FINE451/FINE630 Fall 2013
Assignment 2
1. This problem is to be solved in Excel. In the le a_02_data.xls you are given the quarterly series of
continuously compounded CAD spot rates computed by the Bank of Canada.1
We will look at the hedging of one 10y Z
FINE451/FINE630 Fall 2013
Problem Set 3
1. Convexity adjustment. Consider the exchange rate between USD and CAD. Assume that the amount
in CAD you need to pay to get 1 USD is currently equal to 1. Next year the USD will appreciate
with probability 0:4 and
FINE451/FINE630 Fall 2013
Problem Set 3 answers
1. We have:
0:4
1:276 + 0:6
1
0:849
1
+ 0:6
1:276
1:02 and 0:4
0:849
1:02:
In other words the expected amount in CAD required to get 1 USD and the expected amount in USD
required to get 1 CAD. are both appro
FINE451/FINE630 Fall 2013
Problem Set 4
1. Pricing on a tree. Assume: continuous compounding,
0:4; q (u) = 0:5:
d
u
= 1; r0 = 3%; r1 = 5%; r1 = 2%; p (u) =
2
(a) Compute the 2y spot rate at date 0 r0 :
1
1
(b) Compute the 1y in 1y forward rate f0 !2 and c
Lecture 8
Demand and supply
No-arbitrage
Question: You would like to initiate a new swap with notional 10M, need
to find the swap rate
Answer: By no-arbitrage swap value = the difference between the prices of
fixed and floating rate bonds, in turn these p
Dividend & Other
Payouts
Saif Ullah
Theory of Firm II
Types of Dividend
Regular Cash Dividends: Most firms pay regular cash
dividends four times a year
Stock Dividend: No cash is given. Shares are given as
dividend. For example a 2% stock dividend means f
Issuing Equity
Securities to the Public
Saif Ullah
Theory of Firm II
Requirements for Public Issue
Provincial Bodies in Canada
Securities and Exchange Commission in USA
Registration Statement and Prospectus:
Ensure investors receive all material informat
Limits to the Use of Debt
Theory of Firm II
Saif Ullah
Bankruptcy Risk and Bankruptcy
Cost
Economic vs. Legal Bankruptcy
Risk of Bankruptcy and Cost of Bankruptcy
Risk Neutrality
Bankruptcy costs lower the advantages of
debt
Knight Corp and Day Corp
Knigh
Capital Structure
Theory of Firm II
Saif Ullah
Value of the Firm
S
SB
V=B +S
Financial Leverage and Firm Value
Trans Can Corporation
Currently No Debt
Number of Shares Outstanding is 400, Price per Share is $20
Interest Rate is 10%
Issue $4,000 in Deb
Valuations and Capital Budgeting for
the Levered Firm
Chapter 18
Why?
We assumed that Firm is an All-Equity Firm (Ch7-9)
Levered Firm has Lower Cost of Capital
Changes NPV
Projects Rejected by Unlevered Firm Might Be Accepted by
Levered Firm
Adjusted Pres
Chapter 9: Risk Analysis, Real Options, and Capital Budgeting
9.1 a.
To calculate the accounting breakeven, we first need to find the depreciation for each year. The depreciation is:
Depreciation = $724,000/8
Depreciation = $90,500 per year
And the accoun
Time Value of Money
Theory of Firm II
Saif Ullah
1
The Time Value of Money
Money NOW is worth more than money LATER!
Why?
Dollar received today can be invested to earn interest
The amount of interest earned depends on the rate of return
that can be earned
Corporate Financing
Decision & Efficient
Capital Markets
Theory of Firm II
Saif Ullah
Financing Decisions
Issue Debt or Issue Equity?
When and how much?
Pay Dividends, Buy Back Shares?
Financing Decisions can create value
How?
Financing & Abnormal Re
Risk Analysis, Real Options
and Capital Budgeting
Chapter 9
FINA 395
Decision Tree
There is usually a sequence of decisions in NPV project
analysis.
Decision trees are used to identify the sequential decisions in
NPV analysis.
Decision trees allow us to g
Lecture6
Continuoustimemodels
Afewnotesoncontinuoustime
Our reference period is infinitesimal, of length dt
we model d : the changes in over infinitely small periods of length dt
is annualised, but applies for an infinitely small period of length dt
We na
Lecture7
Futuresandoptions
Interestratederivativesmarketsgrowth
Reminder:FRAsandswaps
Forward rate agreement: contract to exchange forward rate
future market floating spot rate payments on a notional amount N
Long FRA: net payment at T+ (compounding freq
Lecture2
Basicsof
fixedincomeanalysis
Noarbitrage
Many different fixed income securities: Treasury notes, STRIPS, swaps
In this course we will price those securities in a way that will rule out the
possibility of a riskfree profit at zero cost from tradin
FINE451/FINE630 Fall 2013
Assignment 2 answers
1. (a) See Excel le.
(b) See Excel le. Both the level and the slope of the term structure change, inconsistent with the
assumption of parallel shifts
(c) See Excel le. The error is driven by the changes in th
FINE451/FINE630 Fall 2013
Assignment 1
1. This problem is to be solved in Excel/Matlab. Assume semi-annual compounding. On 31/08/2013
you are given the following information about bonds with dierent maturity, all paying semi-annual
coupons.
Maturity
Coupo
FINE451/FINE630 Fall 2013
Assignment 3
1. This problem is to be solved in Excel. In the le a_03_data.xls you are given the weekly series of
continuously compounded instantaneous short rate and the prices of 3m, 6m, 1y, 2y and 5y ZCBs. The
le also contains
FINE451/FINE630 Fall 2013
Assignment 4
This problem is to be solved in Excel. In the le a_04_data.xls you are given ZCB prices for dierent
maturities.
1. Assuming constant volatility for all maturities
( = 0:25)
= 0:75%; build the Ho-Lee tree for the 3m r
FINE451/FINE630 Fall 2013
Problem Set 2
1. Duration.
(a) Consider two 3y bonds, one paying annual coupons equal to 3, the other annual coupons equal to 5.
Without calculations, which bond has higher duration? Assuming 4% (continuously compounded)
term st