# Answers and some Explanations by fanzhongqing

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```									Answers and some
Explanations
Test #2-A, Spring 2005
Financial Markets
WSJ Questions
•   1. D
•   2. C and F
•   3. B
•   4. Milton Friedman strongly disagreed with Professor Siegal and believed that the
stock market would not crash as a result of the baby boom generation retiring. He
did think that corporations would pay more out in dividends, which would keep
retirees satisfied without their having to sell much stock.

• 5. Professor Siegal thought that the one thing that might prevent a bear market according to
his models is if foreigners came in and bought stock when the retirees were selling the stock.

• 6. First the IRS will try to recoup money from the bond issuers. However, if that fails, then the
IRS will tax bondholders.
1st month                                       annual
Payments     Beginning    interest            interest    principal
Tranche   1st month    Principal    rate      r=        payment payment
A          50,240.00       50,000       5.76%    0.0048        240      50,000
B           9,655.00       30,000       5.88%    0.0049        147        9,508
C              51.00       10,000       6.12%    0.0051          51           0
D              54.00       10,000       6.48%    0.0054          54           0
Question 7

492
Total payments =            60,000
less total interest =         -492
=
Principal to be distributed 59,508

2nd month
Payments     Beginning interest            interest   principal
Tranche   2nd month    Principal rate      r=        payment payment
A               0.00            0    5.76%    0.0048          0           0
B          20,592.41       20,492    5.88%    0.0049     100.41     20,492
C           3,353.59       10,000    6.12%    0.0051      51.00       3,303
D              54.00       10,000    6.48%    0.0054      54.00           0

205.4108
Total payments =            24,000
less total interest =         -205
=
Principal to be distributed 23,795

When not running a slide show, double click on spreadsheet to see
the formulas.
Question 8
annual interest rate =             7.20%                0.006 = interest rate per month

time      payment       Interest payment   principal payment  Principal
Now                                                         \$ 125,000.00
1st month        848.48 \$           750.00 \$             98.48 \$ 124,901.52
2nd month        848.48 \$           749.41 \$             99.07 \$ 124,802.45

When not running a slide show, double click on spreadsheet to see
the formulas.
Question 9
annual interest rate =           5.20%   0.013 = interest rate per quarter

Now:       Write options involving 1000 shares            \$     3,000.00            Principal and Interest Computations:
Buy 644.8 shares @ \$30.6/share                 \$   (19,730.88)           \$ 16,730.88
borrow                                         \$    16,730.88            \$          1.01
\$ 16,948.38 3 mo. from now
sell
3 mo from now 276.5 shares @ \$28.2/share                  \$     7,797.30            \$ (7,797.30)
pay back part of loan                           \$    (7,797.30)           \$     9,151.08
\$          1.01
6 mo from now 284.8 more shares @ \$30.7/share             \$    (8,743.36)           \$     9,270.05 6 mo. from now
borrow more funds                               \$     8,743.36            \$     8,743.36
\$ 18,013.41
now
9 mo. from buy 346.9 shares @ \$33.2/share                 \$   (11,517.08)           \$          1.01
(expiration)sell 1000 shares @ \$30/share (strike price)   \$    30,000.00            \$ 18,247.58 9 mo. from now
pay back loan plus interest                   \$   (18,247.58)

Profit at expiration                           \$      235.34

When not running a slide show, double click on spreadsheet to see
the formulas.
Question 10
• Time 0 actions:
The arbitrageur would first borrow 100,000 bebits from B’s credit
market. The arbitrageur would exchange those 100,000 bebits for
340,000 abits, which it then would lend in A’s credit market. The
arbitrageur would also enter into a 360-day forward contract to
exchange 363,800 abits for 113,687.5 bebits.
• Time 1 (1 year from now) actions:
The arbitrageur would receive 363,800 abits on the 340,000 abits it loaned
out at time 0. It would then exchange those 363,800 abits for 113,687.5
bebits using the 360-day forward contract it bought at time 0. The
arbitrageur would then pay back the 107,000 bebits it owes from the funds it
borrowed the year earlier, which results in a profit of 4,687.50 bebits.
• Profit = 4,687.5 bebits:
•   11. E
•   12. A
•   13 (a) Sterling Savings will pay \$7500 to Fannie Mae.
•   13(b) Fannie Mae will pay \$8500 to Sterling Savings
•   14. (a) None since LIBOR is below the strike rate.
•       (b) \$1,000,000 = (10%-8%)*500,000
•       (c) \$500,000 = (9%-8%)*500,000
15. Commercial Paper
• Commercial Paper is short-term debt that is
usually unsecured and issued by an
organization such as a corporation to the public.
• Commercial Paper in the U.S. almost never
exceeds 270 days because otherwise it must be
registered with the SEC.
• Most Commercial Paper in the U.S. does not
exceed 90 days, because otherwise the Federal
Reserve will refuse to discount it at its discount
window.
16. Option embedded in mortgage
• Silvia will have the right but not the
obligation to pay off her loan early or to
make payments that exceed her required
payments. The bank is the writer of this
implicit option and the Silvia is the holder
of the option.
17. Pipeline Risk
• Pipeline risk has to do with the risk a mortgage
lender faces between when the lender agrees to
lend the money and when the mortgage loan is
agreed to.
• The price risk refers to the risk the mortgage
lender faces that the interest rate will move to
hurt the mortgage lender when it tries to sell the
mortgage.
• The fallout risk is the risk the lender faces that
the borrower won’t go through with the loan.
18. Bankers acceptances
• Bankers acceptances usually do not
exceed six months because if they did, the
Federal Reserve would probably consider
those acceptances to be inelligible
bankers acceptances, which would
increase the bank’s reserve requirements.
19. Cross rate
• A cross rate is any exchange rate that
does not involve U.S. dollars. For
example, the exchange rate between the
British pound and the Euro would be a
cross rate, 1.43 euros per British pound.

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