{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

EC3333 Final 2005 Spring - EC3333 NATIONAL UNIVERSITY OF...

Info icon This preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 4
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 6
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: EC3333 NATIONAL UNIVERSITY OF SINGAPORE EC3333 FINANCIAL ECONOMICS I (SEMESTER II : AY2005-2006) Time Allowed : 2 Hours INSTRUCTIONS TO CANDIDATES 1. This examination paper contains FOUR (4) questions and comprises SEVEN (7) printed pages. 2. Candidates must attempt THREE (3) questions. Question 1 is compulsory and it carries 31 marks. Answer any TWO (2) from remaining THREE (3) questions, each carrying 12 marks. 3. This is a CLOSED BOOK examination. 5. The total marks for the paper is FIFTY FIVE (55). 2 EC3333 Question 1 lCompulsoryl [31 marks] (A) State whether the following statements are True, False or Uncertain. Provide a short justification for your answer. (You are evaluated on your justification) (15 marks 3 marks each.) (i) (ii) (iii) {iv} (B) If two assets are negatively correlated, then there is a portfolio of two assets with a variance of zero. In order for investors to be willing to invest their money for the long run, the yield to maturity on a 15 year bond must always be greater than the yield to maturity on a 5 year bond. The stock of ABC is currently trading for $5 and won't pay any dividends in the next three months. Call options on ABC with strike price of $1 and expiration in three months are currently trading for $5.50. There is an arbitrage opportunity. In a CAPM equilibrium, no risky asset will have a lower expected return than the risk free asset. A speculator who expects that the interest rates will go up in the future should invest in a bond portfolio with a long duration. (i) ”There is no real difference between options and futures. Both are hedging tools and both are derivative products. It’s just that with options you have to pay an option premium, while futures require no upfront payment except for a ’good faith’ margin. I can’t understand why anyone would use options.” Do you agree with this statement? Explain. [2 marks] Suppose that you enter into a short futures contract to sell July silver for $5.20 per ounce on the SICOM exchange. The minimum price change is $0.05. The size of the contract is 5000 ounces. Initial margin is $4000, and maintenance margin is $3000. (a) At what price will you get a margin call? [2 marks] (b) How much more will you have to deposit? [1 mark] 3 EC3333 (C) Fresh out of school with your degree, you are considering a position as a head of marketing for XYZ Corporation, a biotech firm. As a new firm, the salary is not that great. But your package will include call options on 10,000 shares of XYZ stock. XYZ stock currently is selling for $10 per share. The options you will be granted if you accept the job have an exercise price of $10 and expire in three years. They cannot be exercised early. The standard deviation of stock return is 28%, and the current yield to maturity on three—year bonds is 3.6%. (a) What is the value of the options on all 10,000 shares? [5 marks] (b) State the effect, if any, of each of the following three variables on the value of a call option: (i) an increase in exercise price,(ii) an increase in stock price volatility, and (iii) a decrease in time to option expiration. [1.5 marks] (D) You have the following information about the prices of a one-year zero coupon bond A and a two-year coupon bond B. 0 Bond A pays $1000 in one year and sells for a current price of $960 0 Bond B has a face value of $1000 and an annual coupon of $60. Bond B currently sells at $1050. (a) What are the 1—year and 2-year spot rates? [2 marks] (b) Consider a 2~year annuity with annual payments of $500. What is the duration of this annuity? [2.5 marks] 4 EC3333 Question 2 (12 marks] Consider the following information: Asset Expected return Std. deviation Corr. with the market Stock A ? 20% 0.4 Stock B ? 30% 0.7 Market 10% 15% 1.0 Risk-free 5% (a) According to the Capital Asset Pricing Model (CAPM), what should be the expected return of stock A and stock B? [2 marks] (b) Suppose the correlation between the return of stock A and stock B is 0.5. What is the expected return and standard deviation of the return of a portfolio (say, P) that has 40% investment in stock A and 60% investment in stock B? {3 marks] (c) What is the beta of the portfolio P in part (b)? [1 mark] (d) Assume that the CAPM is valid. How could you construct a new portfolio (say, Q) using the market and risk free asset that has the same expected return as the portfolio P you considered in part (b) but has the lowest standard deviation possible? What is the standard deviation of the return of this portfolio? [3 marks] (e) Consider an investment that is made up of a combination of the portfolio P and risk-free asset What is the Sharpe ratio of this investment portfolio? Does it outperform the portfolio Q in part (d)? Why? [3 marks] 5 EC3333 Question 3 [12 marks] On Jan 02, 2006 ABC’s stock price closed at $28. The following option prices were quoted in Business Times. Exercise Expiration Call Price Put Price Price 25 June 4.35 1.00 30 March 100 2.69 35 June 0.58 ?? Based on historical returns, standard deviation of returns is 30%. (a) Assuming that there are no dividends paid on the stock and no arbitrage opportunity, compute the price of the 6—months put option (June, 35) with exercise price of 35. The risk-free interest rate is 4% per annum. [2 marks] (b) Compute the intrinsic value and time value of these options. [3 marks] Linda Morgan, an investor, is evaluating option strategies that will allow her to profit from large moves in a stock’s price, either up or down. You believe that the price of ABC could move in either direction from its current price in reaction to expected court decision involving company in the coming months. Linda currently owns no ABC shares and but ask you for advice about implementing a strategy to capitalize on the possible stock price movement. (c) Recommend whether Linda should choose a long straddle or a short straddle strategy to achieve her objective. Justify your recommendation. [2 marks] ((1) Suppose you have recommended her to use options with exercise price of 30. Indicate, at expiration for the appropriate straddle strategy in part (a) the : maximum possible loss per share, maximum possible gain per share and break-even stock price(s). [3 marks] (e) The delta (hedge ratio) of the call option is 0.625. Calculate the appropriate change in price for the call option if ABC’s stock price immediately increases to $38. [2 marks] 6 EC3333 Question 4 (12 marks] (A) Briefly discuss the difference between futures and forwards. [ 2 marks] (B) Stock in the Sunset Corporation (SSC) currently trades for $100. Since it is a relatively new company, it does not pay any dividends. The risk—free rate is 5% per annum. (a) Find the equilibrium futures price, the price that two parties can agree on today for a sale of one share of SSC that will take place one-year from today. [1.5 marks] (b) Suppose that the futures price in the market currently is $106. Is there any arbitrage opportunity? Show all the steps and determine the arbitrage profit. [25 marks] (C) Currently the spot exchange rate is S$1.60/ US$ and the three-month forward exchange rate is S$1.55/ USS Assume that the interest rate in Singapore is 1.5% per annum and 2.5% per annum in the US. Assume that you can borrow as much as S$160,000 or US$100,000. (a) Define covered interest rate parity (CIRP). Determine whether it is holding in the above situation. [3 marks] (1')) If CIRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. [3 marks] 7 EC3333 Black Scholes formula: c = SON(d,) — Xe“”N(d2) “where [%%;]+(r+%:)r (N? m $2 @2fl—ar — END OF PAPER — ...
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern