FM213 Problem Set and Past Paper Flashcards
Amortization loan
Explain intuitively why the yield to maturity on the 1.5 coupon bond is less than that on the 0.5 coupon bond
The yield depends upon both the patterns of coupon payments and spot rates at the time of the coupon payment. The 1.5% bond has a slightly greater proportion of its total payments coming earlier, when interest rates are low, than does the 0.5% bond. Thus, the yield of the 1.5% bond is slightly lower.
Why is the 0.5% coupon bond selling at discount and 1.5% coupon bond selling at premium?
The 0.5% bond is selling at discount because its coupons are small relative to (most of the) spot rates. This implies that the coupon stream is not delivering the market-determined time value of money. Thus, to induce an investor to hold the bond, the purchase price that an investor pays must be below the face value that will be delivered at the end of the bond’s lifetime
Briefly explain the difference between beta as a measure of risk and variance as a measure of risk
What is the correlation coefficient between 2 stocks that gives the maximum reduction in risk for a two-stock portfolio?
(assuming that the portfolio contains long positions in both stocks)
Leveraged position
Market inefficiency
What is risk shifting problem?
Discuss the relationship between risk shifting and face value of debt
What is debt overhang problem?
Conversion premium
Why conversion value is different from market price of convertible?
Can the market price of the convertible be less than the conversion value?
No. Not if the investor is free to convert immediately
Explain how convertible debt alleviate risk-shifting problem?
Share-financed vs cash-financed takeover
How payment methods in takeover affect the size of the merged company?
1) Share-financed takeover keeps all assets in the company
2) cash-financed takeover pays out part of the assets to target shareholders
All else equal, the size of the merged firm financed by stock is bigger
What will happen to the share price on the first day when registered owners are no longer eligible to receive the quarterly dividend?
Assume no dividend and capital gain tax
Since both dividends and capital gains are not taxable, the share price will decrease by the amount of the dividend
Comment on the costs of debt financing
Debt overhang related discussion:
- Reducing equity holders’ incentives to invest in good projects.
- Incremental CF goes to creditors first
Benefit of issuing debt over equity
Explain interest tax shield
Debt is less informational sensitive to avoid information asymmetry and adverse selection problem, which is likely to impact the company.
Interest tax shield is the tax payment over and above the principal.
Foreign exchange spot rate
Arbitrage opportunity - steps
Premium and exercise price
Variance of N securities
**Option in practice
Binomial option pricing model
Risk neutral probability
Binary option vs straight bond
Currency arbitrage
Put value
Higher Sharpe ratio is better?
(2017 q3b)
Yes. Higher return given same risk
Spot rates and forward rates
Relationship between sharpe ration of market portfolio and CML
The slope of the CML is the sharpe ratio of the market portfolio.
Interest rates for borrowers and lenders
Bond Price and yield to maturity
Forward exchange rate
B-S Formula
(2015)
Informational efficiency (2019)
