Download Intl. Finance Exam at NUI Galway: EC568 Seminar in Financial Econ. II and more Exams Finance in PDF only on Docsity!
Ollscoil na hÉireann, Gaillimh GX_____
National University of Ireland, Galway
Semester II Examinations 2008
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) Internal Examiner(s) Professor C. Ryan Mr. B. Kennelly Mr. C. Twomey
Instructions: Answer 3 questions in Section A Answer 1 question in Section B
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 EC568 3 hours No. of Answer Books 1
Requirements : Statistical Tables - Yes
Department(s) Economics
SECTION A
All questions carry 40 marks
(a) Explain carefully what is meant by the expected price of a commodity on a particular future date. (8 marks )
(b) Explain briefly why the futures price converges to the spot price of the underlying asset as the delivery period for a futures contract is approached. (8 marks)
(c) Compare the Keynes and Hicks argument with the modern portfolio theory approach for explaining the relationship between futures prices and expected future spot prices. (14 marks)
(d) Suppose that on April 26, 2008, speculators tended to be short copper futures and hedgers tended to be long copper futures. Assume that the pattern of copper futures prices shows a sharp decline.
What does the Keynes and Hicks argument imply about the future expected future price of copper? (10 marks)
(a) 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? (15 marks)
(b) What is a futures option? What happens if a call futures option is exercised? A futures price is currently 60. Suppose it is known that over each of the next 3- month periods it will either rise by 10% or fall by 10%. The risk-free rate is 8% per annum.
- Calculate the risk-neutral probability of an up move
- Find the value of a 6-month European call option on the futures with a strike price of 60
- If the call were American, would it ever be worth exercising it early? (25 marks)
(a) Using a hypothetical example of each, explain the difference between a plain- vanilla fixed-for-floating interest rate swap and a fixed-for-fixed currency swap. (12 marks)
SECTION B
All questions carry 60 marks
NB: This section is only for M.Econ.Sc. in International Finance students
(a) Suppose you have an option to buy all of the assets of an Irish exploration firm for 2.5bn. The option expires in 9 months. You estimate the firm’s current PV as 2.7bn. The firm generates after-tax free cash flow (FCF) of 50m at the end of each quarter. If you exercise your option at the start of the quarter, that quarter’s cash flow is paid out to you. If you do not exercise, the cash flows go to the firm’s current owners. In each quarter, the firm’s PV either increases by 10% or decreases by 9.09%. This PV includes the quarterly FCF of 50m. After the 50m is paid out, PV drops by 50m.
The risk-free interest rate is 2% per quarter. (i) Build a binomial tree for the firm, with one up or down change for each 3- month period. (ii) Suppose you can only exercise your option now, or after 9 months (not at months 3 or 6). Would you exercise now? (30 marks)
(b) “Real options capture the value of managerial flexibility in a way that NPV analysis does not,” Copeland, Koller, and Murrin, ‘Using Option Pricing Methods to Value Flexibility’, in Valuation: Measuring and Managing the Value of Companies 2/e , 1996, p. 464.
Explain, using examples, why real options have the potential to be an important tool for firms in strategic and financial analysis_. (30 marks)_
“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. (12 marks)
(b) Over the past 15 years there has been a number of high-profile derivative- 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. (48 marks)
