Exam 2 2019, questions PDF

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FINA 4120 – Fixed Income Securities Analysis CUHK Business School Professor Yizhou Xiao Spring Semester 2019

Practice

NAME_______________________________________________

INSTRUCTIONS: 1. Please don't forget to write your name on this page. 2. You have 70 minutes to complete the exam. 3. This is a closed book exam; however, you may use one sheet of notes (front and back) and a financial calculator. 4. There are 15 questions and a total of 100 points on the exam. Before you start, please make sure that your exam is complete.

5. For question 13 to 15, please write your answers in a clear and concise manner. Whenever formulas are used, write the theoretical formulas first and then use them to perform your calculations. This will allow you to get credit in case there is an error in the numerical calculations. In case that your financial calculator “refuses” to work, do not panic. Write down all the steps, relevant formulas and inputs you would use to solve the question. You will get partial credit even if you do not arrive at the correct final answer. In order to get full credit on the problems, you must show ALL your work! 6. Allocate your time wisely. Use the number of points assigned to each problem as your guide. 7. Good Luck!

Multiple Choice (60 points) Choose the best answer for each of the following questions. The se questions are worth 5 points each.

1.

Rob buys a $150,000 house and puts $30,000 down. He finances the house with a 30-year, fixedrate loan. The mortgage rate is 8% (APR with monthly compounding). The monthly mortgage payment is closest to: a) b) c) d)

2.

Which of the following is the maximum price for a freely callable bond? Assume the bond will remain freely callable for the remainder of its life. a) b) c) d)

3.

Its par value The call price The present value of its par value Its par value minus accrued interest

Sally purchases a semiannual-paying Treasury Inflation Protection Security (TIPS) on January 1, 2016 that has a 2% coupon and a $100,000 principal. The annualized rate of inflation is 3% for the next 18 months. What is the principal amount on January 1, 2017? a) b) c) d)

4.

$333. $881. $966. $996.

$101,500.00. $103,022.50. $104,567.84. $105,000.00.

A US T-bill has 75 days to maturity and is currently trading at a price of $99.252 (for a par of $100). What is the discount rate on this bill? a) b) c) d)

0.75% 1.75% 2.59% 3.59%

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5.

Which of the following statements about risks associated with investing in bonds is FALSE? a) b) c) d)

6.

Suppose a bond’s quoted price on WSJ is 105.219 and the accrued interest is $23.54. If the bond has a par value of $1000, what is the bond’s clean price? a) b) c) d)

7.

Eurodollar bond. TIPS. PIK bond. Yankee bond.

An analyst observes a 5-year, 10% semiannual-pay bond. The face value is $1,000. The analyst believes that the required BEY for this bond is 15%. The price of this bond would be? a) b) c) d)

9.

$1,000.00. $1,023.54. $1,052.19. $1,075.73.

A type of foreign bond that carries no currency exchange risk for the US investor is a (an): a) b) c) d)

8.

Credit risk is the likelihood that an investor will be unable to sell the security quickly and at a fair price. Interest rate risk is the risk that a bondholder faces if the price of a bond held in a portfolio will decline due to rising market interest rates. Reinvestment risk is the risk of having to reinvest the proceeds available for reinvestment at a lower interest rate than the instrument that generated the proceeds. Inflation risk or purchasing power risk arises from the decline in value of a security’s cash flows due to inflation, which is measured in terms of purchasing power.

$828.40. $832.39. $1,189.53. $1,193.04.

Consider a highly liquid, 5 year, 6.5% semiannual coupon, AAA rated corporate bond callable at 102% after 2 years. Assume the bond was issued today. During the first year, an investor would be least concerned with: a) b) c) d)

credit risk. prepayment risk. interest rate risk. reinvestment risk.

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10.

Which of the following bond should be sold above par value? Coupon rate 5¼% 6⅝% 0% 5⅞%

a) b) c) d)

11.

Suppose the current yield curve is flat at 5%. An analyst finds that he can trade a 2-year zero at a YTM of 6%. The 1-year zeros and 2-year coupon bonds are available and correctly priced. Assuming all bonds are risk free, how would the analyst take advantage of this arbitrage opportunity? a) b) c) d)

12.

Required Yield 6.25% 6.15% 6.20% 6.00%

Sell 2-year zeros, sell 1-year zeros, and buy 2-year coupon bonds. Sell 2-year zeros, buy 1-year zeros, and buy 2-year coupon bonds. Buy 2-year zeros, buy 1-year zeros, and sell 2-year coupon bonds. Buy 2-year zeros, sell 1-year zeros, and sell 2-year coupon bonds.

In the US, the level of interest rates is determined by: a) b) c) d)

The President and the Treasury Secretary. The White House and the Council of Economic Advisors. The Senate and Congress. The Fed and the market.

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Problems (40 points) Answer each of the questions below completely. Show all your work.

13.

Risks Associated with Bond Investments (15 points) Identify the difference in the major risks associated with the following investment alternatives. Provide a one-sentence justification for each difference you identify.

a)

For an investor who plans to hold a security for one year, purchasing a Treasury security that matures in one year versus purchasing a Treasury security that matures in 30 years. (4 points)

b)

For an investor who plans to hold an investment for two years, purchasing a zero-coupon Treasury security that matures in one year versus purchasing a zero-coupon Treasury security that matures in two years. (5 points)

c)

For a US investor who plans to hold an investment for six years, purchasing a US Treasury security that matures in six years versus purchasing an Japanese government security that matures in six years. (6 points)

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14. Co-cos (10 points) A new breed of bank debt known as “contingent convertibles (or Co-cos)” became very popular recently, especially among European banks. Co-cos are sold as interest-bearing debt that has to be paid back. But they convert to equity in the event that the issuing bank’s capital ratios fall below certain levels. a) In your view, what’s the main benefit of Co-cos from the bank’s perspective? (5 points)

b) UBS AG issued a US dollar 10-year Co-co bond at an attractive yield of 7.25%. The issue was almost 3 times over-subscribed with orders mainly coming from wealthy individuals in Asia. Why is the yield on the Co-co so high? What will be your word of caution to the buyers? (5 points)

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15.

OFO Bike Evaluation (15 points) OFO bike is a leading bike-sharing company in China mainland. They are considering EQUITY IPO in HK financial market. You are working in the ECM team in one investment bank and the key step is to estimate the value of the company. OFO bike now has 100 million register users. Each user deposit 500 HKD to be qualified to rent bikes. Research shows that users will withdraw their deposit 5 years later (and stop using the service). Each time when one user rents a bike, on average they pay 5 HKD per time and the data shows that each user rents 100 times per year. OFO bike owns assets that auditing company values at 8 billion HKD (bikes, operation systems, patents and so on). The annual operation cost is 40 billion HKD. Assume OFO business model is risk free. The market is now facing a 5% flat yield curve. a) What is the value of the firm? (10 points)

b) Suppose OFO users withdraw deposit after 10 years, then what is the value of the firm? (5 points)

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