BUST08018 APPLICATIONS OF FINANCE
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APPLICATIONS OF FINANCE
BUST08018
SECTION A
QUESTION 1
“Markets have two important functions — liquidity and price discovery — and these functions are important for asset pricing.”
O’Hara (2003)
In the context of the statement by Ms/Prof O’Hara, discuss the relevance and interrelatedness of liquidity and price discovery for well-functioning financial markets.
[100 marks]
QUESTION 2
“Blockchain is the biggest opportunity set we can think of over the next decade or so.” Bob Greifeld (2015).
In line with Mr. Greifeld’s assertion, discuss the benefits of Blockchain technology.
[100 marks]
QUESTION 3
“There is one and only one social responsibility ofbusiness — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Milton Friedman (1970).
Contrast Friedman’s view to Socially Responsible Investment (SRI). In your answer, discuss the goals of SRI and different investment types that can create both returns and social value.
[100 marks]
SECTION B
QUESTION 4
Suppose you believe that the prices of shares of Company ABC will increase over the coming three months. The current price of the share is $125, and you do not hold any investment positions in Company ABC. Furthermore, transaction costs and dividends are zero.
a. There is a forward contract with a price of $128 (F0). Explain how this forward contract might be used and draw the payoff diagram by using the following scenarios: i) ABC price drops to $122, ii) ABC price increases to $128, iii) ABC price increases to $135. [30 marks]
b. There is also a future contract with the same price ($128). Would you prefer to buy a future or forward contract? Explain your answer by focusing on the difference between forward and futures contracts. [20 marks]
c. There is also a (European) call option available. The strike price and premium for this contract are $132 and $4, respectively. Explain how this contract might be used to profit from an increase in price and draw the payoff and profit diagram by using the following scenarios: i) ABC price drops to $122, ii) ABC price increases to $128, iii) ABC price increases to $132, iv) ABC price increases to $136 and iv) ABC price increases to $140. [30 marks]
d. Would you prefer to use forward/future or option contracts? Explain the reasons for your preference (there is no right or wrong answer to this question (re-call risk preferences of investors)). [20 marks]
QUESTION 5
Suppose that the spot rate for EUR/GBP is 1.2800 and that iGBP = 3% and iEUR = 4%.
a. Compute 180-day forward rate and forward
premium/discount in pips. [30 marks]
b. If the 180-day forward rate is 1.2700, is there is an arbitrage opportunity? [10 marks]
c. Calculate the profit to be earned if 10m GBP is arbitraged in this scenario (if the 180-day forward rate is 1.2700).
[30 marks]
d. A company based in the UK buys cars from Germany to sell in the UK. How can the company use a forward contract to hedge its exchange rate risk? [20 marks]
e. Explain the difference between nominal and real exchange rate. [10 marks]
QUESTION 6
Suppose two instruments are available — first, the 20-year maturity bond with a par value of $1500 and 10% coupon payment (semiannual payment) and the market interest rate is 9%. Second, a share with a price of $162 and a dividend of $8. Dividend growth is expected to be 4% for the life of the company, and the required rate of return for the stock is 9%.
a. Compute the price of this bond. [20 marks]
b. Discuss the relationship between “bond price and maturity” and “bond price and interest rate” . [30 marks]
c. Compute the equilibrium price of a share based on valuation methods. [20 marks]
d. Compare the computed equilibrium price with the current market price and answer the following questions:
Is the stock overvalued or undervalued? If yes, how would you
get profit from this stock? [20 marks]
e. Discuss the differences between equity and bond.
[10 marks]
2022-05-07