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MOCK EXAMINATION: MN-3005: Financial Services

Answer ALL Questions

Question 1

(a) Discuss the main characteristics of insurance and the factors that impact on insurance pricing. [15 marks]

(b) Considered you are trading in an order-driven market. Below is a snapshot of the limit order book of stock “Impega” (size in thousand):

If following orders (limited/market orders) are entered:

(i) Identify each order: whether the order is taking the market or making the market. And calculate the price if order is executed. [10 marks]

(ii) Illustrate the order book after the execution of above 5 orders and comment on the impact of those orders on the order book. [5 marks]

(c) Describe a strategy used by hedge fund. [5 marks]

[35 marks in total] 

Question 2

(a) It is currently the 1^st September and ThinkBig Co. has invested in a money market loan of £5 million where the interest rate is LIBOR +120 basis points (1.2%). LIBOR is currently 5.5%. The interest rate is due to be reset on the 1^st October. (i.e. LIBOR will be reset). The company wishes to hedge its exposure using short-term interest rate futures contracts (STIRS).

(i) Explain “basis risk” and its impact on the hedge. [4 marks]

(ii) Explain what strategy the company should use, if the actual futures price on the 1^st September is 94.8. [2 mark]

(iii) Following on the question (ii), what is the outcome of the hedge if basis is    -0.1 on the 1^st October and LIBOR is 4.8%? [8 marks]

(b) Gigi Co is an Italian based manufactory company. It has extended its business globally. The company is expected to receive $800,000 from a foreign client and needs to pay $500,000 in 6 months to a foreign supplier. The following exchange rates and interest rates are available in the home country of Gigo Co:

Spot exchange rate: ($/€)                                 1.1211 –1.1263

Six-month forward exchange rate: ($/€)           1.0512 – 1.0897

 Currency                                              Dollar               Euro

        Deposit rate                                      2.5% per year      3% per year

        Borrowing rate                                  4.5% per year      5.5% per year

Using the information provided, discuss the strategy that can be used by Gigi Co on hedging its future transactions. Support your discussion with calculations. [8 marks]

(c) Company A and B have been offered the following rates per annum on a £200 million 10-year  loans:

Design an interest rate swap between Company A and B that is equally beneficial for both companies.   [8 marks]

[30 marks in total]

Question 3

Assume you are in a technical interview for an analyst role for an investment company. You are tasked to evaluate the trading performance of a fund. One of the strategy the fund used in making profit from the UK big cap equity market is “mean reversion”. The relevant data required for calculations and chart are in the appendix (Table1: Data for Question 4) at the end of the question paper.

(a) Explain “mean reversion” strategy.                                   [4 marks]

(b) Explain the significance of “stock index”.                          [4 marks]

(c) Produce a line chart that compares the trend on weekly returns of the investment strategy and the FTSE 100.         [3 marks]

(d) Calculate Alpha for the investment. If the parameters cannot be calculated with given data, try to find them on reliable resource available on the internet (reference required). The assumptions and or rationales of the choice of the parameters used in calculating the Alpha need to be briefly discussed. [12 marks]

(e) Calculate Sharpe ratio, Treynor ratio and Calmar ratio respectively.     [8 marks]

(f) Briefly comment on the ratios you calculated in (d and e). [4 marks]