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ADM 4351M, Winter 2015, Quiz #2 (15 points total)

Time allowed: 80 minutes

Student i.d.:______________________________________

General Rules:
The School's regulations prohibit students leaving the classroom during the first hour and during
the last 15 minutes of the test. This means that you are not allowed to leave the classroom until
you complete this quiz.
Please, place a student i.d. or any photo i.d. in front of you.
Pen/pencils, rulers and calculators are allowed. Everything else MUST be stored in the CLOSED
backpack placed ON THE FLOOR (NOT on the chair next to you and NOT on the table)
DO NOT REMOVE any paper from this test. DO NOT use your own scrap paper. If a sheet of
paper gets separated from this exam, please, report it immediately.
All interest rates are continuously compounded annual interest rate unless specified otherwise
Please, keep at least 5 decimal points while performing your calculations and reporting your

Question 1: Which of the following is true about the convenience yield?

a) It must be higher than interest rate
b) It must be lower than interest rate
c) It cannot be negative
d) It cannot be positive
e) At least two of the above statements are correct
f) None of the above
And: C
Question 2: An option issued by a corporation on its own stock is called
a) Treasury option
b) Executive option
c) Corporate option
d) Self-sustained option
e) Warrant
Ans: E
Question 3: When the company pays dividends or announces a stock split, the strike price of the
options on that company's stock:
a) Is adjusted for both dividends and stock splits
b) Is adjusted for dividends but not stock splits
c) Is adjusted for stock splits but not for dividends
d) Is adjusted neither for dividends nor for stock splits
Ans: C
Question 4: If bid-ask forward prices for 8-month gold contracts are $130-$132; and the spot
bid-ask prices are $125-$126; you can borrow at 5% and invest at 4%, which of the following is
a) You can make an arbitrage using only cash-and carry strategy
b) You can make an arbitrage using only reverse cash-and carry strategy
c) You can make an arbitrage using both cash-and-carry and reverse cash-and carry strategies
d) You cannot make an arbitrage
Ans: D
Question 5: When should you expect futures prices to be higher than forward prices?
a) When the asset is a consumption asset
b) When the asset is an investment asset
c) When there is a positive correlation between interest rates and the asset price

d) When cost of carry is positive

e) When the asset is a financial asset with positive beta
Ans: C
Question 6: The 1-year forward price on a non-dividend paying stock market index is
a) Equal to the expected value of the stock index in 1 year
b) Lower than the expected value of the stock index in 1 year
c) Higher than the expected value of the stock index in 1 year
d) Can be lower than or higher than the expected value of the stock index in 1 year depending on
the relationship between short-term and long-term interest rates
e) Can be lower than or higher than the expected value of the stock index in 1 year independent
on the relationship between interest rates and the forward price
Ans: B
Question 7: If you observe that F>S*exp(r*t) for non-dividend paying investment assets with no
storage costs, then you can make an arbitrage and you arbitrage strategy will include one of the
a) Buying the underlying asset and investing money
b) Selling the forward and investing money
c) Buying both the underlying asset and the forward
d) Borrowing money and selling the forward
e) Selling the underlying asset and investing the money
Ans: D
Question 8: Find the 3-month forward price of gold if spot gold price is $1220 and 3-month zero
rate is 4%
Ans: 1220*exp(0.04/4)=$1,232.26
Question 9: Find forward interest rate from t=4/12 till t=7/12 if 3-month forward price of gold is
$1230; 4-month forward price of gold is $1240; and 7-month forward price of gold is $1268
Ans: 1268=1240*exp(r*0.25). Hence, r=4*ln(1268/1240)=8.93%
Note : the following solutions: r=(12/3)*ln(1268/1230)=12.17% or
r=(12/4)*ln(1268/1230)=9.13% are incorrect

Question 10: Find the 6-month forward price of a 5% coupon (paid semi-annually) bond with
face value of $100 that matures 16 month from now if it is currently sells for $102 and 2, 4, and
6 month zero rates are 4%, 4.2%, 4.3%. IMPORTANT: you must show your work for this
question and you MUST report your answer to the 6th decimal digit.
Ans: (102-2.5*exp(-0.042*4/12))*exp(0.043*6/12)=$101.6979
Question 11: Find the 6-month forward $/ exchange rate if the spot $/ exchange rate is 1.2467,
6-month zero rate in $s is 3% and 6-month zero rate in s is 5%.
Ans: 1.2467*exp((0.03-0.05)*6/12)=1.2343
Question 12: What is the maximum possible 6-month zero rate if the current gold bid-ask quotes
are $1,224.50 and $1,226.75 per ounce and 6-month forward bid-ask quotes are $1,250 and
$1251 per ounce
Ans: R=(12/6)*ln(1251/1224.50)=4.2821%
Give 0.5 points if instead of the maximum the students found minimum
Question 13 (1.5 points): Assume AAA and BBB would like to borrow $100,000,000 each.
AAA can borrow at 5% or at LIBOR+0.5% and prefers to borrow at floating rate. BBB can
borrow at 6% or at LIBOR + 1% and prefers to borrow at fixed rate. Assume AAA and BBB
were able to enter into a mutually beneficial swap agreement in which they exchange the
payment of LIBOR interest rate for a payment of x% fixed interest rate between each other.
a) Find QSD
Ans: 0.5%
b) Which company pays x% in the swap agreement
c) What is the minimum value of x?
Question 14 (1.5 points): Find the value of a swap in which you pay 5% per annum
(compounded semiannually) and receive floating interest semiannually on a principal amount of
$1,000,000. There is 14 month left till the end of the swap agreement. The next floating rate
payment that you will receive (2 month from now) is equal to $22,000. LIBOR rates

(continuously compounded annual rates) for 2 months, 8 months and 14 months are 4.9%, 5.2%
and 5.3% respectively. NOTE: please, provide a detailed solution and clearly state all
intermediate results that you think are important enough to earn you a partial credit in case your
final answer is incorrect.
We will use bond-valuation approach.
Floating rate payments: PV=1022000*exp(-0.049*2/12)=$1,013,687.66
Fixed rate payments: PV=
25000*exp(-0.049*2/12)+25000*exp(-0.052*8/12)+1025000*exp(-0.053*14/12) = 1,012,485.38
Thus, the value of your swap is $1,013,687.66-1,012,485.38=$1,202
0.5 point for the method, 0.5 point for "floating"; 0.5 for "fixed" rate payments. No penalty for
incorrect sign. If the final answer is correct give full mark regardless of non-showing the work.