FIN2139M Financial Markets & Institutions

QUESTION 1

a. The following questions relate to mortgage-backed securities:

(i) Discuss the concept of mortgage-backed securities with relevant examples. (5 marks)

(ii) Evaluate the contribution of the mortgage-backed securities to the financial crisis in 2007-2009 with relevant examples. (10 marks)

b. Distinguish between forward contracts and futures contracts with relevant examples. (10 marks)

TOTAL: 25 MARKS

QUESTION 2

a) With respect to the international expansion of the commercial banks, discuss three main advantages and disadvantages using relevant examples. (9 marks)

b) Compare mutual fund investment and venture capital investment. Discuss how the risk attitude of investors may affect the choice of these two investments with relevant examples. (10 marks)

c) Discuss the concept of purchasing power parity theorem. (6 marks)

TOTAL: 25 MARKS

QUESTION 3

a) You can purchase a T-bill that is 205 days from maturity for $9,000. The T-bill has a face value of $10,000.

Required:

(i) Calculate the T-bill’s quoted yield. (3 marks)

(ii) Calculate the T-bill’s bond equivalent yield. (3 marks)

(iii) Calculate the T-bill’s effective annual rate (EAR). (3 marks)

(iv) Discuss the three common characteristics of money market securities. (6 marks)

b) On October 5, 2019, you purchase a $10,000 T-note that matures on August 15, 2031 (settlement occurs one day after purchase, so you receive actual ownership of the bond on October 6, 2019). The coupon rate on the T-note is 5 percent and the current price quoted on the bond is 110.250 percent. The last coupon payment occurred on May 15, 2019 (144 days before settlement), and the next coupon payment will be paid on November 15, 2019 (40 days from settlement).

Required:

(i) Calculate the accrued interest due to the seller from the buyer at settlement. (3 marks)

(ii) Calculate the dirty price of this transaction. (3 marks)

(iii) Discuss the advantages and disadvantages of investing in TIPS bonds. (4 marks)

TOTAL: 25 MARKS

QUESTION 4

a) Suppose you own 900,000 shares of common stock in a firm with 15 million total shares outstanding. The firm announces a plan to sell an additional 3 million shares through a rights offering. The market value of the stock is £30 before the rights offering and the new shares are being offered to existing shareholders at a £3.0 discount.

Required:

(i) If you exercise your preemptive rights, calculate the new shares you can purchase. (3 marks)

(ii) Calculate the market value of the stock after the rights offering. (3 marks)

(iii) Calculate the total investment in the firm after the rights offering. How is your investment split between original shares and new shares? (3 marks) (iv) If you decide not to exercise your preemptive rights, calculate your investment in the firm after the rights offering. How is this split between old shares and rights? (3 marks)

(v) Discuss three advantages of using rights offering to the issuing firms. (6 marks)

b) An investment bank agrees to underwrite a $500 million, 20-year, 5 percent semiannual bond issue for Lincoln Corporation on a firm commitment basis. The investment bank pays Lincoln on Thursday and plans to begin a public sale on Friday.

Required:

(i) What type of interest rate movement does the investment bank fear while holding these securities? (3 marks)

(ii) If interest rates rise 0.05 percent, or five basis points, overnight, what will be the impact on the profits of the investment bank? Support your answer with calculations. (4 marks)

TOTAL: 25 MARKS