Download Exam Paper: Seminar in Financial Economics II - NUI Galway, Autumn 2009 and more Exams Finance in PDF only on Docsity!
Ollscoil na hÉireann, Gaillimh GX_____
National University of Ireland, Galway
Autumn Examinations 2009
Exam Code(s) 1MIF Exam(s) M.Econ.Sc. in International Finance Module Code(s) EC Module(s) SEMINAR IN FINANCIAL ECONOMICS II Paper No. 1 Repeat Paper Special Paper External Examiner(s) Prof. C. Ryan Internal Examiner(s) Prof. E. O’Shea C. Twomey Instructions: EC568 Students Answer 3 questions in Section A (40 marks each) Answer 1 question in Section B (60 marks each) If you attempt MORE THAN the correct number indicate clearly those questions which you wish to be graded. The use of calculators is permitted - programmable calculators may not be used. Duration 3 hrs No. of Answer Books 1 Requirements : Statistical Tables - Yes Department(s) Economics
SECTION A - Answer 3 Questions
(a) What is meant by basis risk when futures contracts are used for hedging? (b) Explain why a short hedger’s position improves when the basis strengthens unexpectedly and worsens when the basis weakens unexpectedly. (c) A Paris-based fund manager has a portfolio worth €80 million with a beta of 0.80. The manager is concerned about the performance of the French stock market over the next two months and plans to use three-month futures on the CAC 40 to hedge the risk. The current level of the CAC 40 is 5,450, one futures contract is on 250 times the index, the risk-free rate is 4% p.a. with continuous compounding, and the dividend yield on the index is 2% per annum. (i) Write out the theoretical relationship for the futures price. Calculate its value in the above case. (ii) What position should the fund manager take to eliminate all exposure to the market over the next two months? (iii) Suppose that the fund manager wishes to change the portfolio’s beta to 0.45. What position should the manager now take? (i) Based on your strategy in part (ii), calculate its effects on the fund manager’s returns if the level of the CAC 40 in two months is 5,000 and 6,000. 2. (a) Derive the upper and lower bounds for the price of a European put option on a dividend-paying stock. Using the above bounds, identify the arbitrage opportunities in the following situation: A four-month European put option on a dividend-paying stock is currently selling for €0.70. The stock price is €18, the strike price is €18.50, and a dividend of €0.55 is expected in two months. The risk-free interest rate is 5% per annum for all maturities. (b) The price of a share is €40. The price of a 1-year European put option on the stock with a strike price of €30 is quoted as €7 and the price of a 1-year European call option on the share with a strike price of €50 is quoted as €5. Suppose that an investor buys 100 shares, shorts 100 call options, and buys 100 put options. Draw a diagram illustrating how the investor’s profit or loss varies with the share price over the next year?
SECTION B
Please Answer 1 Question All Questions are worth 60 marks NB: This section is for MSc. in International Finance students only
- “Risk is inherent in all economic activity, and financial markets exist to help market participants diversify such risks,” Kuprianov, A., ‘ Derivatives Debacles: Case Studies of Large Losses in Derivatives Markets,’ FRB Richmond Economic Quarterly 81(4), 1995, p.36. (a) Distinguish briefly between a hedger, a speculator, and an arbitrageur in derivatives markets. (b) Over the past 15 years there has been a number of high-profile derivatives related losses. For any one case with which you are familiar:
- Outline the trading strategy responsible for the losses, and
- Discuss the main lessons that you believe should be learned from the case in question.
- “Credit default swaps have developed from a hedging tool into a gateway to greater exposure and higher yield,” J. Chung, Financial Times , October 26, 2005. (a) A credit default swap (CDS) requires a premium of 70 basis points per year paid semi-annually. The principal is €250 million and the CDS is settled in cash. A default occurs after 3 years and 10 months, and the calculation agent estimates that the price of the reference bond is 35% of its face value shortly after the default. (i) Outline briefly how a credit default swap (CDS) operates and how it can be used for hedging in this situation. (ii) List the cash flows and their timing for the seller of the CDS. (b) In his article ‘ Credit Derivatives and Risk Management ’ in the FRB Atlanta Economic Review 4 th Quarter 2007, Michael Gibson concludes that: “ the striking growth of credit derivatives, from nearly nothing a decade ago to tens of trillions of dollars in notional amounts outstanding at the end of last year. Driving this growth, market participants—including commercial banks, investment banks, and investors—appear to find a variety of credit derivative products to be useful for their own risk-management purposes.” Explain clearly why each of these market participants finds credit derivatives useful for risk management.
