Chapter 3 Flashcards
A hedge fund leverages its $100 million of investor capital by a factor of three and invests it into a portfolio of junk bonds yielding 14%. If its borrowing costs are 8%, what is the yield on investor capital?
a. 14%
b. 18%
c. 26%
d. 42%
c. 26%
A corporate bond with face value of $100 is convertible at $40 and the corporation has called it for redemption at $106. The bond is currently selling at $115 and the stock’s current market price is $45. Which of the following would a bondholder most likely do?
a. Sell the bond
b. Convert the bond into common stock
c. Allow the corporation to call the bond at 106
d. None of the above
a. Sell the bond
A convertible bond trader has purchased a long-dated convertible bond with a call provision. Assuming there is a 50% chance that this bond will be converted into stock, which combination of stock price and interest rate level would constitute the worst case scenario?
a. Decreasing rates and decreasing stock prices
b. Decreasing rates and increasing stock prices
c. Increasing rates and decreasing stock prices
d. Increasing rates and increasing stock prices
c. Increasing rates and decreasing stock prices
What is the main reason why convertible bonds are generally issued with a call?
a. To make their analysis less easy for investors
b. To protect against unwanted takeover bids
c. To reduce duration
d. To force conversion if in-the-money
d. To force conversion if in-the-money
Suppose the price for a six-month S&P index futures contract is 552.3. If the risk-free interest rate is 7.5% per year and the dividend yield on the stock index is 4.2% per year and the market is complete and there is no arbitrage, what is the price of the index today?
a. 543.26
b. 552.11
c. 555.78
d. 560.02
a. 543.26
To prevent arbitrage profits, the theoretical future price of a stock index should be fully determined by which of the following?
I. Cash market price
II. Financing cost
III. Inflation
IV. Dividend yield
a. I and II only
b. II and III only
c. I, II, and IV only
d. All of the above
c. I, II, and IV only
The current spot CHF/USD rate is 1.3680CHF. The three-month USD interest rate is 1.05%, the three-month Swiss interest rate is 0.35%, both continuously compounded and per annum. A currency trader notices that the three-month forward price is USD 0.7350. In order to arbitrage, the trader should
a. Borrow CHF, buy USD spot, go long Swiss franc forward
b. Borrow CHF, sell Swiss franc spot, go short Swiss franc forward
c. Borrow USD, buy Swiss franc spot, go short Swiss franc forward
d. Borrow USD, sell USD spot, go long Swiss franc forward
c. Borrow USD, buy Swiss franc spot, go short Swiss franc forward
Which of the following statements is correct when comparing the differences between an interest rate swap and a currency swap?
a. At maturity, there is no exchange of principal between the counterparties in interest rate swaps and there is an exchange of principal in currency swaps.
b. At maturity, there is no exchange of principal between the counterparties in currency swaps and there is an exchange of principal in interest rate swaps.
c. The counterparties in an interest rate swap need to consider fluctuations in exchange rates, while currency swap counterparties are only exposed to fluctuations in interest rates.
d. Currency swap counterparties are exposed to less counterparty credit risk due to the offsetting effect of currency and interest rate risk in the transactiob
a. At maturity, there is no exchange of principal between the counterparties in interest rate swaps and there is an exchange of principal in currency swaps.
The table below shows quoted fixed borrowing rates (adjusted for taxes) in two different currencies for two different firms:
Company A
2% - yen
4% - pounds
Company B
3% - yen
6% - pounds
Which of the following is true?
a. Company A has a comparative advantage borrowing in both yen and pounds.
b. Company A has a comparative advantage borrowing in pounds.
c. Company A has a comparative advantage borrowing in yen.
d. Company A can arbitrage by borrowing in yen and lending in pounds.
b. Company A has a comparative advantage borrowing in pounds.
Consider the following currency swap: Counterparty A swaps 3% on $25 million for 7.5% on 20 million sterling. There are now 18 months remaining in the swap, the term structures of interest rates are flat in both countries, with dollar rates currently at 4.25% and Sterling rates currently at 7.74$. The current $/sterling exchange rate is $1.65. Calculate the value of the swap. Use continuous compounding. Assuming six months until the next annual coupon and use current market rates to discount.
a. −$1,237,500
b. −$4,893,963
c. −$9,068,742
d. −$8,250,000
c. −$9,068,742
The spot price of corn on April 10 is 207 cents/bushels. The futures price of the September contract is 241.5 cents/bushels. If hedgers are net short, which of the following statements is most accurate concerning the expected spot price of corn in September?
a. The expected spot price of corn is higher than 207.
b. The expected spot price of corn is lower than 207.
c. The expected spot price of corn is higher than 241.5.
d. The expected spot price of corn is lower than 241.5.
c. The expected spot price of corn is higher than 241.5.
In commodity markets, the complex relationships between spot and forward prices are embodied in the commodity price curve. Which of the following statements is true?
a. In a backwardation market, the discount in forward prices relative to the spot price represents a positive yield for the commodity supplier
b. In a backwardation market, the discount in forward prices relative to the spot price represents a positive yield for the commodity consumer.
c. In a contango market, the discount in forward prices relative to the spot price represents a positive yield for the commodity supplier.
d. In a contango market, the discount in forward prices relative to the spot price represents a positive yield for the commodity consumer
b. In a backwardation market, the discount in forward prices relative to the spot price represents a positive yield for the commodity consumer.
If a commodity is more expensive for immediate delivery than for future delivery, the commodity curve is said to be in
a. Contango
b. Backwardation
c. Reversal
d. None of the above
b. Backwardation
Which of the following causes led MGRM into severe financial distress?
I. There was a mismatch of cash flows from hedge and physical transactions.
II. MGRM failed to consider hedging market risk from fixed price physical sales contracts.
III. MGRM held a great percentage of the total open interest on the NYMEX. IV. The futures market went from backwardation to contango.
a. I and III
b. I and IV
c. I, III and IV
d. II, III and IV
c. I, III and IV
- Consider an 8% annual coupon, 10-year convertible bond with face value of $1,000. The yield on similar maturity straight debt issued by the company is currently 8.50%, which gives a current value of straight debt of ______.
$967
