F303: Intermediate Investments

Sample Midterm 2
Total: 100 points
In your calculations use two decimals, unless recommended otherwise

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Part I (50 points)

1. Assume that the current yield curve for the next four years is the following: y1 = 4%,
y2 = 5%, and y3 = 6%. Compute the price of the 7% coupon-bond that pays annual
coupons and matures in three years. Assume that the face value is $100.
A. $73.22
B. $88.89
C. $93.65
D. $99.90
E. $103.0

2. You just bought a 6% coupon bond that pays annual coupons and expires in 5 years,
and it has a face value of $100. If you decide to sell the bond right after you received
your third coupon, what is the annualized return on your investment? Consider that
the yield curve is flat at 5% and that you do not reinvest your coupons.
A. 4.73%
B. 2.50%
C. 7.98%
D. 2.03%
E. 3.31%

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3. This is your current portfolio: short on one call option with strike price of $55, short
on one put with exercise price of $70, and long on two calls with strike price of $80.
All of the options are European and have the same maturity. At maturity, what is the
payoff of your portfolio if the stock price is $35?
A. -$35
B. -$5
C. $0
D. -$20
E. -$10

4. This is your current portfolio: short on one call option with strike price of $55, short
on one put with exercise price of $70, and long on two calls with strike price of $80.
All of the options are European and have the same maturity. At maturity, what is the
payoff of your portfolio if the stock price is $100?
A. -$15
B. -$5
C. $0
D. $20
E. $10

5. Today’s stock price of MacBug Inc is $100. In one year the stock price is either $120
or $88. What is the price of an European call option with strike price of $105 on this
stock? The option expires in one year. Consider that the risk free rate is 5%. Use
simple compounding and four decimals.
A. $7.60
B. $11.67
C. $13.89
D. $2.02
E. $3.34

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6. You are the new portfolio manager for a large company’s pension plan. The pension
plan’s assets (chosen by your predecessor) are worth $23.7B, of which $5.3B is invested
in 3-year zero-coupon bonds and $18.4B is invested in 4-year zero-coupon bonds. What
is the overall duration of the fund’s assets?
A. 3.12 years
B. 3.43 years
C. 3.78 years
D. 3.89 years
E. 3.25 years

7. You are the new portfolio manager for a large company’s pension plan. The plan has
to make payments of $5B in a year (t=1), $6B in 2 years (t=2), $7B in 3 years (t=3),
and $2B in 4 years (t=4). The yield curve is flat at 4%. What is the duration of these
liabilities?
A. 2.27 years
B. 1.42 years
C. 3.13 years
D. 2.88 years
E. 1.76 years

8. Assume that Pear Inc stock is trading at $5, the one year zero coupon bond with face
value of $10 is trading at $8, and the European call on the Pear Inc is trading at $5.
The European call expires in one year and has exercise price of $10. What is the price
of an European put option on Pear Inc that expires in one year and has exercise price
of $10?
A. $3.0
B. $4.4
C. $10.4
D. $8.0
E. $6.7

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Part II (25 points)

9. If the yield curve switches from upward sloping to downward, which statement is true?
Assume that the shortest rate, say the 3-month T-bill, remains constant, but all other
rates move downwards so that the yield curve becomes downward sloping.
A. In percentage terms, short-term bond prices are likely to go up by a larger amount
than long-term bonds;
B. Future short rates must have increased dramatically;
C. In percentage terms, long-term bond prices are likely to go up by a larger amount
than short-term bonds;
D. Macroeconomic risk in the long term is now higher.

10. Which of the following statements is true about the yield to maturity (YTM)?
A. The YTM is the return on investment on a bond if all the coupons are reinvested
at the risk free rate;
B. A decline in the YTM leads to a decrease in the bond price;
C. You can compute the price of a bond using the YTM even if the yield curve is
non-flat;
D. The YTM is the return on investment on a bond as long as the coupons are
reinvested at any rate.

11. All else constant, if the year 2 yield (y2 ) increases, the price of a 2-year coupon-bond
will , and the price of a 4-year coupon-bond will .
A. decrease; decrease
B. increase; increase
C. remain constant; decrease
D. decrease; remain constant
E. remain constant; increase

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12. You were hired to help manage the risk exposure of an airline company. What do you
think is the best way to hedge the business risk of your company?
A. Buy put options of firms in the oil extraction industry;
B. Buy call options of firms in the oil extraction industry;
C. Buy call options of firms in the the airline industry industry;
D. Buy stocks of firms in the airline industry industry.

13. Image that you strongly believe that the stock market is going to be highly volatile in
the near future. Which of the following portfolios should you purchase if you intend to
act on your beliefs? Assume that all portfolios have the same maturity date.
A. Buy an equal amount of calls and puts on the market portfolio index with strike
price equal to the current price.
B. Sell an equal amount of calls and puts on the market portfolio index with strike
price equal to the current price.
C. Buy X puts on the market portfolio index with strike price equal to the current
price, and sell X calls on the market portfolio index with strike price equal to the
current price. X depends on your available wealth.
D. Sell X puts on the market portfolio index with strike price equal to the current
price, and buy X calls on the market portfolio index with strike price equal to the
current price. X depends on your available wealth.

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Part III (15 points)

In all questions below use four decimals points. Suppose you are given the information
about the following four bonds that have face value of $100:

• The 1-year zero-coupon bond has an YTM of 10%;

• The 2-year coupon-bond with annual coupon rate of 3% has an YTM of 2%;
• The 3-year zero-coupon bond has an YTM of 6%;
• The 4-year coupon-bond with annual coupon rate of 8% has an YTM of 7%.

14. What is the yield for year 2?

A. y2 = 2.4%
B. y2 = 2.1%
C. y2 = 2.3%
D. y2 = 1.9%
E. y2 = 1.6%

15. What is the forward rate in year 3?

A. 12.47%
B. 14.72%
C. 9.32%
D. 11.92%
E. 12.45%

16. You are planning on buying the 4-year coupon bond today and selling it after receiving
the third coupon, what is the annualized expected return if you do not reinvest your
coupons?
A. 3.7%
B. 16.9%
C. 5.3%
D. 11.1%
E. 8.9%

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Part IV (10 points)

The current price for a non-dividend paying stock is 100. Each year, the stock price
either goes up by 25% or down by 25%. The yield curve is flat, and the price of a
two-year zero-coupon bond is $90.70—assume the face value is $100. Compute the
price of an European call option on the stock that expires in two years with a strike
price of $80. Consider simple compounding. Use four decimals.

17. What is the price of the call option in the end of year 1 if the stock goes up in the first
year?
A. $18.2
B. $23.1
C. $48.8
D. $11.7
E. $15.5

18. What is the price of the call option today?

A. $23.5
B. $45.2
C. $37.9
D. $30.9
E. $50.3

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Answer Key
1. E
2. A
3. A
4. B
5. A
6. C
7. A
8. D
9. C
10. C
11. A
12. B
13. A
14. D
15. B
16. C
17. C
18. D

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Scratch Page

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 F303: Intermediate Investments 10

Scratch Page

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 F303: Intermediate Investments 11

C C C C +M
P = + 2
+ ··· + T −1
+
(1 + r) (1 + r) (1 + r) (1 + r)T
M
P =
(1 + r)T
(1 + y2 )2 = (1 + y1 )(1 + r2 )
(1 + yn )n
1 + fn =
(1 + yn−1 )n−1
C C C C +M
P = + 2
+ ··· + T −1
+
(1 + y1 ) (1 + y2 ) (1 + yT −1 ) (1 + yT )T
C C C +M
P = + ··· + T −1
+
(1 + Y T M ) (1 + Y T M ) (1 + Y T M )T
C C C +M
P = B1 + B2 + · · · + BT
M M M
CF/(1 + y1 ) CF/(1 + y2 )2 CF/(1 + yT )T
D = 1× +2× + ··· + T ×
P rice P rice P rice
∆P ∆y
≈ −D ×
P 1+y
1+r−d
p =
u−d
p × Cu + (1 − p) × Cd
C0 =
1+r
er − d
p =
u−d
p × Cu + (1 − p) × Cd
C0 =
er
V1 V2 VM
DP = D1 + D2 + · · · + DM
V V V
Call Payoff = max{0, S − X}
Put Payoff = max{0, X − S}

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Buy a Call Buy a Put

S S

Sell a Call Sell a Put

S S

Buy a Stock Lend B

B × (1 + r)

0 0
S S

Short a Stock Borrow B

0
S

0
S

−B × (1 + r)

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