Fin Practice Final

FIN 441 Practice Final

(Must show calculations in detail to earn credit)

1. The price of a put option decreases when interest rates rise. Explain why. (9 points)

1. A stock price is currently $100. Over each of the next years it is expected to go up by 4.88% or down by 2.53%. The risk-free interest rate is 2.5% per annum. What is the value of a two-year American put that has a strike price of $100? (18 points) Answer: $0.79

1. Would an American call be worth more than its European counterpart if the stock (a) does not pay dividend and (b) does pay dividend? Explain. (9 points)

1. Would an American put be worth more than its European counterpart if the stock

(a) does not pay dividend and

(b) does pay dividend? Explain. (9 points)

1. Why do higher interest rates lead to higher call price but lower put prices? (9 points)

1. If the futures price is lower than the spot price plus carrying cost, is there an arbitrage opportunity? If so, design a trading strategy. (9 points)

1. Under the terms of an interest rate swap, CAT Financial has agreed to receive 12% per annum and to pay three-month LIBOR in return on a notional principal of $200 million with payments being exchanged every three months. The swap has a remaining life of 6 months. The three-month LIBOR is 13% per annum for all maturities. The three-month LIBOR at the last payment date was 11% per annum. What is the value of the swap to CAT Financial? (15 points) Answer: VFX = $198.844m; VFL = 198.929m

Receive 12% fixed and pay LIBOR on the notional principle $200 mil every 3 mo.

Current or future LIBOR is used for discounting, all the past LIBOR is used for PMT calc

12% 200 mil next pmt in 3 mo (.25)                        12% on 200 mil + principle in 6 mo

.12(200 mil) (.25) = 6mil                                6mil +200 mil =206 mil

6e-.13x.25                                                 206e-.13x.5         =198,844,032-receive

11% + principle in 3 mo

.11(200 mil) (.25) = 5.5mil         +200 mil =205.5 mil

205.5e-.11x.5         =198,929,613 pay

Vswap = -$84,581

1. Companies A and B have been offered the following rates per annum on a $20 million five-year loan:

___________________________________________________________________________

Fixed Rate                         Floating Rate

___________________________________________________________________________

Company A                         13.00%                         LIBOR + 0.4%

Company B                         15.00%                         LIBOR + 0.8%

                                2%                                        0.4%         Net difference is 1.6%