BE331: The Following Table Shows a Market where there are two Assets Their Returns With the Probabilities are Shown in The Table Below: The Pricing of Securities in Financial Markets Assignment, UOE, Singapore

QUESTION 1
The following table shows a market where there are two assets. Their returns with the probabilities are shown in the table below.

1. Calculate the expected return for each asset.

2. Calculate the standard deviation for each asset.

3. Calculate the covariance and correlation of the return for the assets.

4. If a portfolio is constructed with equal weights of A and B, find the return and the risk of the portfolio.

QUESTION 2

A bond is selling at $950 today. The interest rate is 6% per annum (continuously compounded).

What is the price of a six-month forward contract?

The price of the bond is $960, two months from today. What is the value of the
contract 2 months from today?

B

A share is selling at $50 today. The interest rate is 8% per annum on a continuously compounded basis. The share is expected to pay a dividend of $0.75 at the end of 6 months.

What is the price of a 10-month forward contract? Show your workings.

The price of the share is $60, three months from today. What is the value of the
contract three months from today? Show your workings.

C
Discuss the similarities and differences between futures contracts and forward
contracts.

QUESTION 3

A

The price of the share is $20 today and the interest rate is 10% compounded
continuously.

1. Calculate the lower bound of the one-year European Call option with the strike price of $18.

If the Call option is selling for $3, find the arbitrage profit, if any, in the following
scenarios:

2. Stock price one year later is more than $18. (10 marks)

3. Stock price one year later is less than $18. (10 marks)

B

There is a European PUT option and a European CALL option. Both have the
exercise price of X and the expiration time T. An investor buys the Put option and sells the Call option.

1. Find out the payoff of this strategy at expiration when the spot prices are St.

2. Compare this strategy with a Forward Contract.

QUESTION 4

A

R Ippon Inc. has a loan on $100 million. It must pay an interest of 5.8% per year on this loan. The company believes that the interest rates are to decrease and would like to swap its fixed rate loan to a floating rate. A swap bank has agreed to pay a rate of 5% in exchange of floating rate of Sibor+1%. Today SIBOR is 6%

1. What is the effective interest rate for the company if it undertakes the swap
arrangement with the swap bank? Draw the block diagram and explain.

2. Show the payments between Rippon and the swap bank when the SIBOR is
5%.

B

XYZ Inc. is based in the United Kingdom and would like to borrow $100 million at a fixed rate of interest for five years in U.S. funds. As the company is not well known in the United States and faces difficulty in borrowing USD in the US. The company can however borrow at 12% per annum on fixed-rate five-year sterling funds.

Company ABC is based in the United States and would like to borrow the equivalent of $100 million in Sterling funds for five years at a fixed rate of interest. It has been unable to get a quote on Pound Sterling but has been offered a borrowing rate on U.S. dollar funds at 10.5% per annum.

Five-year government bonds currently yield 9.5% per annum in the United States and 10.5% in the United Kingdom. Suggest an appropriate currency swap that will net the financial intermediary 0.5% per annum. (20 marks)

C

Discuss the advantages of an interest rate swap