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Unformatted text preview: 20:3 «#2005 MT Question 1 {21} marks) (a) /f (b) (C) (2 marks) Bank A oﬁers a 3 gear ﬁxed term savings vehicie which oﬁ‘ers 7% in the ﬁrst year, §§§2ain the secazzd year and e t 'rd and ﬁnal year. Bank B also oﬂ’éﬁggwyear ﬁxed term
savings plan that offers 3% in the ﬁrst year, 5% in the second year and 7% in the third and ﬁnal
year. Both pians require invegtors to ieave their meaty in the plans fer the entire 3 year period with no opportunity to withdraw their ﬁmds. Which of these plans would an invests: prefer?
Please explain 3hsz 2,3; we 5% Eng (4; 813m ‘1 if‘ﬁﬂitwsgﬂ t M“ «if m: M aauk 5.» I “$51105” m "M (2 marks) Money grows at 8% pa! year and inﬂation during this same period is 3% per year.
How mach better off is an investor at the and 0f the year? n *— 3?“ ;"' Sfiﬁ' 1'! $4535 ~ :3 v
{851$ Zea “F563 W E 6‘ C‘WSthﬁ
.2 élgfggfﬁ (2 marks) You are reading the bond quotation table: in the Financial Fest and notice that two
diﬁ‘erem campanies who have cumming corporate bands with identical maturity ﬁtcs and
coupon rates are yiekcﬁng 5.17 % and 9.25 %. What is the mast 5ker reason far this difference in yieid?
NYE; risk: Rig}! e~r . {Nu éafa‘ua ﬁsh at“? 44x: Emmi ‘ h ﬁ‘ﬁﬂ :5 5‘1???» ‘ Magafuq“ Mg3~§W§ ﬁgmamé K Page i of 9 (2 marks) Provide an initiitive reason why bond prices are inversely related with yieids. 5 {9% Euﬁéﬁzﬁvts i (View a;va ‘9‘ wig; *0 mm m WW: Lgéaié At {is EMA immitVS {o m {5 a
‘ 3:21am we». Mmﬁ we mg mg (mm in
CEKILWEBL 3t Esgéﬂk' {31v damaging 5311A; ‘ Emmi gr???) {My
‘1"? with “Ni Jw wwc‘ mi; m “I‘M w: mth a“? mw‘u‘i «m. (e) (2 marks) if the Bank of Canada guts $1,000 more into circulation and if we assumethe
commamiaj banks’ average reserve ratio is 8%, than by how much will the moﬁéy supply mareasefdecrease? _ m
‘ [5/9454
$9 : iwﬁ Q: i _ ‘w
. yr” I
$3453" 333? "M 41330
Em *
5 “‘3‘ ‘ m ~ szsaw f) (2 marks) What is :he main purpcse of ﬁnancial markets? mi“ WWW»: E; *9 ﬁu mvgaims amt: 32ft?“ wma (Sawv'i 3 {ﬁn 11M {‘owww was) mm; a “Whit? v £¢£€u€€ﬂ£¢§ Page 2 of 9 {g} (3 maxks) Why would you buy a bond selling at a premium ifyou know for sure that yau wili
incur a cagitai loss because you intend to haid the bond to maturity? M wagw. “(€125 wi mé W «Gafﬁb mil 6" {Est (mgPWB 2‘1. ML,
{QWW » Eve,“ “Ham :gjn \ 5 wtﬁw‘ iv. (imamm a («yiml (as; (A mtuv Eng ‘
5‘{ M Eweﬁ‘mmk Met; 5‘1 W58 x 3: sum @mmhcx M m ﬁrms‘2‘ (W3 ﬂu”? am 4%}; M3. "imifla a; waWE‘hS ‘5‘“! Patna: Mm 6f” “‘19? (“EW5 5““‘4 M W (aft ' ’i’ ¥ {A 3 E§ 3 \ M
(h) (3 marks) A perpetuai band issued by the British Government has a price today of $3,250. If
market yieids remain unchanged, what win this bond sell for 20 years ﬁom new? Provide a
brief economic explanation of your result.
Wm
39 W“ {WM ww‘ W95, grabsci u?“ $51 i=1 90:33 A {ECO Lg“ (i) (2 marks) List 2 major functiens ofthe Bank of Canada. L0 “51‘: {make :93 ﬁnish/*5; 15‘; L wgwé mum! ﬁgwx*"’"' {pvﬁ'Vﬁ Yd} ‘4~a?€“§ wﬁ Em. Wé‘av / Page 3 of 9 Question 2 ( 10 marks) Suppose you would be able £0 borroﬁ§4£0€i your relative Undo Rico, at the very low rate 3%. “*
APR, comgoundqg annuaily. Payments @311 be made with _e ual yggﬁﬁggyﬂeptsrfggényﬂs begixming at the end of the ﬁrst year. We Eocal bank offers a savings aném7§é§you 9% APR,
compounded semivaﬁnually. Since you are borrowing at a lower rate than you could cam on the savings account, you are better off. ‘ W ,
as}; 1. Ass 7’» 1w 5,: g
(8 marks) In doiiar temségow muoh better off are you? b 4 .0" m5? :, 1 4‘ v ‘ I
29,313; _ 1 7, x a of Y 3 id .
. 4 ‘ 3%, q»%‘% 70 " )c x ,4 x x 36: Sam3&3.
4m m
/“ . 315m. "~31
f  ' f 3'. " h ‘1 ‘5
Mr“; AM u; ojgciﬂ'(‘‘$3g) a o‘oathg {ktﬂymﬂfi
j = " 331m“: ﬁrm/'5 mini
WMMW M A i P
;. ‘ % m 4 ~ M F a, 3 \ I” « ¥ ‘3‘?
a: QM 33%. Skim g a war“, of ﬁx ‘ P NM £3ng a 43;;
x . 1 M, \ " Féw. 4: x " W
I \N M ..... M ;
\V\Lf/nv_4,,w u. (b) {’2 marks) Grandma beliech that Uncie Rico is foolish for having offered you what she cans “a
bad doai”. Rico’s answer is that it is not a “’oad deal because if you take the loan, he‘Il end up wé'ih mom than the $4,009 he started with. Criticaily comment on Rico’s logic. m
‘éﬁ'a’ a 96:“ haw mart. Rama Ru $‘fs‘ﬁm Rikﬂ ii" (Tm) A F
iéwv‘é“ \ é:qu {ca/aw Ex gig; ago)» 45,”? au. $25M“? . gm)! "gm = '1' ? w 1' g . *
yum“ ‘5‘ 3*"??? o a» W wo‘ aim we FWﬁwhitx M‘Ewifrfiffi‘“ 5'" Tog“ WW km" ‘Eﬁ‘i’i S‘E Wib‘f ‘3 “{va 4151‘“ S ‘ <;I:\‘:3’f‘ Page 4 of 9 Jgestion 3 ( 19 marks) imagine that you have graduated with your Bacheior of Commerce degree and you have a. job as an
independent credit counseior. A, client, Nam comes to you for advice. He needs a 25year, ﬁxed rate mortgage of 3330.309 in order to purchasg his ﬁrst home. His local credit union wﬁﬁahim the
money at an _3 gercent APg, compounded seaﬂ—annualiy. (This interest rate is truly ﬁxed for 25 years,
the entire life of the martgage). However, Norman beiieves he can only afford monthiy payments of
$2900, 'i‘herefore, the credit union is wilting to allow Norman to pay oﬁ‘ any remaining loan balance at
in end of the Roan in the form of a singie iumpvsum paymem. The credit union queued the amount of :his fump~sum payment and Norman is horriﬁed. He is sure thai there must be: a mistake. 1} (7 marks) Assurrﬁng that Norman keeps his monthly payments at $2,000, how large must this iump
mm payment be? Caiculate this number for Normaa E3" W“ 15' W ,x {1
i {1* {M'le ‘ S
s .u 4 "» M 361; tar s
ayuhﬁﬂss‘qg Mam 2630 [main . am i 9~£>5$ma w w '6
K ’ hi3 W‘ﬁéig fﬁims ‘I _ . U3. m I w ‘m "‘ 3 _ ﬂ ‘\ “3 10%: (mg. tumMW a £32. .. i S“ '2 {inguiul
‘35 ism {{ éiﬁﬁem m ta; ‘* Fir.“ : (EMEWDNLMV «*2: $1M ug 4‘»
f“ x  " L/ 9 am #5553434 1‘ itamymm ijmm‘t $5. ‘ 31 iSA‘ 121,4S f5 IWWM ) (.3 marks) Please expiain to Norman, in terms he can understand, why the impsum gayment is {he
ize that you have calculated. ' {1511b yaﬁsunﬁ“ :5 3;, Maﬁa 9: Emma VNL ‘ilm Wﬁiq‘ ?;g;{;m‘§\ magi: cf w $1636 i?) ma w gags Swag am am“ ﬁring“ a “(.3 wan? wt“ $ a  3 . \ . ..
a 3x, ﬁgsm 9’? W , um 33?: Maia W ganglia, (fag19‘,me fdnik “Egan {iv fax“ {:Fh ‘wa Min 5%; Miami; rats: {w
saw1 Wii'éq \ i a jaw Ewy‘ww :5 (Mug. ﬂak} « V ‘U A a 3 i
Page 5 of 9 0X4 marks) Flease ﬁst twc diﬁ‘mnt. alternatives, unﬂining what Norman could do differently to avoid
paying  this lumpsum paymeate I. hwy:3} a. ﬁatgt“: «949.651 35* Mégﬂ www.m‘wmmumwn N: {mm “s m (Wham $021k Cmﬁmm m‘éaizj Piuﬁimﬁf‘: .
5 .am M mu «:1 3&2 agatna gagmﬁs safe Q. ~ M .gmsa u» {I‘wsﬁsmmﬁ} W¢i\ no 1m? mm a n2wa our}!
M MW: :3 5%me ma rm
2“ Fiwsi a Wat ﬂax!» ’3 wait: 4“: kié‘aw ha“ 5‘ kiwi) {cm} We; {rank ﬁzwa lu rm affwé mv (av1:6 mmﬁ’iifi Wﬁamfﬁ‘ {Mkm in; kw. {mwa‘z mil ~ ﬁﬁww‘fw?hm MﬁWh W 6%“ Ex {Jam mam: Mé Wt: (can? gum fugué‘f'ed. d) (5 marks) Choose any one efﬂw We aitcmatzves ii in gran (c) above and previde the calculatioas
and solution that would be necessary to support the: aitematiw chosen. (Sham : mm Ni WWW mm ‘ M W55 “13‘” Maura“: Pulls “M‘s.
W5 . V5 = in” ( . I _»'5,w )
3m campassﬁiqb M (I. 55 ggfﬁq‘zx $§§qm w. x {151.0%}.24315‘: x .~.. grams». €113?“ ; «iizsaaﬂs / Iva 5’53“! gaﬁzuﬁ 11% Mﬁﬁlts ‘ W ? l; ‘3‘“ . q W m“‘ ‘1‘ {M3 m ﬁ‘é #m‘ 23"?“ lgzuv' [mm‘n’um «’w fig/WV“; W"; 3‘3 Raw; 93 J 19;}: Page :6 of 9 ,Erestion 4 ( 13 marks} Five‘years age, Ramona paid $412453 to purchase a Government ofCanacia mg} face value bond.
The bWﬁﬁééﬁ‘mg to mamrity at the time Ramona purchased it, a coupon rate of 8.5%, with
' cm; 0 aid scrapannual , a ’eid to .maturi of 79’ . . \ (5 marks) Caicuiate the current pﬁce a; which Ramona selis the bond.
1 e; .g: 1 x 1/2533“ my. s. 1* h l ‘ i a.
m e. 3 v; “ ’ ‘ ‘ ‘5 .h A 1% rﬂwmumb  GI by!” SW & V; “g g?" .\ V K gzh'xccﬁ
a « Km ' _ +2~s _ W 3
Pﬁ 31: «(3Q Y} (0 PVJb;43 0‘“? (3“ (Lazy) ) + Lays“) {‘5
d :mym : 3,57% KP '01“ x = $425 masw . 31 $4» 2"???” 1
\a w” ( i m {ﬁx/"Ha a pm or “bi é'io.m§"%5'* 3 éztijy
‘* Migg‘im‘a‘é's =“‘ [13118 @(8 marks) Caiculate Ramcm’s reaiized holding period rate of rerun: on this bond investmeni. How
oes it campare to the band‘s purchase date Y'IM of 7%? Piease pEOVide a brief economic ’f expiaaation for your result. 7. ,1 , g i: 2 2. g 4 V k: p was /
5 i i 7 ‘ V 1...”! g .1
335‘ mamhmmmwwmm m.mm.‘_..WW f: g 4 {p cigfi 5* 1 6% f ‘ ‘
ﬁmxs "5 mm? WW; €w m WW '~ 42‘5'f21wﬁﬁmmﬂﬁ i)
magma“: i... 3% ‘ hm my s ; Ragnar «emmﬁAG “» Hﬂcﬁﬂﬁg ﬁm,‘ a»? m (“pm {3213‘
ﬂu hwmtui mu 53 aim 5"
w WOﬁE 1 Nb“ 0 '* *r ‘1 Wm w“ Wm g #70“.
; 'er 1» ii‘ﬁ $456; ‘ M s{ m Wang I { milw
. 26’ E x: '3
r =~ $1, {1; £3 ‘gy’gg Emuaé mfg {mtv‘t‘puﬁd 4w ﬁn "\ Questitm 5 ( 18 marks) @rﬁw‘ Suppose you want to determine the price ofBond 3, a 2year Government of Canada, zero canyon bond
with a $1001) face value. You obtain irrigate quotes (:11 two other Government of Canada bonds, bath with
$1000 face vaiue. Those bonds which pay coupons do so annually, and please assume {hat they have
just paid their most recent coupon. (Le. yam: have exactly one yaar to go before the next coupcn
payment), You should assume that these two bands are correctly priced. Details are as fellows: Bend 1: 4% angina} coupon, face value x $1000, 2 years to maturity, current price = $896.20
Bond 2: 6% annuai coupon, face vatue = $1080, 2 years to maturity, current price = $931.10 a) (6 masks) Using Bonds 1 and 2, Show how you can repiicate Bond 3, the 2*year zero coupon
Government. of Canada band with a $1,000 face value. What quantities of Bonds 1 and 2 wozﬂé you buy or sail t0 repiicate one of Bond 3? W
f’rm; iq h. 7% {afikauiz Ema “$3 :
‘wf’ ‘35:: r ‘3?“319 £36 Maw 34 mg; {G M5 3 i
\f 3:“ ; $ {wtm {3‘0 $953.0 gang 1?“ M3 {kg 3 4, g
g 1
§' jg G 3mm» L! f
m, {A #1232 w £07 at: ’/
&? ~'%x ‘ g .& ﬂ
« w~w w w? *3
=~ A
at, “£3 Ecitbx 1» wéu? r“ $§m m
Mini f ieéaﬂ 55:} “m gag“ a. 3 3; gim
v v: rd 3:, x
E$$im a ﬂaw
% “ 3; b)(2 marks) Based on you: replication strategy in part (a) above, what price should Bond 3 sail for
taday‘? Why must thiS be the prim? i: V ‘
:9; 3:35:15; { a: §ﬂ5g.xb} x; '
M . a i‘gﬁwsi “gm: 5?
3%.— ~'» {i’SLiO PM L $§3&%1§ g Page 8 of 9 5.45: 337'? ‘ 525 marks) Suppose you ﬁnd that the tunem price for Bend 3 is actually $800.00. Does this present
" you with an arbitrage oppoﬁunity? if so, please expiain the exact arbitrage strategy you would use to
proﬁt from this Isis—pricing (5e, cleariy identify how much you would buy and sell of each bend
involved in your strategy), and haw much week! you make each time you performed this arbitrage
trade. If this situation does not present you with an arbitrage eppoﬂnnity, please explain why not. \: W53 a»: Mme mew‘ie» a“ Wm“ (*“M‘ “9“ ‘3 W M“
‘1: we MBHH? whwix 35 ﬁzeﬂe 83m a? e we»: ﬂaws ﬁg *3“) e 5 "mg; 3% en refiuwtiw ﬁg ﬁes«*5 “% M a: e a}, m We e. We at We“: (“QM‘ 'f“ 5M “3
’3 Ruse 31 wmxé Sex! g ef sen/‘5 “1 ewes £15 2‘1. e“? M5 g?“ “{‘W “M5 Wié‘ eﬁw M h gem m ﬁgéwmi 9* M {if , d){2 marks) Assume that Bend 3 trades for the price you found in (b). What is its YTM?
iwe ‘= Keeée {l *z‘f E1 r = b‘ iweéeé‘mi ./ i‘ﬁﬂ 1 Whine ‘3‘; @3 marks) Assume that you netice that a two~year, $1,060 face value, zereceupon bend issued by
{EM is primed at $780.00. Does this fact, cembined with the introduction to this question, present you
with an arbitrage opportunity? Ifso, please expiain the exact arbitrage strategy you would use to proﬁt
frem this miswpricing (Le. cleariy identify how much you wouid buy and sell ef each bond inveived in
your strategy), am! haw much weuid you make each time you performed this arbitrage trade. Ifth
situation does .1301 present you with an arbitrage opgertunity, piease expEein why not. Ne 1. ma EGM gm wit {5QO am weave»? gygxeiwﬁvg gamma! ‘Femie. 5:5 M M\ a“ a e»? ﬁnal. W411 5w gig/Nev a Mae?
3 ~ , » ‘ ‘s w 
WK a gem {me am mm «s m m fag M ﬁe: {were W44»
,9” x3 =\
y&; ‘ Sine. MRS 33m he be {$5 mm ﬁg (W? W 35% {Wax $1 Emmi. {E} f Page 9 of 9 ...
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This note was uploaded on 04/24/2010 for the course COMM 298 comm 298 taught by Professor Briangraham during the Spring '10 term at UBC.
 Spring '10
 BRIANGRAHAM

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