mid1s-W09 TA version

mid1s-W09 TA version - Financiad Economics ECN134 Midterm 1...

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Financiad Economics ECN134 Midterm 1 Winter 2009 Prof. Farshid Mojaver *********************************************************************** * [20 pts] 1- Some Financial Terms and Ideas i. What is securitization? Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. ii. What is financial engineering? Creating new financial instruments by combining other derivatives, or more generally, by using derivatives pricing techniques iii. What is Credit Default Swap (CDS)? A CDS is a contract in which one party (the protection seller) agrees to reimburse another party (the protection buyer) against a default on a financial obligation by a third party (the reference entity). iv. How might CDS have contributed to the current financial crisis? The protection seller needs to cover its position when the reference entity is in high risk of default. One way to do this is to short the securities of the reference entity. But this will reduce the stock price of the reference entity leading to it collapse. When the reference entity goes bankrupt the position of all those institutions that hold its share becomes weaker. People that hold shares of these institutions buy CDS to cover this risk. The protection seller shorts the shares of these companies leading to their faster collapse. That is one event cascades to the other leading to a systematic collapse of the entire financial market . [11 pts] 2-Derivation of the formula for Growing Annuity Show that the present value of a growing annuity that pays a stream of cash flows C and grows at a constant rate g for a fixed number of periods T can be simplified to : + + - - = T r g g r C PV 1 1 1
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[12 pts] 3- Annuity Weak consumer spending has led automobile manufacturers to offer zero interest financing or cash back options to stimulate sales. Suppose you can buy the car of your choice for its negotiated price of $16,200 less $500 cash back, or you can finance the entire $16,200 car cost for 36 months at zero interest. You have the cash necessary to pay for the car in an account that earns a stated annual interest rate of 4%, compounded monthly. You will either finance it or pay cash depending on which is the best deal. a.
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mid1s-W09 TA version - Financiad Economics ECN134 Midterm 1...

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