826midterm2 - Finance 826 Midterm Professor Helwege Fall...

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Finance 826 Professor Helwege Midterm Fall 2002 You have the entire class period to finish this exam. You may use a calculator, a one page formula sheet that has been approved for this exam, scrap paper, and a writing tool to complete this exam. You may hand in the scrap paper (with your name on it) to help you receive partial credit for incorrect answers. Total points=100. Part I. Answer all questions in this section to receive full credit. (80 points) (5 pts.) 1. You have a taste for risk-taking and rather than placing $100,000 on red in Las Vegas, you have decided to bet on Federal Reserve behavior. For simplicity, assume that only one of two events can happen: either the Fed eases to avoid a prolonged recession and the yield curve shifts down 50 bp over the next year or the Fed does nothing. You are convinced the Fed will ease, but you might be wrong. Rank the following bets according to how much you would gain if the Fed eased, where 1 is assigned to the bet with the most potential gain, 2 is assigned to the answer with the next highest potential gain, etc. . a. One-month T-bills . __4____ b. Mortgage backed securities with a Macauley duration of 10 years and a WAC of 6% _3_____ c. Put options on a 10-year Treasury bond (buy the put options) __5____ d. 30-year Treasury STRIPS bonds (principal only) __1____ e. Treasury bonds with a Macauley duration of 10 years and a coupon of 6% __2____ (5 pts.) 2. For each pair of bonds below, circle the one which should have the lower yield: A residential mortgage originated in 2002 A residential mortgage originated in 1978 Lower inflation A two-year Treasury bond in Feb. 1989 when the A ten-year Treasury bond in Feb. 1989 when bond market is expecting the 1990 recession the bond market is expecting the 1990 r e c e s s i o n inverted yield curve A Baa1-rated corporate bond maturing in A Baa2-rated corporate bond maturing in 5 years when the Treasury curve is exactly 10 years when the Treasury curve is exactly flat flat The rating is higher on this one (credit yield curve Goes in the same direction too) A bond issued by American Airlines that is secured A bond issued by American Airlines that is by airplanes (equipment trust certificates) senior subordinated. This one is higher in the capital structure A 30 noncall 10 bond maturing in 2015 issued by A 30 noncall 10 bond maturing in 2015 issued a firm whose rating has gone from BB to A- by a firm whose rating has dropped from AAA to BBB+ This is trading a yield to call and expected maturity is lower – with upward sloping yield curve and very similar credit risk (slightly less) yield is much lower.
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(15 pts.) 3. Answer True or False to the following questions: a. If your application for a mortgage is about to be rejected because the TDS is too high, you are more likely to receive the mortgage if you lower the LTV on the mortgage by buying a cheaper house.__T__ - use the same downpayment cash on a smaller house and downpayment % is higher (lower LTV) while monthly payments go down (TDS is lowered)
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826midterm2 - Finance 826 Midterm Professor Helwege Fall...

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