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OFFICE USE ONLY

OFFICE USE ONLY Monash University Semester One Final Examination 2013 Faculty of Business and Economics Department

Monash University

Semester One Final Examination 2013

Faculty of Business and Economics Department of Accounting and Finance

EXAM CODES:

AFC2000

TITLE OF PAPER:

FINANCIAL INSTITUTIONS AND MARKETS

EXAM DURATION:

3 hours

READING TIME:

10 minutes

THIS PAPER IS FOR STUDENTS STUDYING AT: (office use only - tick where applicable)

Berwick

Clayton

Peninsula

Distance Education

Open Learning

Caulfield

Gippsland

Sunway

Hong Kong

Other (specify)

During an exam, you must not have in your possession, a book, notes, paper, calculator, pencil case, mobile phone or any other material/item which has not been authorised for the exam or specifically permitted as noted

below. Any material or item on your desk, chair or person will be deemed to be in your possession. You are reminded that possession of unauthorised materials in an exam is a disciplinable offence under Monash Statute

4.1.

AUTHORISED MATERIALS

CALCULATORS

YES

NO

(Permitted calculators: Citizen SRT-135, Casio FX82MS scientific calculator, the Casio FX82AU scientific calculator, and Sharp EL-735 financial calculator, or calculators with an 'approved for use' Faculty label)

OPEN BOOK

YES

NO

SPECIFICALLY PERMITTED ITEMS

YES

NO

This paper consists of TWO SECTIONS A & B. Section A contains 20 multiple choice questions; Section B contains 8 Short Answer Questions and three pages of formula printed on a total of 10 pages. ALL QUESTIONS must be attempted.

PLEASE CHECK THE PAPER BEFORE COMMENCING. THIS IS A FINAL PAPER.

STUDENT ID: ………………………… ... DESK NUMBER: …………………….
STUDENT ID: …………………………
...
DESK NUMBER: …………………….

THIS EXAMINATION PAPER MUST BE INSERTED INTO THE ANSWER BOOK AT THE COMPLETION OF THE PAPER. NO EXAMINATION PAPERS SHOULD BE REMOVED FROM THE EXAMINATION ROOM

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS SECTION A (20 Marks) Choose the correct answer

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

SECTION A (20 Marks)

Choose the correct answer and write down your answers on the FIRST page of your exam scrip. In questions requiring a day count convention, assume 365 days unless otherwise stated. All multiple choice questions MUST be answered.

  • 1. A savings-surplus unit is an entity:

  • A. that needs to borrow funds from a surplus unit

  • B. whose income exceeds its spending

  • C. whose spending exceeds its income

  • D. called a company

    • 2. If interest rates move lower after a Treasury note is issued, a holder selling it into the

secondary markets:

  • A. receives a capital gain

  • B. receives a capital loss

  • C. receives the original price, as short-term markets are not so affected by interest rate

movements

  • D. receives a higher yield owing to the time elapsed

    • 3. A Treasury bond differs from a Treasury note in that it:

      • A. is issued for a period less than a year

      • B. pays interest quarterly, unlike the monthly interest payments for a Treasury note

      • C. is a discount instrument

      • D. is a longer term coupon security

        • 4. An increase in the prices of goods and services causes the demand for funds to

market interest rates should _______.

  • A. fall; increase

and

_____

  • B. fall; decrease

  • C. rise; increase

  • D. rise; decrease

    • 5. If market interest rates move upwards after an investor buys a government bond, the investor

may:

  • A. sell the bond back to Treasury

  • B. sell the bond in the secondary markets for a capital loss

  • C. sell the bond in the secondary markets for a capital gain

  • D. hold the bond until the market rates return to their original level and then have a capital gain

    • 6. Banks have gradually moved to liability management in the management of their balance

sheets. Which statement best describes liability management?

  • A. The loan portfolio is tailored to match the available deposit base.

  • B. The deposit base and other funding sources are managed in order to fund loan and other

commitments.

  • C. The ratio of debt to equity is managed to meet capital adequacy requirements.

  • D. The liability to assets ratio is maintained within Reserve Bank standards.

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS 7. Asset management for banks refers to: A.

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

  • 7. Asset management for banks refers to:

    • A. managing the assets of the banks; that is, their deposits

    • B. managing the real assets, the bank buildings

    • C. managing the loans portfolio

    • D. protecting the deposits by using derivatives

      • 8. The liability of shareholders in ‘limited liability’ companies signifies that:

A.

creditors of a company can call upon the shareholders in the case of company default to

contribute an amount based only on the current market price of the shares

B.

shareholders are only liable for any amount that is unpaid on the shares of a company

C.

in the event of company default, the creditors have no claim on the shareholders for any

contribution

D.

shareholders do not have a right to participate directly in the day-to-day management of a

company

  • 9. The subscription price in a rights offering is generally:

    • A. below the current share price

    • B. equal to the current share price

    • C. above the current share price

    • D. not related to the share price

      • 10. What should be the price of a share that constantly pays $2.50 annually in dividends, if the

growth rate is zero and the required rate of return is 8% per annum?

  • A. $22.86

  • B. $28.00

  • C. $31.25

  • D. $33.75

    • 11. Which of the following statements about bank bills is INCORRECT?

  • A. The interest rate on a bank bill is generally higher than on a bank overdraft.

  • B. The interest rate on a bank bill is generally lower than the yield on a Treasury note.

  • C. The interest rate on a bank overdraft is generally higher than the yield on a Treasury note.

  • D. The interest rate on a bank overdraft is generally higher than the yield on a Treasury bond.

    • 12. For a commercial bill, the interest rate is quoted as a/an:

  • A. annual percentage rate

  • B. compounded annual rate

  • C. effective rate

  • D. holding period yield

    • 13. In a call option, the:

  • A. buyer is committed to receive the underlying asset at a specified time

  • B. seller is committed to handing over the specified asset at a specified time

  • C. seller may choose whether or not to deliver the underlying asset at a specified time

  • D. buyer will choose to exercise the option only if the price of the underlying asset falls

    • 14. An agreement between two parties to exchange a series of cash flows similar to those

resulting from an exchange of different types of bonds is called a/an:

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS A. credit swap B. interest rate swap C.

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

  • A. credit swap

  • B. interest rate swap

  • C. yield curve swap

  • D. notional spread

    • 15. In a fixed-for-floating interest rate swap:

  • A. the amounts payable between parties depend on a specified principal that is exchanged at the

outset

  • B. one party pays another party an amount calculated according to a floating interest rate on a

notional principal, in exchange for an amount calculated on the basis of a fixed interest rate

  • C. only interest flows are exchanged until maturity, when the principal is exchanged according to

the difference in the interest rates over the lifetime of the swap

  • D. the amounts payable between parties depends on a specified principal that is exchanged at the

beginning and at the end

  • 16. Borrowers may access the international debt markets if:

  • A. they have a number of debt issues already

  • B. they have a large number of shares on issue

  • C. a large number of investors are willing to buy their shares

  • D. they have good credit standing

    • 17. Which of the following best defines a euromarket-type transaction?

  • A. A transaction conducted in ‘European currency units’ within the European Union.

  • B. A financial transaction denominated in a currency outside the currency of the country where

the debt issue is made.

  • C. A wholesale foreign exchange transaction of a government or institutional investor.

  • D. A financial transaction in USD, conducted solely within the European markets.

    • 18. When an investment bank helps a company sell large parcels of shares directly to institutional

investors, this is called:

  • A. due diligence

  • B. private placement

  • C. securitisation

  • D. underwriting

    • 19. A defined benefit plan:

  • A. is always fully funded, with no shortfall requirement

  • B. may have a shortfall, but the Commonwealth government will make good the shortfall

  • C. may have a shortfall, but the employer will make good the shortfall

  • D. is where the employee bears the risk if the performance of the investment is bad

20. Which of the following statements about life insurance companies is FALSE?

  • A. As inflows of funds are relatively predictable, they have a very stable level of liabilities.

  • B. They have greatly increased their assets over the past decade.

  • C. They sell contracts that offer financial cover against premature death.

  • D. They have large amounts of short-term liquid securities.

(20 × 1 mark = 20 marks)

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS SECTION B (80 Marks) Question 1 Discuss the

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

SECTION B (80 Marks)

Question 1

Discuss the three channels through which RBA decision to increase interest rate affect future domestic GDP growth.

Question 2

(10 marks)

  • a) What are the three main financial system regulators and what are their main functions?

  • b) In March 2013, the Cyprus government has to consider a new one-off levy on bank deposit in order to secure a European bailout. What were the main concerns of this policy?

Question 3

(6 + 4 =10 marks)

A highly rated corporation has issued $1 million of bonds, with a fixed-interest coupon equal to current interest rates of 13 per cent per annum, coupons paid half-yearly and a maturity of seven years.

  • a) What amount would the corporation have raised on the initial issue of the bonds?

  • b) After one year, yields on identical types of securities have fallen to 12 per cent per annum. The existing bond now has exactly six years to maturity. What is the value, or price, of the existing bond in the secondary market?

  • c) Explain why the value of the bond has changed.

Question 4

  • a) Explain what is Bank Accepted Bill (BAB)?

(3+ 4 + 3 = 10 marks)

  • b) A customer of a bank has $275 000 in surplus funds that need to be invested for a short period of time. The bank offers to sell a 90-day negotiable certificate of deposit to the customer at a yield of 6.45 per cent per annum. Calculate the face value of the security and advise the customer of the dollar return on the CD.

(5 + 5 = 10 marks)

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS Question 5 XYZ has a current share price

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

Question 5

XYZ has a current share price of $15.50. The company has made a renounceable rights issue offer to shareholders. The offer is a three-for-ten pro-rata issue of ordinary shares at

$15.35.

  • a) What is the price of the right?

  • b) Calculate the theoretical ‘Ex-Rights’ share price.

  • c) Explain why an actual ex-rights price of a share may at times differ from the calculated theoretical price.

Question 6

(4+ 3 + 3 = 10 marks)

An investor enters into a long call option on Boral Limited shares with an exercise price of $7.25 per share in two months, and pays a premium of $0.70 per share.

  • a) Calculate the break-even price for the short-call position.

  • b) Draw a fully labelled diagram of the long-call and short-call positions.

  • c) At what minimum stock price will the option buyer exercise the option on the expiration date?

Question 7

(3 + 5 + 2 = 10 marks)

An Australian company is exporting iron ore to Japan. The company has a receivable of JPY5 000 000 due in three months’ time. The company approaches its bank and enters into a forward exchange contract. The spot rates are quoted as 1AUD/JPY82.35–40, forward points 7–5.

  • a) What is the three month bid/ask forward rate?

  • b) What transaction should the Australian company take to hedge their position?

  • c) How much will the Australian company receive (in Australian dollar) if they hedge their position. How much will they receive if they do not hedge and the future spot rate is 1AUD/JPY82.01– 06.

  • d) In part c, which option is better for the Australian firm? Why would they hedge?

(2 + 3 + 3 + 2 = 10 marks)

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS Question 8 a) It is said that the

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

Question 8

  • a) It is said that the distinction between merchant banks and investment banks has become blurred. Briefly discuss the origins of merchant banking and investment banking. Explain why these two types of institutions have become very similar in their business activities

  • b) How does a restrictive covenant minimize objective risks?

(5 + 5 = 10 Marks)

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS Formula Sheet C C 1 0 r =

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

Formula Sheet
Formula Sheet
C C 1 0 r = C 0 f S = P 1 + i 365
C
C
1
0
r =
C
0
f
S
=
P 1
+
i
365
S
P =
f
1 +
i
365
n
S = P(1 + i)
S
P =
n
(1
+
i)
1
i
=
[(1
+
r )(1
+
r
)
.
.
.
(1
+
r
)]
n
1
1
2
n
1
+
q
r
=
1
1
+
p
m
j
i
=
1
+
1
m
jn
S = Pe
j
i
=
e
1
1
P
n
n
i
1
P
=
o
P
t
r
=
n
t
P
t
1
P
P
t
t
1
r
=
t
P
t
1
C
C
C
1
2
n
+
+
...
+
C
=
0
2
n
0
1
+
r
(1
+
r)
(1
+
r)
R
1
P =
1
n
i
(1
+
i)

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS R n 1] S = [(1 + i)

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

R n 1] S = [(1 + i) i R 1 = R + 1 i
R
n
1]
S =
[(1
+
i)
i
R
1
=
R
+
1
i
n -1
(1
+
i)
1
R
1
P =
1
k 1
n
(1
+
i)
i
(1
+
i)
R
1
R
P =
1
1
k +n 1
i
(1
+
i)
i
R
P =
i
log[R/(R
Pi)]
n =
log(1
+
i)
N P
(
S
)
m
R =
N +1
NP
+
S
m
P
=
x
N +1
D
(1
+
g)
o
P
=
o
r
g
t
c
Imputation Credit =
1
t
c
C
1
F
P =
1
+
n
n
i
(1
+
i)
(1
+
i)
1
+
rt
terms
f
= s
com/terms
com/terms
1
+
rt
com

P

(1

1

+

i)

k 1

Franked Dividend

OFFICE USE ONLY

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS Gap = RSA -RSL P P t t

AFC2000 FINANCIAL INSTITUTIONS AND MARKETS

OFFICE USE ONLY AFC2000 FINANCIAL INSTITUTIONS AND MARKETS Gap = RSA -RSL P P t t

Gap = RSA -RSL

P P t t 1 % PB = 100 P t 1 i % PB =
P
P
t
t
1
%
PB
=
100
P
t
1
i
%
PB
=
D
100
(
1 + i
)
n
n
CF
( )
t
CF
(
t
)
t
t
(
)
t
(
)
t
1 + i
1 + i
t
1
t
1
D =
=
n
t = 1
CF
PB
t
(
t
1 + i
)
(
1
+
)((
=
1
+
R
)(
1
+
f
)(
1
+
f
)(
...1
+
f
))
tn
t
1
t
+
1
1
t
+
2
1
tn
+
1
1
((
n
n
1
)
1
+
R
)
/ 1
(
+
R
)
1
=
f
t
n
t
n
1
t
+
n
1
1
P =
F
1 + y
n
365

1/ n