Answer ALL the questions.

Details of calculations are required.

Question 1. Capital markets (30 marks in total)

Answer the following independent questions:

a) Historical nominal returns for Coca-Cola have been 8% and -20%. The nominal returns for the market index S&P500 over the same periods were -15% and 28%. Calculate the beta for Coca-cola. (5

marks)

b) The covariance between stocks A and B is 0.0014, standard deviation of stock A is 0.032, and

standard deviation of stock B is 0.044. Which of the following is the most appropriate to depict the

risk-return characteristics of a portfolio consisting of only stocks A and B, and explain why? (5 marks)

(A) (B) (C)

c) Assume that using the Security Market Line (SML) the required rate of return (RA) on stock A is found

to be half of the required return (RB) on stock B. The risk-free rate (Rf) is one-fourth of the required

return on A. Return on market portfolio is denoted by RM. Find the ratio of beta of A (๏ขA) to beta of B

(๏ขB). (10 marks)

d) Assume that the short-term risk-free rate is 3%, the market index S&P500 is expected to pay

returns of 15% with the standard deviation equal to 20%. Asset A pays on average 5%, has standard

deviation equal to 20% and is NOT correlated with the S&P500. Asset B pays on average 8%, also has

standard deviation equal to 20% and has correlation of 0.5 with the S&P500. Determine whether

asset A and B are overvalued or undervalued, and explain why. (10 marks)

(Hint: Beta of asset i (๐ฝ๐) =

๐๐๐๐๐

๐๐

, where ๐๐

,๐๐ are standard deviations of asset i and market

portfolio, ๐๐๐ is the correlation between asset i and the market portfolio)

Question 2. Foreign exchange markets (35 marks in total)

Statoil, the national company in Norway, is a large, sophisticated, and active participant in both the

currency and petrochemical markets. Although it is a Norwegian company, because it operates within

the global oil market, it considers the U.S. dollar ($), rather than the Norwegian krone (Nok), as its

functional currency. Ari Karlsen is a currency trading strategist for Statoil. Answer the following two

independent questions a) and b):

a) Statoil sold 1 million barrels of crude oil to the Norwegian petrol station chain, Circle K, today

for 120 Nok per barrel (Nok denotes the Norwegian Krone). Statoil expects to receive the full

payments from Circle K in 3 monthsโ time when the crude oil is delivered to Circle Kโs facilities

in Norway. Statoil is informed that Circle K will pay for the oil in Norwegian Krone. Ari is asked

by the Chief Financial Officer (CFO) about the strategy to reduce the uncertainty around the

expected payment from Circle K. Ari is faced with the following market rates:

Spot exchange Rate Nok 6.0312/$

3-month forward rate Nok 6.0186/$

U.S. dollar 3-month interest rate 5%

Norwegian Krone 3-month interest rate 4.45%

Based on the above information, what hedging strategy should Ari advise the CFO that works the best

for Statoil? Explain why Ari should choose such hedging strategy. How much U.S. dollar will Statoil

receive at the end of 3 months by using this hedging strategy? (20 marks)

b) In a daily meeting, the Chief Financial Officer (CFO) gave Ari the following table of market rates

Spot exchange rate: Yen 106/$

U.S. dollar interest rate per annum 10%

Japanese Yen interest rate per annum 6%

and told Ari that the companyโs financial analyst expected the Japanese Yen to depreciate against the

U.S. dollar by 3.46% in 90 days. Assume there are 360 days in a year, and all interest rates are simple

interest rates. If the financial analystโs prediction about the US dollar and Japanese Yen turned out to

be true:

b.1) What would the spot exchange rate (Yen/$) be in 90 days? (5 marks)

b.2) Would Ari make a profit by borrowing 1 million US dollar and investing in the money markets?

If yes, how much profit would Ari realize in 90 days?

If no, explain why. (10 marks)

Question 3. Bond (35 marks in total)

Consider a bank with the following balance sheet (M means million):

Assets Value Duration of the Asset Convexity of the Asset

5yr bond bought at a yield of 3.4%

(lending money)

$550M 4.562 12.026

12yr bond bought at a yield of 4%

(lending money)

$800M 9.453 53.565

Liabilities Value Duration of the Liability Convexity of the Liability

2yr bond sold at a yield of 2.4%

(borrowing money)

$300M 1.941 2.384

4yr bond sold at a yield of 2.8%

(borrowing money)

$500M 3.759 8.206

a) Calculate the equity (total asset โ total liability) to asset ratio of the bank

(Hint: equity to asset ratio = total equity/total asset) (2 marks)

b) Calculate the duration and convexity of the both asset and liability sides; (8 marks)

c) If the interest rates go up by 1%, using the duration and convexity rule to determine the net

worth of the bank and the equity to asset ratio; (10 marks)

d) In c)โs scenario, to maintain the equity to asset ratio at 40% which is required by the regulation,

the bank decides to raise cash (zero duration and zero convexity) from the equity holders.

How much cash does the bank need to raise? (10 marks)

e) Do you agree with the following statement? Explain why. (5 marks)

โThe information about a bondโs duration and convexity adjustment is sufficient to quantify

interest rate risk exposure.โ

Type of service-Academic paper writing

Type of assignment-Coursework

Subject-Accounting

Pages / words-5 / 1200

Academic level-GCSE / A Level

Paper format-MLA

Line spacing-Double

Language style-UK English