Fall 2010 Midterm_II_Key

Fall 2010 Midterm_II_Key - Professor O’Brien Fall 201 0...

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Unformatted text preview: Professor O’Brien Fall 201 0 Department of Economics Lehigh University Eco 29 Midterm II A Name: €\// TA’s Name and Recitation Time: 1. Take time to think before answering. Make sure your answers to the short—answer questions are clear and legible. In order to receive full credit, you must Show your work. 2. In order that everyone has the same amount of information available to answer the problems, we won’t be able to respond to requests for clarification or elaboration. A RT“ GIFRT, 111‘” DIUJ.‘ o Ur. A... Furl,” PT 13‘ A 013‘ DE A“ _LI.U lUl LUUC. 14131-103134 Riki-1U The work on this midterm exam is entirely my own. During this exam I have not received assistance from anyone, nor have I given assistance to anyone. I have not cheated in any way. (Your signature) 1. (2 pts) Use the data in the following table on Treasury securities of different maturities to answer the question: Date 1 yr 2 yr 3 yr 10/21/10 0.22 0.37 0.52 Assuming the liquidity premium hypothesis'is correct, on October 21 , 2010, What did investors expect the interest rate to be on the one-year Treasury bill two years from now if the term premium (or risk premium) on a two-year Treasury note is 0.05 and the term premium on a three- year Treasury note is 0.10? I Q 0.3-3. + a. \ H1 0.37”; 0% = f +o.or r’" ‘9 Clem z O‘qA'ZD Q 2. (6 pts) a. Acme Widget is expected to pay no divided at the end of this year or at the end of next year. At the end of the year after next year, Acme is expected to pay a dividend of$10 per share every year forever. If investors have a required rate of return on this stock of 10" 0, what will be the current price of the stock? We "P: ./O . 3 talker ( MN” 19. Suppose you expect Longs Drug Store to pay a dividend of $8.00 per share at the end of the current year, and you expect the dividend to grow at a rate of 5 percent per year forever. If your required return on this investment is 10 percent, and if Longs’ share price is currently $175, should you invest in the stock? Briefly explain. gumdmwMUL/Q UM“ : OJO -ouor Qud You SVdufl-A IAd't [biweb’l' th. c. Suppose you expect IBM to pay a dividend of $250 per share one year from new at which time you expect the price of its stock to be $100. If investments with equal risk to IBM’s stock have an expected return of 12%, what is the most that you would pay today for IBM’s stock? What dividend yield, rate of capital gain, and rate of return would you expect to earn at this price ./ 3. (4 pts) Use the following information on call and put options for Amazoncom to answer the questions. In your answers, ignore any costs connected with buying and selling options or the underlying stock apart from the prices of the options or stock. Underlying stock price: 93.60 Amazon ( AMZN ) Expiration Strike can Last Volume Open Interest Last Oct 105.00 0.03 341 3863 11.10 Nov 105.00 1.73 1509 6799 13.30 Jan 105.00 3.59 73 8453 13.60 Apr 105.00 6.70 1 152 17.30 a. Why are the put options selling for higher prices than the call options? 1 I! V“ , , ,, ,, 919+er$ ma M L Lt. Cle option/‘43 We “M v Put Volume Open Interest 55 1511 12 289 14 584 ' 1 125 1 ' i ‘2 “ll/U) 11,, b. Why does the April call sell for a. higher price than the January call? If t I J _ 72M ‘l/Lh/‘l’l/W awm/ 4/011 €prVAi7onLa/Lojcfmk W LMM Luatvmsrc Wm Wwa/ VFW C/l/LClflC—Q O‘l W 01911011 will mmm—ef and (3th 04 W 0W1” VIM MCCJM‘ Wt 0. Suppose that you buy the November call at the price listed and exercise it when the price of Amazon stock is $122. What will be your profit or loss? a yum pm. og Wot-W; r. 230,). yam Wiu %:\’aclc L3 1 « vaa «BMW :0 M73, “(or 0L (WNW 96 973-}? wk W200 MMS’W d. Suppose that you buy the April call at the price listed and price of Amazon’s stock remains $93.60. What Will be your profit or loss? v ' witi ht mi W WM’ [M m AOW/ 6 '— his; *8“qu WM eKei/UK "th {M-S+€M fliC-Luéa q 1‘? W dp-‘riwt‘s Pflfl‘fi 4. (3 pts) a. Use the following information to prepare the balance sheet for Duckburg National Bank (DNB): The bank has $20 million in US. Treasury bills, $40 million in demand deposits, $40 million in vault cash, $5 million in loans from other banks, $30 million in mortgage-backed securities, $50 million in commercial and industrial loans, $5 million in discount loans from the Federal Reserve, $70 million in other checkable deposits, $10 million is savings account deposits, $30 million in deposits at the Federal Reserve, $5 million in cash items in the process of collection, $5 million in municipal bonds, $2 million in bonds DNB has sold to investors, and owns a building worth $4 million. I 150M4th Loom/L) , ‘ “k mm, Daniel ng‘tLu’K Cir—C Lows g WWW“ f 3.3— in, L Bgmdl “M \‘4\ l . WUMACS ¥§W‘[\‘W 5L5 brewpub!“ Cu 0A 1 EMS {TA Tobi gamma. Harman“ c/fIM you.» V5 BIA-A (ing 54% Milk Cap: Hi tonal-Lite,“ 70% L56. Milli“! “MUM-k + Cert“ ‘(lEt/e, T «l4 ?/E&\/ M‘ b. Here are the Federal Reserve’s current reserve requirements: Reserve Requirement Amount of Transactions Deposits More than $55.2 million How much in excess reserves does DNB have? m M stms 1:. (g/Ov’ZMElHM‘X-cb) 0&4L / $7Qmillgmfl fists ms-ewu 7- mugs/Mum F... '1 II. Multiple Choice. Select the best answer. l/2 point each. 1. The term “interest carry trade” is sometimes used to refer to borrowing at a low short—term interest rate and using the borrowed funds to invest at a higher long—term interest rate. How would you advise an investor who is thinking of following a carry trade strategy? a. A carry trade strategy should earn a profit, adjusted for the greater risk and lower liquidity of holding long—term bonds, provided that investors generally expect that the inflation rate will remain unchanged. b. A carry trade strategy should earn a profit, adjusted for the greater risk and lower liquidity of holding long—term bonds, provided that investors generally expect that the inflation rate will increase. c. A carry trade strategy should earn a profit, adjusted for the greater risk and lower liquidity of holding longkterm bonds, provided that investors generally expect that the inflation rate will decrease. The liquidity premium theory indicates that a carry trade strategy will not earn a profit after adjusting for the greater risk and lower liquidity of holding longwterrn bonds. On Friday the December futures price forgij was about ” $82 per barrel. $245 per barrel. -. $24.50 per barrel. d. $2.45 per barrel. 3. What is the difference between options contracts that are listed and options contracts that are not listed? . Listed options are traded on exchanges, while those that are not listed are traded over—thew counter. b. Listed options can only be exercised on their expiration dates, while those that are not listed can be exercised on any day between when they are purchased and when they expire. c. The profits from listed options are taxed, while the profits from those that are not listed are tax free. d. Call options are always listed, while some put options are listed and some are not. 4. According to an article in the Wall Street Journal, Canadian firms that import goods that are priced in U.S. dollars “buy futures contracts that guarantee that they can exchange Canadian dollars for U.S. [dollars] at fixed prices. . . .” Do you agree that futures contracts make it possible to fix the price of the underlying asset? ' a. Yes because this statement accurately describes how futures contracts work. b. No because futures contracts in foreign exchange do not exist. @ No because the prices in futures contracts are not fixed. d. Yes because writers for the Wall Street Journal never make mistakes. 5. When a loan is amortized, a. the interest rate must be fixed for the length of the loan. b. the interest rate must change as prevailing market interest rates change. C9 each payment is a combination of interest and principal. d. the loan must be capable of being resold in a secondary market. 6. On Friday, the value of the Nasdaq was about 2479. b. 11120. c. 1181. d. 3765 . 7. According to Burton Malkiel: “Taken to its logical extreme the [efficient markets] theory means that a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.” The best explanation for this statement is that a. monkeys are smarter than most people think. @all the information relevant to the future value of a stock is already embodied in its current DI‘ICC. . wwwwere77%teehniealeanalysisi—sabettenteohforepredieting future vanes of stock thanis fttIId’Em‘IBTfIta‘l’i’””””””"””i"’i analysis. 5 d. “insider trading” has distorted the true values of many stocks. 8. Fannie Mae and Freddie Mac traditionally required a LIV ratio of 80% or less because a. with higher LTVs, it would be difficult for a home buyer to get a reasonable return on his or her investment. ' b. the interest on loans with higher LTVs was not tax deductible. [IE/209113 XVIII-lid LT‘JS vyerp mnrn l'lla‘chlw' {n n-n in+n (lane nl+ L] uu 1114; 1 u LLLULV 11L\\J1J' LU 5U 111m.) uvkaulb. d. loans with higher LTVs would decline in value if the economy began to suffer from deflation. 9. Assume that you own Treasury securities and have sold futures contracts to hedge against I interest-rate risk. If interest rates fall, then a. you will lose on your long position, but gain on your short position. CE you will gain on your long position, but lose on your short position. 0. you will lose on both your long position and on your short position. d. you will gain on both your long position and on your short position. 10. If you pay $3 for a call option on Microsoft stock with a $50 exercise price, and $2 for a put option on Microsoft stock with a $48 exercise price, you will break even if Microsoft’s price on the expiration date is a. $46. b. $48. ...
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Fall 2010 Midterm_II_Key - Professor O’Brien Fall 201 0...

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