FNCE 201

TERM 1 2004-05 EXAMINATION SEPTEMBER 2004

FNCE 102 FINANCIAL INSTRUMENTS, INSTITUTIONS AND MAKRETS

INSTRUCTIONS TO STUDENTS 1 2 3 The time allowed for this examination paper is 2 hours. This examination paper comprises TWO (2) Sections. There are 10 short questions in Section A and 3 problems in Section B. You are required to submit the entire question paper to the invigilator at the end of the examination.

Student Name

:___________________________________

Student ID Number:___________________________________
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SECTION A (20 MARKS) ANSWER ALL QUESTIONS. EACH QUESTION CARRIES TWO (2) MARKS 1. Which of the following bonds has the highest reinvestment risk? (a) Low-coupon long-term bonds (b) High-coupon short-term bonds (c) High-coupon long-term bonds (d) Low-coupon short-term bonds (e) Long-term bonds Callable bonds are often issued when (a) the current interest rate is high and expected to remain stable over time (b) the current interest rate is low and expected to rise over time (c) the current interest rate is low and expected to fall over time (d) the current interest rate is high and expected to rise over time (e) the current interest rate is high and expected to fall over time Which of the following bond features or provisions best minimize the risk that the bond issuer defaults on its obligation to redeem the bond at maturity? (a) Floating rate feature (b) Subordinate clauses (c) Call provision (d) Conversion feature (e) Sinking fund provision A downward sloping yield curve indicates that _______________ (a) The forward interest rates are rising over time (b) There is no liquidity premium. (c) Interest rates are rising over time (d) Markets are segmented and interest rates are determined by demand and supply conditions in those market segments. (e) Interest rates are falling over time

2.

3.

4.

5.

If ABC Bank charges 3% per month for cash advance on its credit card, the effective interest rate is _____________% p.a.

6.

Given the current interest rate environment in Singapore, companies should (a) Issue a fixed-coupon bond (b) Borrow a variable rate term loan (c) Borrow through overdrafts (d) Issue a float-rate bond (e) None of the above

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7.

When there are no financial markets, individuals will _____________. (a) (b) (c) (d) (e) Be indifferent about the amount consumed when young or old Consume everything when they are young and nothing when old Consume everything when they are old and nothing when young Save and consume part of their endowment Consume their endowments

8.

If financial markets exist in a 2-period world, individuals can _____________. (a) (b) (c) (d) (e) Save or Invest Obtain more wealth Obtain a higher level of utility of consumption (a), (b) and (c) (b) and (c)

9.

ABC bank offers daily compounding for its deposits. If the deposit rate is 1.25% per annum, your savings of $10,000 will grow to $_____________ at the end of the year. Which of the following bonds has the highest volatility? (a) Low-coupon long-term bonds (b) High-coupon short-term bonds (c) High-coupon long-term bonds (d) Low-coupon short-term bonds (e) Long-term bonds

10.

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SECTION B ANSWER All QUESTIONS PROBLEM 1 (10 Marks) Shown below are the credit card transactions of Mr. Stanley for the month of June. Compute the average balance outstanding and the interest cost if the interest rate charged is 2.5% per month. Show your working on the space provided below. No marks will be awarded if workings are not shown. No of days 3 4 10 14 Balance outstanding 3000 5000 12000 4000

* PROBLEM 2 (15 Marks) 4

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Fill in the blanks for the 2 loans shown below. No marks will be awarded if workings are not shown. Loan A Type Interest rate Loan period Interest payment Loan received at the beginning of loan period Amount payable at end of of loan period APR of loan Simple Interest 5.5% p.a. 3 months ___________ ___________ ___________ ___________ Loan B Discount 4.25% p.a. 3 months _____________ _____________ _____________ _____________

* PROBLEM 3 (55 Marks) 5

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You are keen to invest in bonds. Currently, there are two semi-annual coupon bonds traded in the market as shown below: Bond JTC 4.926% 121024 HDB 4.85% 091201 (a) Bid price 1.05 1.02 Ask price 1.06 1.05

Suppose you are willing to pay the price currently quoted by the seller, determine the current yield and yield to maturity for these two bonds. Give your solutions to 4 decimal points. No marks will be awarded if workings are not shown.

(b)

Oil prices have crept up to levels that may slow down the U.S. economy significantly. The market now expects Alan Greenspan, Chairman of Federal Reserve to decrease interest rate by 0.5%. How would the two bonds react to a fall in interest rate? Quantify the % change in the price of the bond. No marks will be awarded if workings are not shown.

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(c)

Based on an analysts report, you now expect the reinvestment rate of coupons to fall to 3%. If your expectation is realized, compute the reinvestment yield to maturity for these two bonds. Which of the two bonds have higher reinvestment risk? Explain. No marks will be awarded if workings are not shown.

(d) You expect the reinvestment rate of coupons to fall to 3%. You may need to fork out a sum of money as down payment for a car in the future. What is your yield if you cash out of the bond at the end of year 4? Based on the term structure of interest rates, 1-year bond and 4-year bonds will be quoted at yield to maturity of 2.95% and 3.15% respectively at the end of year 4. No marks will be awarded if workings are not shown.

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