. 4. Convince some of the CD investors to exchange their CDs for 1 year CDs. 5. Sell futures contracts on Treasury bonds. (Note for this question, any strategy that helps should be circled. #2 would not necessarily fully protect the firm from interest rate risk, but it’s better than just borrowing short and lending long.) (6 pts) 2. Your mutual fund owns Worldcom bonds due in 2012. The bonds are rated BBB+ and trade at a YTM of 7.60%. The price is 104.79. The spread on the bond is currently 245 bp and the duration of the bond is 7.53 years. Worldcom appears to be suffering from the recession and a highly competitive environment. Hence many investors expect its rating to drop to BBB and its spread to widen by 25 bp. Should the bond suffer the events expected, while Treasuries remained unchanged, what would be the new value of each Worldcom bond in your portfolio? (Show your work for full credit.) __ 102.89____ First, note that the coupons are semi-annual, which you always assume unless explicitly noted. . To get the price change when rates go up by 25 bp, use the modified duration formula: % change in P = - MD * rate change
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2 % change in P = - MD * 25 bp MD = 7.53/(1.038) = 7.2543 [New P - 104.79]/104.79 = -7.2543*25 bp New P -104.79= -1.814%*104.79 New P = 104.79-$1.90 = 102.89 (2 pts.) 3 . True or False: A yield curve slope of more than 200 basis points is an indication that the economy is likely to go into a recession. __ F - an inverted yield curve means recession not a steep one (200 bp difference between long and short yields is very steep)__ (2 pts.) 4. True or False: The net present value of an interest rate swap at origination is typically zero.
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826Fall2001midterm - Midterm Finance 826 Professor Helwege...

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