Exam 2018, questions and answers PDF

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~~FN1024_ZA_2016_d0

This paper is not to be removed from the Examination Hall

UNIVERSITY OF LONDON

FN1024 ZB

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas in Economics and Social Sciences Principles of Banking and Finance

Wednesday, 9 May 2018 : 10:00 to 13:00 Candidates should answer FOUR of the following EIGHT questions: ONE from Section A, ONE from Section B and TWO further questions from either section. All questions carry equal marks. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

PLEASE TURN OVER © University of London 2018 UL18/0195

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SECTION A Answer ONE question and NO MORE THAN TWO further questions from this section. 1.

(a) Distinguish between liquidity and solvency in relation to a bank. Explain how a bank could become insolvent and explain the role of capital and liquidity in preventing insolvency. (12 marks) (b) Explain market risk and how it affects banks and critically evaluate how banks manage this risk. (13 marks)

2.

(a) Discuss the role of asymmetric information in explaining the existence of banks. (15 marks) (b) Briefly outline Leland and Pyle’s informational economies of scale theory. (10 marks)

3.

(a) Distinguish between weak-form, semi-strong form and strong-form levels of market efficiency. Discuss the implications of weak, semi-strong and strong form efficient equity markets for investors. (6 marks) (b) Explain the joint-hypothesis problem encountered when testing for informational efficiency of a market. (7 marks) (c) Discuss the evidence relating to semi-strong efficiency of equity markets. (12 marks)

4.

(a) Discuss the reasons for the regulation of banks.

(12 marks)

(b) Discuss how Basel 3 improves on Basel 1 and 2 in terms of improving the ability of banks to withstand shocks. (13 marks)

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SECTION B Answer ONE question and NO MORE THAN TWO further questions from this section. 5.

A firm is considering two investment projects, A and B. These projects are NOT mutually exclusive. Assume the firm is not capital constrained. The initial costs and cashflows for these projects are: Year 0 1 2 3

A -48,00 19,000 17,000 25,000

B -42,000 10,000 35,000 8,000

(a) Using a discount rate of 10% calculate the net present value for each project. What decision would you make based on your calculations? (4 marks) (b) How would your decision change if the discount rate used for calculating the net present value is 12.5%? (4 marks) (c) Calculate an approximate IRR for each project. Assume the hurdle rate is 10%. What decision would you make based on your calculations? (6 marks) (d) Calculate the payback period for each project. The company looks to select investment projects paying back in 2 years. What decision would you make based on your calculations? (2 marks) (e) Discuss the advantages and disadvantages of the payback rule of investment appraisal. (4 marks) (f) Discuss the limitations of the internal rate of return method of investment appraisal (5 marks) 6.

(a) Outline the key features of Markowitz’s modern portfolio theory (MPT) and discuss the implications of MPT for an investor in risky securities (the use of diagrams in your answer is encouraged). (13 marks) (b) You are given the following information: (i) A stock with a beta of 0 has an expected return of 5%. (ii) A portfolio made up of 20% invested at the risk free rate and 80% invested in the market portfolio has an expected return of 14% What is the market risk premium?

(4 marks)

(c) Discuss the limitations of the Capital Asset Pricing Model.

(8 marks)

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7.

(a) Distinguish between re-financing risk and re-investment risk. Give examples of each and explain which of these risks a bank is more likely to face. (8 marks) (b) Consider the following extracts from the balance sheet of Exxobank (values in £millions and duration in years): Loans (short term) Loans (long term) Mortgages T-bonds

Value 1800 3000 4000 1200

Duration 0.9 3.6 8.4 3.2

Deposits

9000

1.6

Calculate the duration gap for Exxobank

(5 marks)

(c) What is the change in the market value of equity of Exxobank, as a percentage of assets, if interest rates increase from 4.5% to 5.0%? (3 marks) (d) Explain the respective roles and limitations of liquidity gap and duration gap analysis in helping banks manage interest rate risk. (9 marks)

8.

(a) Briefly discuss the problems of valuing common stocks, preferred stocks and corporate bonds. (6 marks) (b) Formally derive and explain the dividend discount model used for the valuation of common stocks. (9 marks) (c) Discuss the usefulness of the Gordon Growth model for the valuation of stocks. (4 marks) (d) Consider the following stocks: Stock A is expected to pay a dividend of £3 next year and then an annual dividend of £4 from the following year, forever. Stock B is expected to pay a dividend of £4 next year (t=1) with dividend growth expected to be 10% per annum for the next first three years before settling down to 4% a year thereafter (t=5 …). If the required return on similar equities is 8%, calculate the price of each stock. (6 marks)

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