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Week 12 Quiz Sample Practice Questions updated May 21

Week 12 Quiz Sample Practice Questions updated May 21 -...

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Week 12 In Class Quiz: Duration: 30 mins, Format: Two questions with parts, covers Weeks 9 and 10; one question on duration, convexity and/or immunization and one question on options trading strategies and/or options like securities. Some sample practice questions: 1. Explain why a collateralized loan is similar to a covered call option. ANSWER: BKM P697 9. You can see it from the bank manager’s perspective. The bank manager is long the asset (the collateral, e.g., the house) and sell a call option on the asset to the mortgagee. See Figure 20.13 P699. 2. Explain why levered equity and risky debt is similar to a covered call option. ANSWER: BKM P698 9. You can see it from the debt holders perspective. The debt holder is long the company and sell a call option on the company to the equity holders. The equity holders retain a call option on the company. You need to draw a graph similar to Figure 20.13 to explain. The “Payoff to Lender” in Panel A should now be “Payoff to debt holders” and the “Payoff to call with exercise price L” in Panel B should now be “Payoff to call with exercise price D”, where D is total value of debt. 3. Explain why callable bond is similar to a covered call option. ANSWER: BKM P693 4. See Figure 20.11 P694. 4. Explain why convertible bonds are option like securities. ANSWER: BKM P693 5. See Figure 20.12 P695. 5. Explain why puttable bond is similar to a protective put option. ANSWER: BKM P449. Draw a graph similar to Figure 20.11 P694 but for a protective put for the puttable bond. 6. (a) Calculate the modified duration and convexity of a bond that pays 4% coupon annually, a yield to maturity of 5% per annum, and has 2 years to maturity. (b) Use the modified duration and convexity to approximate the percentage change in the bond price when its yield changes by 25 basis points. ANSWER: Use the spreadsheet “2Y Annual Coupon Bond” in the file “FINS5513 L9 Duration and Convexity Examples.xls” to check the answers to your calculations. Try to do a few other examples by changing the coupon rate, yield to maturity and change to its yield. 7. Illustrate, with a numerical example, how one would implement a short strangle options trading strategy. What are the breakeven points? What are the maximum loss and/or maximum profit of this options trading strategy? Graph the payoff and profit this options trading strategy. Explain under what market condition one would take this position.
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