FNCE401v7 Assignment 1

Instructions
Assignment 1 should be submitted after you have completed Unit 2. This assignment is
worth
15 percent of your final grade.
Assignment 1 contains six problems. The maximum mark for each problem is noted at
the beginning of the problem. This assignment has a total of 100 marks.
Read the requirements for each problem and plan your responses carefully. Although
your responses should be concise, ensure that you answer each of the required
components as completely as possible. If supporting calculations are required, present
them in good form.
*Note: Students must submit two files for Assignment 1: one Word file and one
Excel file. The Word file should contain the written answers to Problems 1, 2, 3, 4, 5, and
6. The Excel file should contain the spreadsheet work performed for Problem 5.
When you receive your graded assignment, carefully review the comments the marker
has made. This review component is an important step in your learning process. If you
have any questions or concerns about the evaluation, please contact the Student Support
Centre.
Problem Marks Available Lesson Chapter

1 15 2 2

2 15 3 3

3 10 3 3

4 15 4-6 4-6

5 20 4-6 4-6

6 25 4-6 4-6

Total 100

FNCE 401v7 Assignment 1 July 2018

Problem 1 (15 marks)
The bid and ask bond equivalent yields of a U.S. T-bill are 7.8% and 7.6% respectively.
The maturity of the T-bill is 120 days.
1. Calculate the bid and ask bank discount yields of the T-bill.
7.8% = (F - Pbid) / Pbid x 365 / 120
(F - Pbid) / Pbid = 7.8% x 120 / 365
F / Pbid = 1 + 7.8% x 120 / 365 = 1.0256
F / Pask = 1 + 7.6% x 120 / 365 = 1.0250

2. Find the bid-ask spread of the T-bill.

Bid bank discount yield = (1 - Pbid / F ) x 360 / N = (1 - 1 / 1.0256) x 360 / 120 = 7.50%
Ask bank discount yield = (1 - Pask / F ) x 360 / N = (1 - 1 / 1.0250) x 360 / 120 = 7.31%

Bid ask spread = Pask - Pbid = F / 1.0250 - F / 1.0256

Bid ask spread = 10,000 / 1.0250 - 10,000 / 0.0256 = $ 6.25

3. Find the effective annual yield based on

a. the bid price of the T-bill.
b. the ask price of the T-bill.

Pask = F / 1.0250 = 10,000 / 1.0250 = 9,756.23

Pbid = F / 1.0256 = 10,000 / 1.0256 = 9,749.97
= [1 + (F - Pbid) / Pbid]365/N - 1 = (F / Pbid)365/N -1 = 1.0256365/120 - 1 = 8.01%
= 1.0250365/120 - 1 = 7.80%

Problem 2 (15 marks)

You have just borrowed $67,500 on margin to buy shares in BCE, which is currently
quoting as the bid price of $29.99 bid and the ask price of $30.00 ask per share. The
minimum margin is 35%, and your initial margin requirement is 55%. Assume that BCE
will pay no dividends before you return the loan and that that you pay no interest on your
loan.
1. If you buy BCE in margin, what is the maximum number of shares you can buy?

67,500/55%=122,727 , 122,727/30=4091 share

2. Suppose you bought the maximum number of shares of BCE as in (1).

FNCE 401v7 Assignment 1 July 2018

 a. Assume that immediately after your purchase, BCE’s share price drops to $26.00
per share. Calculate your new margin. Will you receive a margin call?
4091*26*35% = 3728

67500-(30-26)*4091 = 51136
No margin call will be recieved

b. What is the maximum price at which you will receive a margin call?
67500-(30-p)*4091 = 4091*35%*p
67500-122730+4091*p = 1431.85*p
55230 = 2659.15*p
55230/2659.15 = $20.77

c. If the stock price falls to $20, you would get a margin call. If that happens, how
much in additional funds would you need to add to your account to respond to
the margin call?
4091*20*35% = 28637
67500-(30-20)*4091 = 26590
28637-26590=2047

Hints:
 New fund needed = Original loan – Maximum Loan given market value
 Maximum loan = (1 – minimum margin) (Market value of shares
 When margin call occurs, the margin balance is bumped up to the minimum
(maintenance) margin.

Problem 3 (10 marks)

Assume you sell short 100 shares of Shell Corp. at $100 per share, with initial margin at
45%. The minimum margin requirement is 30%. The stock will pay no dividends during
the period, and you will not remove any money from the account before making the
offsetting transaction.
1. At what price would you face a margin call?
(100*100+100*100*45%-100*S)/(100*S)<30%
=>S>111.53

FNCE 401v7 Assignment 1 July 2018

 2. If the price is $110 at the end of the period, what is your margin ratio at that point?
$45-(110-100)= $35 35x100=3500

FNCE 401v7 Assignment 1 July 2018

Problem 4 (15 marks)
You have $100,000 invested in a complete portfolio that consists of a portfolio of risky
assets (P) and T-Bills. The information below refers to these assets.
E(rp)=10%
σp =20%
T-Bill rate=3%

Proportion of T-Bill in the complete portfolio: 30%

Proportion of risky portfolio P in the complete portfolio: 70%
Composition of P:
Stock X 30%
Stock Y 25%
Stock Z 45%
Total 100%

1. What is the expected return on your complete portfolio?

= (0.7*10%) + (0.3*3%)

= 7.9%

2. What is the standard deviation of your complete portfolio?

= 0.7*(20%)

= 14%

3. What are the dollar amounts of Stocks X, Y, and Z, respectively, in your complete
portfolio?
X= 30% *70000 =21000
Y=25% * 70000 = 17500
Z= 45% *70000 = 315000
4. If your degree of risk aversion is A=2, is your complete portfolio optimal? (Assume P is
the optimal risky portfolio.)
= (0.10-0.03)/(2*0.20^2)

= 0.875
Optimal portfolio risk would be 87.5% and non risk should be 12.5

FNCE 401v7 Assignment 1 July 2018

Problem 5 (20 marks)
SPY and XIU are ETFs tracking the S&P 500 and S&P/TSX 60 index, which are often
used as proxies for the U.S. and Canadian stock markets, respectively. From a set of their
historical data, the annual expected returns and standard deviations of those two ETFs
and their covariance are estimated as follows:
SPY:
E(r)= 0.15
𝜎 =0.28
XIU:
E(r)= 0.18
𝜎 =0.32
Covariance between SPY and XIU = 0.0618
Suppose that you have $10 million to invest for one year and you want to invest that
money into SPY, XIU, and the Canadian one-year T-bill. Assume that the interest rate of
the one-year T-Bill is 3% per annum.
Suppose that you have the following utility function:

U=E(r) – ½ Aσ2 and A=3

Answer the following questions using Excel:

1. Draw the opportunity set offered by these two securities (with an increment of 0.01 in
weight).
2. What is the optimal portfolio of SPY and XIU?
3. Determine your optimal asset allocation among SPY, XIU, and T-Bill, in percentage and in
dollar amounts.
Note: Include your answer to this problem in the same Word file as your other answers. Also
submit an Excel file to show your work.

FNCE 401v7 Assignment 1 July 2018

Problem 6 (25 marks)
A pension fund manager is considering three mutual funds. The first is a stock fund, the
second is a long-term government and corporate bond fund, and the third is a T-bill
money market fund that yields a rate of 8 percent. The probability distribution of the
risky funds is as follows:
Expected Return Standard Deviation
Stock fund (S) .20 .30
Bond fund (B) .12 .15

The correlation between the fund returns is 0.10.

1. What are the investment proportions of the minimum-variance portfolio of the
two risky funds, and what is the expected value and standard deviation of its rate
of return?

=.1x30x15
=45

=15^2
=225

=30^2
=900
Bonds stocks
Bonds 225 45
Stocks 45 900

=(225-45)/(900+225-2x(45))
=180/1035
=.1739

Max stock is .1739

Max bond is .8261

FNCE 401v7 Assignment 1 July 2018

 2. Solve numerically for the proportions of each of the assets and for the expected
return and standard deviation of the optimal risky portfolio.
3. What is the reward-to-variability ratio of the best feasible CAL?
4. You require that your portfolio yield an expected return of 14 percent and be
efficient on the best feasible CAL.
a. What is the standard deviation of your portfolio?
b. What is the proportion invested in the T-bill fund and each of the two
risky funds?
5. If you were to use only the two risky funds and will require an expected return of
14 percent, what must be the investment proportions of your portfolio? (Compare
its standard deviation to that of the optimized portfolio in question 4.)

FNCE 401v7 Assignment 1 July 2018