FMI - Mock General answers PDF

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Financial Markets and InstitutionsGeneral ExamDecember 18, 2015InstructionsThis exam consists of 25 questions. For each question, please choose thecorrect answer (there is only one). Each question that you answer correctly is worth 1 point. There are no penalties for wrongly answered questions. Plea...

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Financial Markets and Institutions General Exam December 18, 2015

Instructions This exam consists of 25 questions. For each question, please choose the correct answer (there is only one). Each question that you answer correctly is worth 1 point. There are no penalties for wrongly answered questions. Please mark your answers on the answer sheet provided. Answers marked on the exam itself will not be considered. This exam will last 90 minutes. If you wish to withdraw from this exam, you must declare your intention to withdraw within 30 minutes after the start of the exam. Otherwise, your exam will be graded. You must remain in the room until the end of the exam, even if you decide to withdraw.

Rules of conduct during exams or other tests: During exams, students must remain quiet and may not use any external support aids, whether paper or digital (e.g. manuals, lecture notes, personal papers, books, publications, cell phones, handheld computers or other electronic devices), if not expressly authorized by the teacher in class. In addition, students may not copy or look at other students’ exam paper or contact or attempt to contact other people in any way. Students must remain in the classroom for the whole of the time and only for the time needed to finish his or her exam, unless teachers in class give other orders. Students who have questions for the teacher must raise their hand and wait for the examiner to come to them. At the end of the exam, students must return the exam script and the exam paper to the examining faculty member and leave the room. Any breach of these regulations or any other orders given by the faculty member present at the time of the exam will result in the test being cancelled and an official report sent to the Disciplinary Board in all cases. All disciplinary sanctions will be recorded in the student’s academic career. Sanctions greater than a warning will result in forfeiture of benefits for the right to study (scholarships, housing etc.). The Honor Code and detailed regulations for taking exams and other tests are published on the University website http://www.unibocconi.eu/honorcode.

Signature: I hereby undertake to respect the regulations described above and undersign my presence at the exam.

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1. Assume in some market buyers have less information about an asset’s (hidden) quality than sellers. What are the consequences of such situation? I market prices can fall below the average quality of that asset II sellers of the highest quality may leave the market III trading activity in that market may cease entirely IV the market suffers from adverse selection (a) (b) (c) (d)

I only I and II only I, II, III and IV ✔ I, II and III only

2. Banks’ liquidity management would lose much of its relevance if... (a) (b) (c) (d)

all bank deposits were fully insured. banks would invest only in securities rather than loans. the liabilities of banks had the same maturity as banks’ assets. ✔ banks were entirely funded with commercial paper rather than deposits.

3. The term “Debt Deflation” refers to the process whereby: (a) (b) (c) (d)

None of these possibilities Deflation causes the nominal interest to fall (due to the Fisher equation) Reduction in the price levels render an existing debt burden larger in real terms ✔ The nominal value of debt falls after a devaluation

4. Take a bond with a price of 1,000 and YTM i=10%. Suppose that interest rates rise to 11% and the price falls to 900. Then the duration of the bond is equal to (a) (b) (c) (d)

11 ✔ 10 9 1

5. Suppose we have deflation (π e ↓) and the government improves its budget position. What will be the combined effect of deflation and the reduction in government deficit on nominal interest rates today? (a) (b) (c) (d)

It cannot be determined from the information provided. Interest rates will remain unchanged. Interest rates will go up. Interest rates will go down. ✔

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6. Bank A has assets of 100 and liabilities of 94. 90 of its assets are invested in risky loans with a risk weight 1, the remaining 10 assets are invested in cash, which has a zero risk weight. Regulation specifies: i) a ratio of equity to liabilities of at least 5%, and ii) a total capital requirement of 10%× risk weighted assets. Bank A: (a) Complies with requirement i) but not ii) ✔ (b) Complies with both requirements i) and ii) (c) Complies with requirement ii) but not i) (d) Complies with neither requirement 7. BMW has just paid a dividend of 5 euros per share and announced that, instead of growing its dividends, BMW will reinvest its profits into building more efficient cars. As a result of this investment, it will be able to grow its dividends at a higher rate in the future. BMW will thus stop paying dividends until 2020. In 2020, it will pay 6 euros per share, which will grow at the perpetual rate of 5% after that. Calculate BMWs price today if the required return on its stock is 15% (round to the whole number). (a) (b) (c) (d)

39 34 ✔ 30 35

8. A two-year discount bond with a face value of $100 currently sells for $60. Suppose that the demand for the bond unexpectedly increases. What will be the new interest rate on this bond? Round your answer to first decimal place. (a) (b) (c) (d)

Cannot be determined without the coupon rate. Exactly 29.1% Less than 29.1% ✔ More than 29.1%

9. Consider two bonds: one is a Treasury bond with a yield of 4%, and the other is a municipal bond with a yield of 3%. They are similar in every respect, except for their default risk and tax status. Which of the two bonds will be preferred by a risk-averse investor with a marginal tax rate of 25%? (a) (b) (c) (d)

The municipal bond It is impossible to determine based on the information provided The investor is indifferent between the two bonds The Treasury bond ✔

10. After an interest rate increase of two percentage points, bank X experiences a drop in income equal to 2 billion euros. The banks interest sensitive assets are equal to 100 billion euros. What is the amount of the bank’s interest sensitive liabilities? (a) (b) (c) (d)

200 billion euros ✔ 0 billions euros 100 billions euros It cannot be established

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11. Suppose you have a portfolio of bonds worth $100 million and you add $10 million securities with a duration of 8 years, so that the new portfolio has a duration of 11. What was the duration of the original portfolio? (a) (b) (c) (d)

10.2 11.3 ✔ 14 12.7

12. Which of the following are reserves in the sense that they count towards banks’ minimum reserve requirements? I vault cash II commercial loans III federal reserves borrowed overnight from other banks IV treasury bills (a) (b) (c) (d)

II, III and IV only I, III and IV only I and III only ✔ I, II, III and IV

13. If the (strong or semi-strong) efficent market hypothesis is correct, (a) the future evolution of a stock’s price is best predicted by its historical trend. (b) newly disclosed information never affects the price of a stock. (c) the law of one price holds: at any point in time, one and the same asset should have the same price on all exchanges. ✔ (d) all stocks in the market should yield the same expected return at any point in time. 14. You invest in class A shares of an open-end mutual fund whose NAV is $14.70. The fund charges you an up-front fee of 2%. One year later you redeem your shares. If upon redemption the fund has the positions shown below and has 12,400,000 shares outstanding, what was the return on your investment? Round your result if necessary. Stock (market value) Bonds (market value) Cash Liabilities (fees) (a) (b) (c) (d)

$140,000,000 $65,000,000 $1,500,000 $1,200,000

10.4% ✔ 11.3% 12.6% 11.7%

15. The primary reason why banks monitor borrowers after giving out a loan is to (a) (b) (c) (d)

reduce borrower moral hazard. ✔ renegotiate loans before default occurs. reduce problems of costly state verification. learn which borrowers are eligible for a loan. 5

16. In an over-the-counter market: (a) (b) (c) (d)

Sellers and buyers of securities meet directly in the same physical location. For each security, there is one and only one market maker. A broker matches buyers and sellers for a commission. Market makers maintain inventory of securities and provide liquidity to the market. ✔

17. Bank Z has a duration gap of 3 years, assets of 100 billion euros, and liabilities of 95 billion euros. What is the percentage change in the bank’s net worth after a one half percentage point, i.e. 50 basis points, increase in the interest rate? The baseline interest rate is 1%. Approximate to the closest decimal. (a) (b) (c) (d)

−3000% −15% −300% −30% ✔

18. An investor has 100 shares of firm ABC’s stock. Additionally, he has sold 10 call options on the same stock with a strike price of $50 and a premium of $2 per option (each option is written on one share of stock). Calculate the investor’s total net gain/loss on his entire portfolio if today’s stock price is $40, while the stock price on the expiration date of the options is $55. (a) The investor has made a profit of $1,870 (b) The investor has made a profit of $1,320 (c) The investor has made a profit of $1,370 (d) The investor has made a profit of $1,470 ✔ 19. Consider an oil producer that plans to produce 100,000 barrels of oil in the next 3 months. In order to hedge against oil price risk, this producer sold 100 futures contracts (each futures contract is written on 1,000 barrels of oil). At the time when the producer entered the market, the spot price of oil was $30, and oil futures were trading at $40 per barrel. At the time when the contracts were closed, oil futures were trading at $45 per barrel. Calculate this producer’s gain/loss on the futures position. (a) (b) (c) (d)

The producer lost $1,500,000 on the futures position. The producer lost $500,000 on the futures position. ✔ The producer gained $500,000 on the futures position. The producer gained $1,500,000 on the futures position.

20. In securities’ underwriting, a firm commitment contract: (a) Allows the issuing firm to receive a fixed amount of capital ✔ (b) Allows the investment bank to receive a fixed profit (c) Allows the investment bank to share its risk with the issuing firms (d) Insures both the investment bank and the issuing firm 21. All else equal, a callable bond: (a) Will have a higher yield than a non-callable bond. ✔ (b) Will have a lower yield than a non-callable bond. (c) Will have the same yield as a non-callable bond. (d) May have a higher or a lower yield than a non-callable bond.

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22. Primary markets are: (a) (b) (c) (d)

either over-the-counter (OTC) or organized exchanges the only markets to buy and sell stocks only available for Treasury bills where securities are first issued ✔

23. Which of the following observations is incompatible with market efficiency (in the strong or semi-strong sense)? (a) Stock prices keep going up steeply despite the fact that many investors are short-selling. (b) Some overoptimistic irrational investors buy very risky stocks in the stock market. (c) Fluctuations in stock prices are larger than the fluctuations in their fundamental value. ✔ (d) The stock of one firm has greatly outperformed the rest of the market for several years in a row. 24. Ceteris paribus, a relatively less capitalized bank has: (a) (b) (c) (d)

Neither higher nor lower incentive to take risk It could have either higher or lower incentive to take risk A higher incentive to take risk ✔ A lower incentive to take risk

25. A group of banks, called primary dealers, are accused of manipulating the primary market for Treasury bills. They stand accused of bidding artificially high yields (low price) in the primary market in order to resell the securities at a higher price in secondary markets. Which of the following statements is correct? (a) The accusations are false: T-bills do not have an active and liquid secondary market. (b) The accusations are true: the Treasury decides on the yield, but the bidders (banks) decide on the price. (c) The accusations are true: banks can collude on a low price in the primary market and then resell at a higher price in the secondary market. ✔ (d) The accusations are false: T-bills are auctioned only with non competitive bids, so banks have no influence on the price. Good luck!

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