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
                                                    Actual call premium =    3.00
                                               Theoretical call premiumn=    2.77
                                   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
          buy
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:
                  More answers
•   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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