Financial Markets Practice Examination Paper

Question 1 -

Part a) As per the expectations theory the relationship between the current short-term interest rate and expectations about the future short-term interest rates are explained by the following rates:

Current four year bond interest rate = 13%,

Expected interest rate of one year bond starting after one year = 10%

Expected interest rate of one year bond starting after two years = 9%

Expected interest rate of one year bond starting after three years = 11%

Find out the current one year bond interest rate.

Part b) David has $20,000 to deposit in a bank account for 5 years. Such deposit account pays 10% p.a. interest. How much will he have accumulated in that deposit account at the end of five years, if the interest rate is compounding as follows:

(i) semi-annually;

(ii) continuously.

Part c) "A stock split does not increase the total capital in a company, it only increases the number of issued shares in the market; issuing bonus shares does not bring new capital in the company but increases the number of outstanding shares in the market" Do you agree or disagree with this statement? Explain your arguments.

Question 2 -

John is going to retire in 10 years. He is planning to build a retirement fund that he would like to receive at the end of 10 years from now. Company X offers a package of two investment opportunities A1 and A2. John will have to make separate investments in A1 for 10 years and A2 for 5 years. The investment in A1 should start now, however the investment in A2 will start in 6th year. Both investment (A1 and A2) will mature at the same time at the end of 10th year. The details of A1 and A2 investment plans are as follows:

Investment A1: The required investment at present is $80,000.00 which will go through 4 following phases (phase 1 to 4) in next 10 years. At the end of phase 1, 2 and 3 the entire fund will automatically be rolled over to the next phase for reinvestment. The investment will mature at the end of phase 4. The 4 phases are as follows:

Phase 1: During first 2 years the investment will earn 12% return p.a. as per simple interest method, then roll over to phase 2;

Phase 2: In the following 3 years the investment will earn 12% return p.a. compounding monthly, then roll over to phase 3;

Phase 3: In the following 3 years the investment will earn 8% return p.a. compounding annually, then roll over to phase 4;

Phase 4: The final 2 years of the investment will earn 10% return p.a. compounding daily. The investment matures at the end of phase 4.

Investment A2: This investment is spread over 5 years. It will commence in the 6^th year of the 10 year investment plan. A2 requires an investment of $10,481.00 at the end of each quarter for 5 years, which will earn 12% p.a. return compounding quarterly.

Both investments in A1 and A2 will mature at the end of the 10th year. How much, in total, will John accumulate from both investment opportunities at the end of 10th year?

(Assume 1 year = 12 months = 52 weeks = 365 days).

Question 3 -

Part a) Your company is considering raising $100 million capital from the market. You have been asked to find out the weighted average cost of capital of this funding.

You can issue 40,000 corporate bonds with each $1,000 face value and paying 11% p.a. coupon. This will allow you to maintain the current debt equity ratio in the company.

Your market research team has supplied you the following information: the current cash rate is 5% p.a.; commonwealth government securities are paying 6% p.a. interest; the return on market index is 11% p.a.; and corporate tax rate is 30% p.a. Your company's equity beta is 1.4.

Part b) A Treasury bond has a face value of $5000, pays 10% per annum with half-yearly coupons and matures on 15 December 2016. Current yields for similar Treasury bonds are 8% per annum. Calculate the price of the bond in the secondary market on:

(i) What would be the price of the bond on 16 December 2013?

(ii) What would be the price of the bond on 22 February 2014?

Part c) Distinguish between

(i) Total capital vs. Venture capital

(ii) Angels vs. Sweat equitty

Question 4 -

Part a) You are buying raw materials from two different suppliers. Both of them offers you trade credits:

Supplier 1: trade credit is (2/14, n/45)

Supplier 2: trade credit is (3/10, n/35)

Which supplier should you use?

Part b) You are attending a security auction. There are two types of T-notes are in the auction. A 182-day T-note with a face value of $100 000 is traded with winning bid of $92,140. It has full 182 days to run to maturity. The other 182-day T-note with the same face value and same winning bid price however has 100 days to run to maturity.

(i) Calculate the yield of each of the T-notes

(ii) Explain the reasons behind the difference in yields.

Part c) What is the key difference between asset management and liability management?

Question 5 -

Part a) You are taking part in the tender for $50,000 T-notes of 75 day maturity on behalf of your company. The expected yield of your company is 6.5% p. a. What is the maximum price can you offer in this bidding?

Part b) (i) Given a quotation of EUR/AUD1.6155-1.6165 can you identify AUD/EUR quotation?

(ii) A company approaches a FX dealer for a forward quote on the USD/CHF with a 2-month (60-day) delivery. The spot rate is USD/CHF1.1675. The dealer needs to calculate the forward points. Assume the 2-month euro-dollar interest rate is 5.00% per annum and the 2-month euroSwiss franc interest rate is 7.00% per annum.

Part c) (i) Briefly explain the difference between primary and secondary security.

(ii) The evolution of nation-state financial systems into an integrated global financial system has occurred, and continues to occur, due to a number of specific factors. Identify and discuss the factors that have influenced the development of the global financial system.

Attachment:- Formula Sheet.rar