Spring 08 Final - Version A Name (please print) : Business...

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Unformatted text preview: Version A Name (please print) : Business 171a Professor Reza Spring 2008 San Jose State University Final Examination Instructions and notes: 1. Please put your name on BOTH the scantron and this exam. If your name is missing from either, you will receive ZERO on the exam — no exception and no changes afterwards. II. Please put your test version on the scantron. If the version is missing, your exam will be assigned a version at random and corrected; the result will not be changed. III. This is a closed-book, closed-notes exam. Do not consult others. You may use only a calculator. IV. There is one correct answer to each problem. Multiple answers receive zero point. V. Unless specified otherwise, approximations should be rounded to 2 places after the decimal. Unless specified otherwise, a debt security has,a face (par) value of $1,000 VI. Unless specified otherwise, assume that a. investors maximize their net worth (i.e., they are “rational”) and firms maximize their common shareholders’ net worth. b. all markets are efficient. c. firms are typical of the industry in which they operate. 1+ ' . . 15—: 1 {D , where F= forward forex rate (in $ per forelgn currency) + 1W , S=Spot forex rate (in $ per foreign currency) i0 = US interest rate iW= foreign interest rate . l 1 . . PV of annuity = C 7 —— where C = regular periodic payment 2 1 +1 1' = the annual rate of interest N: the number of periods payments are made/received AE = - [DA — £ DL] A Ar/(l+r) ; E = Equity; A =Assets; L = Liabilities; D = duration of A A or L; r = interest rate; the term in the brackets [.] represents duration (or leverage—adjusted duration) gap. Also AA = - DA A Ar/(1+r) and AL = - DL L Ar/(1+r). 1. Regarding interest rates on 3-month T—bills: (a) The current rate is around 8%-9% (mostly because of the sub-prime issue) , lower than any time in the past 25 years The T—bill rate is always the same as the Fed funds rate ’(c The current rate is around l.5%—2.5% ) The current rate is around 4%-5%, not much higher than at any time in the past 25 years 2. The relationship between bond price and the rate of interest is best described by: (a),They move in the same directions and convex ‘" hey move in opposite directions and convex W(c) They move in opposite directions along a straight line (d) None of the above Consider the various influences on the overall market rate of interest. (a) When there is less willingness to borrow, interest rates tend to fall “V (b) When the risk of default by issuers of bonds rises, interest rates tend to rise (c) When the risk of default by issuers of bonds falls, interest rates tend to fall Both (a) and (b) ’ ‘ i ' ‘ 7(6) Both (a) and (c) I/iL/iield to maturity and the spot interest rate are the same. L” (a) True <® False 5. Data suggest that in the recent past (say, the past 20-25 years) (a) Short—term interest rates have generally been less volatile than long-term rates (b Short—term interest rates have generally been as volatile as long—term rates (a. hort—term interest rates have generally been more volatile than long-term rates 6. Consider two bonds A and B. Both have the same YTM and the same maturity. But A pays a coupon rate of 8% while B pays a coupon rate of 12%. (a) Without knowing the exact YTM we cannot determine the bonds’ durations (b){_},Without knowing the exact maturities we cannot determine the bonds’ durations ' 0"": Bond A has the shorter duration " ) Bond B has the shorter duration 7. Everything else the same, if consumers find owning homes more attractive than before, the result would be a lower overall market rate of interest. (a True g False You check the newspaper and notice that yields on almost all corporate and Treasury bonds have increased. The yield increases may perhaps be explained by which one of the following (a) An decrease in current and expected future returns of real corporate investments (b ; Increased Chinese purchases of US. Treasury Bills/Bonds A 'ciw'An increase in US. inflationary expectations “C Decreases in the US. Government budget deficit (e) Both (c) and (d) 9. The future value in 3 years of $1,000 received today if your investment pays 6% compounded 4 ‘ u .I ,000 (1.06)3 [ 1060000)3 1000 (0) 1,000 (6%)3 +1,000 p (d) (1.06) 3/ 1,000 , ' @A negotiated non-standardized agreement between a buyer and seller (with no third party involvement) to exchange an asset for cash at some future date, with the price set today is called a (an) 1’ . ~ (a) Future (b Option c orward 4' "'d) None of the above 11. Major liabilities for banks include I.“ Business loans ,Deposits by clients 5Cfi(c) Interest expense paid on deposits ’ ((1) Equity capital (e) Securities held for sale \ I‘ll/You bought a stock 1 year ago for $50. You received a dividend of $2 today and then sold your stock immediately for $45. a5 Total rate of return on your stock is -6%, consisting of +4% in dividend yield and -10% in capital gain V fl Total rate‘ of return on your stock is +15.56%, consisting of +4.44% in dividend yield and +11.11% in capital gain (figures are rounded) /(z)/ Total rate of return on your stock is +11.11%, consisting of +4% in dividend yield and +7.11% in capital gain (d) None of the above ' 13. fl ou sell a June 2008 crude oil futures when the June futures crude oil price is $1141 . (9) Since you and your counterparty are bound to trade at the price of $114, then the value of / your contract remains unchanged regardless of what happens to the spot price of crude oil «\at delivery time ‘ (b) The value of your contract is zero at contract time but will be positive (i.e., you earn a \ _ rofit) if the spot price of crude oil is higher than $1 L4 at delivery time in June 59/ he value of your contract is zero at contract time but will be negative (i.e., you lose) if the V spot price of crude oil is higher than $114 at delivery time in June ((1) Regardless of what the spot price of crude oil is at delivery time in June, you will not experience a loss (e) Both (a) and (c) ,/ / V/ ou invest $1,000 in a one—year, Japanese yen—denominated riskfree government bond that - I offers 3% per year in return. The current spot exchange rate is $1 = ¥ 100. (a) This guarantees that you will end up with $1,030 in one year (b) This guarantees that you will receive ¥ 103,000 but you are subject to foreign exchange risk; to eliminate the forex risk you should sell ¥ 103,000 in the forward (or futures ) market his guarantees that you will receive ¥ 103,000 but you are subject to foreign exchange risk; to eliminate the forex risk you should buy ¥ 103,000 in the forward (or futures ) market (d) There is no way to eliminate the forex risk since one cannot predict the exchange rate in the future with certainty 15.7.bne reason commercial banks are strictly regulated is that because of asymmetric information between banks and depositors the government provides insurance for deposits. But this leads to moral hazard. rue (b) False 16. We observe the current rate on one—year loan to be 3% and the rate on two-year loan to be 5%. What is the market expect that the one-year loan to be next year, rounded to one digit after the decimal (under the Unbiased Expectations Theory)? [notez use the model that was presented in the lecture, Feb-14] f a; ,a, :3 (a) 7.0% \ u 9§ /f[ A) 3’ Kr :- .0 % e - 1 (c) Some figure between 3% and 5%, but cannot be determined more precisely (d) Cannot be determined at all since it is a future rate 17. In general, depository institutions’ profits tend to rise. (a) When the yield curve is downward sloping (b) When the yield curve is flat (0) When the Federal Reserve discount rate is high but the long-term interest rates are low @When the yield curve is upward sloping \ {/1/8. fiVe observe the spot one-year US Government security rate to be lower than the spot two-year \w/ US Government security. What can be inferred about the one—year US Government security ‘ expected one year from now? ext year’s one-year rate is expected to be higher than the current one—year rate ((b) Next year’s one-year rate is expected to be lower than the current one-year rate (0) Next year’s one—year rate is expected to be the same as the current one-year rate (d) There is nothing that can be inferred from the current rates about next year’s rates )9: You buy a bond fois¥$960f The bond pays interest of $100 at the end of year 1, at which time / you sell it for $980. The rate of return you expect to cam on this investment is approximately (a) 2.08 %' g, (b) 10.53 % N @1250 % 1, fist? (d) 10.47% 05‘ ‘5: , «:2: (6) None of the above Q [j ,e 20.0nd A has duration 4 years; Bond B has duration 3 years. _ 1\ //f interest rates fall, Bond A’s price rises by a greater percentage than the rise in the price of B (b) If interest rates fall, Bond A’s price rises by a smaller percentage than the rise in the price of B ‘ /(c) If interest rates fall, Bond,A’s price falls by a greater percentage than the fall in the price of b‘/” B V (d) If interest rates fall, Bond A’s price falls by a smaller percentage than the fall in the price of B )f/Y The percentage changes in bond prices have nothing to do with duration 21. Among differences between ordinary bonds and most ordinary mortgages is (are) .\ (a) ordinary bonds pay coupon semiannually but ordinary mortgages make their payments monthly . (b) ordinary bonds are amortized but ordinary mortgages are not (c) “ordinary mortgages are amortized but ordinary bonds are not (d both (a) and (b) 0th (a) and (c) 22. You have borrowed a $100,000, 6-year, 5%—fixed-rate balloon payment mortgage, compounded yearly._Y0u make your payments at the end of each year. What are your payments? —g—-+ C + + C 1.05‘ 1.052 1.056 (a) Use the formula to solvefor C: $100,000 = @1000 for 6 years, plus $100,000 at the end of the 6th year C + b + +C+100000 1.051 1.052 1.056 (c) Use the formula to solve for C : $100,000 = 23. The required reserve ratio is R=10%. The monetary authorities inject $100 in currency into the banking system. Assume no leakages of any kind. (a) This will increase the amount of required reserves by $100 (b) This will increase the total money supply by $1,000 This will increase the total money supply by $100 (d 0th (a) and (b) (6) Both (a) and (c) \ 24. You promise to take delivery of 1,000 barrels of oil in June at the price of $106. This means that (a) You have a short position and if the spot price at delivery time is lower than $106 you make a profit . You have a short position and if the spot price at delivery time is lower than $106 you ' incur a loss (/c)”You have a long position and if the spot price at delivery time is lower than $106 you make / a profit (cl/)"lYou have a long position and if the spot price at delivery time is lower than $106 you incur a loss 25./ ou have promised to accept delivery of a security on June 20, 2008 in exchange for $40, if / your counterparty chooses to deliver it to you. You do not owe anything if your counterparty decides not to deliver the security to you. This represents a (a) Put option that you have sold (b) Call option that you have bought (0) Short future (or forward) position :>(d) Long future (or forward) position (tars ‘w taxis“? N w . I v“- flak-v (6) Call option that you have wé xgaffi (W . ’35-” 26. You hold (i.e., own) a call option on a stock with exercise price X = $30 and expiration time on April 20, 2008. The current price of the stock is p = $35. The value of this option moments before expiration is '7 Mm (a) $0 ifp 5 $30 4.: K3 (b) $5 if p = $25 rs) (c) $5 ifp=$35 Both (a) and (b) 0th (a) and (c) 27. A U.S. investor has borrowed pounds (£), converted them to dollars and invested the dollars in the U.S. to take advantage of interest rate differentials. To cover the currency risk the’investor should (a) Sell pounds forward (5}) 4 ‘ uy dollars forward EV? ‘ x ( U r: uy pounds forward ) Sell pounds spot (6) None of the above 28. A US. bank converted $1 million to Swiss francs to make a Swiss franc loan to a valued corporate customer when the exchange rate was 1.5 francs per dollar. The borrower agreed to repay the principle plus 5% in francs interest in 1 year. The borrower repaid Swiss francs at loan maturity and when the loan was repaid the exchange rate was 1.4 francs per dollar. What was the bank's dollar rate of return? ‘g .glfi E& 6.00% “‘1 r . pm (a) 50% iflM -> lt‘bé‘DOtQOQ 57 (c) -11.67% \ 3mg x VO 3 “A lwéngfiDQQ f (d) 7.14% £4. (e)—2.00% rhtklggeoo / r m f 6" 5’ t /2/ @he Fed targets EeUU‘fié Qw) {23E}- EQQQ m 5? M Tth MT. ................ a, .... ., n ‘ \13 V f KP? 7‘ {.3 Km "(diam 3-month T—bill rate (e) None of the above 30. I hen the FI increases the number borrowers to whom it lends the result is (a) To reduce the specific (or unique) component of credit risk I (3)40 reduce the systematic component of credit risk y ((c)\,,.Both (a) and (b) ' Yd) Neither (a) nor (b) B I < 315 To avoid liquidity risk, a depository institution must have (a) Stored liquidity (b Purchased liquidity Either or both (a) and (b) ) None of the above 8 @ Consider a commercial bank’s Balance Sheet, with required reserves ratio of 10%. Liabilities and E ui Reserves Deosits $ 100 Loans Borrowed Funds 15 Securities E - ui 20 If depositors withdraw $5, the bank can fulfill its legal requirement by (a) selling some of its securities (b) \selling some of its loans (0) borrow more funds ' flamof the above (ca/>061), (a) and (b) :Tou buy a bond for $250.255. The bond pays interest of $100 at the end of year] and another " $100 at the end of year 2 year 2, at which time you sell it for $980. The (annualized) rate of return you expect to earn on this investment is approximately 12 %. () True alse fay/bank has total assets of $120 million and $15 million in equity. The managers of the bank (i realize that $10 million of its $100 million loan portfolio will not‘be repaid. After the bank ' charges off the bad loans the bank's equity to asset ratio will be approximately @ (a) 12.50 % x (b) 10.00 % \ (c) 4.55 % (d) 4.17% \ ,/\ \x \ ,x" \ / 35. iLiquidity risk arises from l\ j(a) Unexpected loan demand “ W” (b) Unexpected deposit withdrawals (c) Loan defaults $ (d) All of the above (6) Only (a) and (b) A bank has invested in US. Treasury securities that mature in 2 years, to be held until Kw// maturity. The investments are funded with 6 month maturity deposits. During the next two years, this bank faces ' ‘ (a) Reinvestment risk $ (b) Refinancing risk (0) Default risk (d) None of the above 1. {/3 Adverse selection and client moral hazard explain why 9. _\ 1 $9) FIs screen and monitor borrowers 3i (b) there is government deposit insurance (c) depository institutions are required to hold reserves (d) all of the above (e) Only (b) and (c) 38. It is because of adverse selection and client moral hazard that FIs (a) Ration credit _ a __ (b) Require collateral i? (0) Both of the above (d) None of the above ’ educe or minimize interest rate risk, a F1 .4???“ hould lend at the highest rate possible but borrow at the lowest rate possible i ’15? should lend at the longest possible maturity but borrow at the shortest possible maturity " gee)” should select the duration of the securities it buys and sells to be very similar All of the above *' ’ one of the above ‘\ . . . . . l: reason why credit problem (1.6., default) can be serlous for commercral banks 18 .7 a Banks are highly leveraged 5 Banks are required to keep 10% in required reserves (0) Both of the above V' (d) None of the above Jredit scoring systems attempt to determine / (a) Which borrower will default and which will not (b) What is the probability of default by any particular borrower (c) _When is a particular borrower likely to default a? “'(d) All of the above (e) None of the above 42. You just bought $1,000 worth of UK pound—denominated 1-year bonds that pay 8% interest annually. The current spot rate is £1= $2. What will your total return be if the \ 6 g; >< r‘ pound’s spot rate is £1=$1.60 by maturity? ' O O N _, J A-» (a) +13.6 % 39.43“ Lu h” M 25 f $4 (b)+33% f SE g N ‘9 (c) +35 % “ M M 313.6 % 6) cannot be determined since we don’t know the forward rate of exchange ‘43 The rate of interest on 3-month US is 6%, the foreign exchange spot rate is ’/irr£1=i$2,\,and the forward rateis £1v;_fj—’j’$2_.qllr.j?or what rate of interest on 3-month UK W goVern'ment bills would you find it profitable to invest in the UK bills? =9 (a) 5:5% or more (b) 5.0% or less “h g) L (c) 5.5%\or less l u.» . Q 6 ‘54 a (d) None of the above k V, 44/ allable bond @ Gives the issuer the right to force the bondholder to sell the bond back to the issuer " at the call price; these bonds offer a higher rate of return than similar bonds but without the call provisién Gives the bondholder the right to force the issuer to buy the bond back at the call price; these bonds offer a lower rate of return than similar bonds but without the call provision )1; Has a “call option” attached to it, giving the bondholder the right to buy common l stock in the issuing firm at the exercise price; these bonds offer lower returns than 1 similar bonds but without the call option. e repricing approach to interest rate risk involves (a) Measuring the impact of interest rate changes on the equity value of the FI (b) Measuring the impact of interest rate changes on the income of the Fl (0) Measuring the impact of interest rate changes on the duration of the H’s assets (d) All of the above (6) None of the above 46. Consider the FI with Assets = $7@ on which it earns interest at the rate of 8% and Liabilities: $500 on which it pays interest at the rate of 6%. If interest rates rise by 1 percentage point (100 basis points) across the board, the impact on the FPS profits will be (a) $ +7 . n. (b) $ -2 32 31?: 4 51 C; 3 +2 w - 3’? '37“ (d) $ _7 5 51%;) 2’ (e) None of the above 10 / /7/ x47. onsider the balance sheet of a PI as shown below. Assume that the FI pays the same l- rate of interest on its borrowed funds as it receives on funds it lends (this is assumed to simplify the problem): the rate of interest for this F1 rises from 6% to 8%. The durations are DA = 5 for assets and DL = 6, and r = rate of interest. Liabilities and Equity Assets 9000. Liabilities c x 7000 Equity 2000 Total 9000 Total 9000 If the FI wants to eliminate interest risk on its equity value (a) it should manage its assets and liabilities to make its DA = DL . (b) it should manage its assets and liabilities to make Ar /(l+r) = 0 (c) it should make its L/A = 0 P‘ ((1) none of the above Use the information in Question 47. To eliminate interest risk on its equity value, the FI (a) Should get its L/A= 5/6 (b) Should get its L/A = 6/5 (0) Should reduce its assets to A = 0 ((1) None of the above / '1 2 QWUSC the information in Question 47.1-The impact on the equity value of the PI of the interest rate change is I (a) $ + 56.60 (b) $ — 55.55 (c) $ - 56.60 (d) $ +55.55 (e) None of the above n 50-: Use the information in Question 47. The impact on the asset value of the F1 of the “(interest rate change is "(a) $ —849.06 (b) $ -833.33 (c) $ +833.33 (d) —l6,981.13 (e) None of the above 11 51. Liquidity risk can be managed through (a) “storing” liquidity — which means holding excess reserves (b) “purchasing” liquidity — which means purchasing US Treasury securities when needed [@oth of the above d) None of the above 52. Among the causes in the shortfall (i.e., insufficient amount) of liquidity for a F1 is (are) (a) Unexpected withdrawals of liabilities \ (b) Unexpected rise in assets (5w ’2'” 0th of the above ' {5) ’ ((1) None of the above 53. Using stored liquidity to offset a deposit drain will reduce the size of the bank as measured by its assets, but using purchased liquidity to offset the drain will not. @h‘ rue AV \\ (b) False yr/54./~Which one of the following situations creates the most liquidity risk? i\ ,7 (a) Long term assets funded by long term liabilities if é / \ \/ (b) Short term assets funded by short term liabilities f =9(c) Long term assets funded by short term liabilities } it Ric/leg (d) Short term assets funded by long term liabilities UM "“ (e) Long term liabilities funded by short term assets (65/; The two main reasons why runs on US. commercial banks no longer occur are (a) Reserve requirements and higher bank liquidity ratios (b) Required positive financing gap and bank use of purchased liquidity (c) The FDIC and the discount window a; ((1) Both (a) and (c) (e) None of the above 74 12 { 5 bank has a negative (leverage-adjusted) duration gap. Interest rates decline. Which one of the following best describes the effects of the interest rate change? The bank's market value of equity (a) is unchanged since the market value of its assets and liabilities move in the same direction. (b) goes up because the market value of its assets goes up by more than the market value of its liabilities goes down. (c) goes down because the market value of its assets goes up by more than the market value of its liabilities goes down. ((1) goes down because the market value of its assets goes down by more than the market value of its liabilities goes down. (e) goes down because the market value of its liabilities increases by more than the market value of its assets increases 57.\Some U.S. investors have started to invest in Malaysian bonds (both government and private). One reason is that the Malaysian currency is expected to appreciate relative to the US dollar. (a) True Q (b) False l3 ...
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Spring 08 Final - Version A Name (please print) : Business...

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