826Fall2000midterm - Midterm Finance 826 Professor Helwege...

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1 Midterm Professor Helwege Finance 826 Fall 2000 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). 1. Bank Barbie, KenBank and First Federal Bank of Malibu (FFBM) each have assets of $100 million which are comprised solely of 8% fixed rate home mortgages due in 30 years. Bank Barbie has funded three-quarters of the mortgages with deposits (1 year CDs paying 5%) and one quarter with a 10 noncall 0 bond with semi-annual coupons of 6%. KenBank has funded all of its mortgages with 5 year CDs at 5.5%. FFBM has funded all of its mortgages with a 10 noncall life bond that pays semi-annual coupons of 5.88%. In each question below, rank the answers from largest to smallest (Each question: 2 pts.). Bank Barbie KenBank FFBM a. Rank the banks’ maturity gaps ____ 1__ __ 2___ __ 3__ b. Rank the increase in profits if rates drop 100bp ____ 1__ ___ 2__ __ 3__ c. Rank the decrease in profits if rates rise 100 bp ____ 1__ ___ 2__ __ 3__ (6 pts) 2. Best Buy and Kmart each have bonds outstanding that pay semi-annual coupons of 10% and have durations of 6 years. Both bonds trade at par. Kmart’s bond is noncallable for life while Best Buy’s is callable immediately at 103. If rates on Treasuries fall by 100 bp and each firm’s spread is unchanged, how much do they pay to retire their bonds? (Show your work for full credit and state the prices to the nearest penny per $100 face value). Kmart: _ 105.71__Best Buy:_ 103_____ % change in P = -6 * (-100 bp) = 600 bp = 571.4 bp or 5.714% _______ ------- 1 + (.1/2) 1.95 As the bonds were trading at par originally, the market price would be 105.71, which is what Kmart pays to retire its bond. Best Buy has the option to pay 103 for its bonds, which is a considerable savings over the true value. Hence Best Buy would call their bonds at 103.
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2 (2 pts.) 3 . True or False: Given two firms that are identical in terms of financial distress, the one in the United States is less likely to continue as a going concern than the one located in Germany. The U.S. has a very pro-debtor bankruptcy system, meaning compared to most other countries, the U.S. is more likely to let the firm continue operations. The only countries that would have a higher chance would be those seen in the Asian crisis to ignore their own bankruptcies rules and let the companies continue without dealing with the debt. (4 pts.)
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826Fall2000midterm - Midterm Finance 826 Professor Helwege...

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