Problems and Short Answers (20 points) 1a. Suppose the real interest rate is 6 percent and the expected inflation rate i
Posted: Tue Nov 23, 2021 8:53 am
Problems and Short Answers (20 points)
1a. Suppose the real interest rate is 6 percent and the
expected inflation rate is 1 percent. What would you expect the
nominal rate of interest to be? (1.5 points)
1b. Assume that, as of today, the annualized two-year
interest rate is 10 percent and the one-year interest rate is 12
percent. Use this information to estimate the one-year forward rate
- based only on the pure expectations theory. (show your work) (1.5
points)
2a. What relationship is shown by the yield curve?
Mention how financial market participants may use the yield curve
(no description is necessary). (2.5 points)
2b. You have a choice of investing in two identical
bonds: C and N. These two bonds are identical except C is callable
and N is non-callable. In general, witch bond will provide you
higher yield? Why? (2 points)
3. After the peak of the COVID-19 crisis, the
economy is now growing significantly. What specific monetary policy
actions are available to many Central Banks to slowdown the
economy? (no description is necessary) (1.5 points)
4. You sold T-bill futures contracts when the
quoted price was 92.50. When this position was closed out later,
the quoted price was 91.50. Determine the profit or loss per
contract ($1,000,000), ignoring transaction costs. (show your work)
(2 points)
5a. You buy a call option on ROCK stock with an exercise
price of $96. Today, the stock’s price is $95. The premium on the
call option is $3. Just before expiration, the stock’s price is
$100. Will you exercise the option? What is your net profit or
loss? What is the break-even price? (show your work) (2.5
points)
5b. You sell a put option on ROLL stock with an exercise
price of $97. Today, the stock’s price is $95. The premium on the
put option is $2. Just before expiration, the stock’s price is $94.
Will the option be exercised? What is your net profit or loss? What
is the break-even price? (show your work) (2.5 points)
5c. What is the maximum potential gain from selling a
put option? Explain. (1.5 points)
6. The Bank of US has negotiated a plain vanilla
swap with the Bank of EU – with a notional principal of $10
million. Under the agreement, the Bank of US will pay fixed
payments of 8 percent to the Bank of EU and receive floating
payments equal to (U.S. dollar) LIBOR plus 1 percent from the Bank
of EU at the end of each of the next five years. At the end of the
1st year, the LIBOR is 10%. Which bank will pay which bank and how
much? (show your work – only for year 1) (2.5 points)
1a. Suppose the real interest rate is 6 percent and the
expected inflation rate is 1 percent. What would you expect the
nominal rate of interest to be? (1.5 points)
1b. Assume that, as of today, the annualized two-year
interest rate is 10 percent and the one-year interest rate is 12
percent. Use this information to estimate the one-year forward rate
- based only on the pure expectations theory. (show your work) (1.5
points)
2a. What relationship is shown by the yield curve?
Mention how financial market participants may use the yield curve
(no description is necessary). (2.5 points)
2b. You have a choice of investing in two identical
bonds: C and N. These two bonds are identical except C is callable
and N is non-callable. In general, witch bond will provide you
higher yield? Why? (2 points)
3. After the peak of the COVID-19 crisis, the
economy is now growing significantly. What specific monetary policy
actions are available to many Central Banks to slowdown the
economy? (no description is necessary) (1.5 points)
4. You sold T-bill futures contracts when the
quoted price was 92.50. When this position was closed out later,
the quoted price was 91.50. Determine the profit or loss per
contract ($1,000,000), ignoring transaction costs. (show your work)
(2 points)
5a. You buy a call option on ROCK stock with an exercise
price of $96. Today, the stock’s price is $95. The premium on the
call option is $3. Just before expiration, the stock’s price is
$100. Will you exercise the option? What is your net profit or
loss? What is the break-even price? (show your work) (2.5
points)
5b. You sell a put option on ROLL stock with an exercise
price of $97. Today, the stock’s price is $95. The premium on the
put option is $2. Just before expiration, the stock’s price is $94.
Will the option be exercised? What is your net profit or loss? What
is the break-even price? (show your work) (2.5 points)
5c. What is the maximum potential gain from selling a
put option? Explain. (1.5 points)
6. The Bank of US has negotiated a plain vanilla
swap with the Bank of EU – with a notional principal of $10
million. Under the agreement, the Bank of US will pay fixed
payments of 8 percent to the Bank of EU and receive floating
payments equal to (U.S. dollar) LIBOR plus 1 percent from the Bank
of EU at the end of each of the next five years. At the end of the
1st year, the LIBOR is 10%. Which bank will pay which bank and how
much? (show your work – only for year 1) (2.5 points)