A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2%

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1 1 Exam FM Questions Practice Exam 1 1. Consider the following yield curve: Year Spot Rate 1 5.5% 2 5.0% 3 5.0% 4 4.5% 5 4.0% Find the four year forward rate. A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2% 2. Find the Macaulay duration of a -year 00 par value bond with 8% annual coupons and an effective annual interest rate of 6.5%. A) 7.2 B) 7.4 C) 7.6 D) 7.8 E) At an effective annual rate of interest i, a person can pay off a loan of K in two ways: 1) 475 now and 475 in 1 year, or 2) 570 in 2 years and 570 in 3 years. Calculate K. A) 893 B) 901 C) 909 D) 917 E) A -year annuity-immediate pays 0 quarterly for the first year. In each subsequent year, each payment is increased by 5% over the payment for the previous year. There is a nominal annual interest of 8% convertible quarterly. Find the present value of this annuity. A) 2997 B) 3075 C) 38 D) 3225 E) 3333

2 2 Practice Exam 1 Exam FM / Exam 2 5. The present value of a -year annuity-immediate with level annual payments and interest rate i is X. The present value of a 20-year annuityimmediate with the same payments and interest rate is 1.5X. Find i. A) 7.2% B) 7.4% C) 7.6% D) 7.8% E) 8.0% For Problems 6 and 7 use the following account summary: Date Balance Before Deposits Withdrawals Activity January 1 0,000 March 1 5,000,000 September 1 112,000 30,000 December 31 95, Find the time-weighted yield for this account. A) 17.2% B) 17.5% C) 17.9% D) 18.1% E) 18.5% 7. Find the dollar-weighted yield for this account. A) 14.9% B) 15.3% C) 15.6% D) 16.1% E) 16.4% 8. An investor has 3000 worth of 5-year bonds with a modified duration of 4.615, 7000 worth of -year bonds with a modified duration of and,000 worth of 20-year bonds with a modified duration of What is the modified duration of this entire portfolio? A) 13.5 B) 13.7 C) 13.9 D) 14.1 E) A company has liabilities of 00, 3000 and 5000 payable at the end of years 1, 2 and 3 respectively. The investments available to the company are the following zero-coupon bonds: Maturity Effective Annual Par (years) Yield 1 7% % % 00 Determine the cost for matching these liabilities exactly. A) 6918 B) 7024 C) 7165 D) 7368 E) 7522

3 3. A man creates a retirement fund by depositing payments at the end of each month for 20 years. For the first years the deposits are 0 per month and for the last years the deposits are 200 per month. The fund earns interest at a nominal rate of 6% per year converted monthly. Upon retirement he uses the proceeds to purchase a 30-year annuity-immediate with monthly payments. The annuity earns at a nominal rate of 8% converted monthly. What are monthly payments from this annuity? A) 408 B) 425 C) 437 D) 441 E) An annuity pays annual payments at the beginning of each year for 20 years. For the first years the payments are 0. Starting with payment 11 each payment is increased by 6% over the previous payment. The annuity earns at an annual effective rate of 8%. Find the present value of this annuity. A) 1177 B) 1190 C) 1202 D) 1213 E) A corporate bond is priced to yield 7.2% and has a price of The Macaulay duration is D = Estimate the change in price if rates increase by 0.%. A) B) C) D) E) A 40-year loan is paid with level annual payments at the end of each year. The principal paid in the 20 th payment is and the principal paid in the 25 th payment is Find the interest rate for this loan. A) 7.7% B) 8.0% C) 8.2% D) 8.5% E) 8.8% 14. Linus deposits 0 into an account at the end of each year for 20 years. This account earns interest at an annual effective rate of 5%. Lucy deposits money into an account at the end of each year for 20 years. Her account also earns interest at an annual effective rate of 5%. Her deposits are: P, 2P,., 20P. At the end of 20 years the accumulated amounts are the same. Find P. A).93 B) C) D) E) Schroeder borrows money to buy a new piano. He agrees to pay back the loan with level annual payments at the end of each year for 30 years. The annual interest rate is 7%. The interest in his th payment is What is the interest in his 20 th payment? A) B) C) D) E)

4 4 Practice Exam 1 Exam FM / Exam A woman makes a deposit into an account. For the first 5 years the account accumulates with a force of interest of For the next years the fund accumulates with an annual nominal discount rate of 6% convertible quarterly. For the 15 year period, what is the annual nominal interest rate convertible monthly? A) 5.59% B) 5.71% C) 5.83% D) 5.96% E) 6.04% 17. Violet purchases a -year 00 par bond with 8% semiannual coupons. The bond is priced to yield 7.5% convertible semiannually. She reinvests the coupon payments in a fund that pays a nominal rate of 7% convertible semiannually. What is her nominal annual yield convertible semiannually? A) 7.36% B) 7.41% C) 7.48% D) 7.56% E) 7.63% 18. You are given the following yield curve: If i 4,5 = 6.1%, find s 4. Year Spot Rate 1 4.0% 2 4.2% 3 4.6% % A) 4.81% B) 4.83 C) 4.85% D) 4.87% E) 4.89% 19. A 20-year annuity-immediate has annual payments. The first payment is 0 and subsequent payments are increase by 0 until they reach 00. The remaining payments stay at 00. The annual effective interest rate is 7.5%. What is the cost of this annuity? A) 6201 B) 6372 C) 6413 D) 6584 E) A woman buys a 00 par 5-year zero coupon priced to yield 6%. At the same time she buys a 5-year 00 par bond with 8% semiannual coupons which is priced to yield 7%. The coupon payments are reinvested at 6.5% convertible semiannually. What is her annual effective yield for the combined investment? A) 6.0% B) 6.2% C) 6.4% D) 6.6% E) 6.8%

5 5 21. The S&R index currently has a price of The price of a six month forward contract is What annual interest rate (compounded continuously) is implied by this forward price? Note that the S&R has no dividend. A) B) C).0305 D).0355 E) The S&R index currently has a price of The price of a three month 1320-strike put is The annual interest rate is 4% compounded continuously. A buys this put, and B enters into a long forward contract. In three months A and B have the same profit. What is the price of the index in three months? A) 13 B) 1297 C) 1289 D) 1291 E) The current value of the a stock is S 0 = 25, and the continuously compounded risk free rate is r =.04. The price of a six month ( T =.5 ) 26-strike call is and the price of a six month ( T =.5 ) 26-strike put is Find the continuously compounded dividend yield δ. A) 1% B) 2% C) 3% D) 4% E) 5% 24. Investor C buys the S&R index at time 0 for 10 and buys an 10-strike put with T =.25 for a price of If the interest rate is r=.04, what is his minimum profit (loss)? A) B) C) D) E) There is no minimum 25. The current (spot) rate for corn is 1.60 per bushel. The 6 month forward price is $1.50 per bushel. The continuously compounded annual rate is r =.035. Farmer Brown, has total fixed and variable costs of 1.44 per bushel, and plans to produce 0,000 bushels for $144,000. A six month ( T =.5 ) put with a strike price of 1.52 per bushel is available at a price of What are the minimum and maximum profits for Farmer Brown in six months if he is hedged with a purchase of this put? A) minimum = -4,212, maximum = 19,678 B) minimum =-6222, maximum = 19,678 C) minimum= -4,212, no maximum D) minimum = -6,242, no maximum E) none of the above

6 6 Practice Exam 1 Exam FM / Exam Company XYZ makes an aircraft which costs 80,000,000 to manufacture. It will be completed in six months. At that time it will sell either for 90,000,000 with probability.5 or 74,000,000 with probability.5. The company decides to enter into a forward contract to sell the unit for 85,000,000 in six months The company has a 40% tax rate, and has no tax benefit for losses. What is the company s expected profit after tax? A) -1,000,000 B) 0 C) 1,000,000 D) 2,000,000 E) 3,000, A stock has current price. S 0 = 25 The annual continuous interest rate is r =.03. If the expiration time for a forward contract is T =.25 and the forward price is 25.15, what is the continuous dividend yield δ? A) B) C) 0.0 D) E) The S&R index has a spot price of S 0 = 10. The continuous interest rate is r =.03 and the continuous dividend yield is δ = 0 The one year forward price is Which of the following positions results in a synthetic long forward contract? A) Sell the index short for 10 and lend the proceeds at r =.03 B) Sell the index short for 10 and borrow 00 at r =.03 C) Borrow 00 at r =.03 and buy the index. D) Borrow 00 at r =.03 and sell the index short E) None of these. In Problems 29-30, use the following table of quarterly oil forward prices and zero-coupon bond prices. Quarter Oil Forward Price Zero-coupon bond price Find the price of a four quarter oil swap. A) B) C) D) E) Suppose you enter a three quarter interest rate swap. What net interest payment will be made to you in the second quarter if the spot interest rate for the second quarter is.018? A).00 B).0012 C).0016 D).0018 E).002

7 7 Solutions 1. The four year forward rate i 4,5 is given by 1 + i 4,5 = (1 + s 5 ) 5 /(1 + s 4 ) 4 = / = i 4,5 = ( Ia) ( Ia) ( Ia) 80 + (00) v D = Bond Price v a&& ( a&& v ) = i = = = (be sure calculator is in BGN mode) = Bond price = 1,7.83 (Reset calculator to END mode. N =, PMT = 80, I/Y =6.5, FV = 00. CPT PV = ) D = [80( ) + 5,327.26]/1,7.83 = Answer B 3. K = v = 570v v 2 = [475(1 + v)]/[570(1 + v)] = v = K = 475( ) =

8 8 Practice Exam 1 Exam FM / Exam 2 4. The accumulated amount at the end of year one is (N = 4, I/Y = 2, PMT = 0, PV =0. CPT FV = ) We can view the annuity as a -year annuity-immediate with annual payments, the first being and subsequent payments are increase by 5% each year. The effective annual rate is i = (1.02) 4 1 = The present value of this annuity is (412.16)[1 + (1.05/ ) + + (1.05/ ) 9 ] = [1 (1.05/ ) ]/( ) = X = (1 v )/i, 1.5X = (1 v 20 )/i Hence 1 + v = 1.5, v = 0.5, i = Answer A 6. For the time-weighted yield 1 + j = (5,000/0,000)(112,000/115,000)(95,000/82,000) = j = For the dollar-weighted yield, I = 95,000 0,000 (,000 30,000) = 15,000 i = 15,000/[0,000 + (1 1/6)(,000) (1 2/3)(30,000)] = Answer B 8. The weights are 3/20, 7/20 and 1/2 respectively for the 5-year, -year and the 20-year bonds. The modified duration is DM = (3/20)(4.615) + (7/20)(9.323) + (1/2)(19.085) = Answer A 9. The company must invest the present values of 00 in one year at 7%, 3000 in 2 years at 8% and 5000 in 3 years at 9%. The cost is 00/ / / = Answer D

9 9. The deposits can be viewed as payments of 0 into a 20-year annuityimmediate and 0 into a -year deferred -year annuity-immediate. The accumulated amount in the first annuity is 46, (N = 240, I/Y = 0.5, PMT = -0, PV = 0. CPT FV = 46,204.09) The accumulated amount in the second annuity is 16, (Reset N = 120. CPT FV = 16,387.94) Total accumulation is 62, The monthly payments from the 30-year annuity are (N = 360, I/Y =0.6667, PV = - 62,592.02, FV = 0. CPT PMT = ) 11. The present value of this annuity is 9 0 a && + (6 / 1.08 )[1 + (1.06 / 1.08) + K + (1.06 / 1.08) ] To get the value of the first term set the BA II Plus to BGN mode. Set N =, I/Y = 8, PMT = -0, and FV = 0. CPT PV = The value of the second expression is (6/1.08 )[1 (1.06/1.08) ]/[1- (1.06/1.08)] = Present value is = 1, Answer A 12. The change is ΔP = (D)P(i)Δi/(1 + i) = (7.1245)(972.48)(0.001)/(1.072) = Answer A 13. PRin k is the amount of principal repaid in the k th period. Prin k+n = (1 + i) n PRin k. Let k = 20 and n = = (1 + i) 5 (166.59). i = (244.78/166.59) 1/5 1 i =.08 Answer B

10 Practice Exam 1 Exam FM / Exam The accumulation in Linus s account is 0s 20 = 3, (N = 20, I/Y = 5, PV = 0, PMT = -0. CPT FV = 3,306.60) The accumulation is Lucy s account is P( Is ) 20. (&& s20 20) ( Is) = = , P = = Answer D 15. Let P be the annual payment. The interest paid in the th payment is P(1 v ) = P(1 v 21 ) = P( ) = P = For the 20 th payment the interest is (1 v 11 ) = ( )= If Y is the amount deposited, then the accumulation is A = Ye 0.05(5) ( ) 40 = Y. There are 180 months in the 15 year period. If j is the monthly interest then j = /180 1 = i = 12( ) = Answer B 17. The price of the bond is (N = 20, I/Y = 0.375, PMT = 40 and FV = 00. CPT PMT = ) The accumulated amount of reinvested coupon payments is 40s 20 = The total accumulation is The semiannual yield on the investment is j = ( /34.74) 1/20 1 = The annual yield is 2(.0368) = Answer A

11 i 4,5 = (1 + s 5 ) 5 /(1 + s 4 ) 4 (1 + s 4 ) 4 = (1 + s 5 ) 5 /(1 + i 4,5 ) = (1.051) 5 /(1.061) = s 4 = , s 4 = This can be viewed as a -year increasing annuity and a -year deferred -year annuity. The present value of the -year deferred annuity is 00v a = = 3, ( )( ) The present value of the increasing annuity is 0( Ia ). ( Ia) ( a&& v ) = = = i Total cost is 3, , = 6, The price of the zero-coupon bond is 00/ = To find the price of the second bond with the BA II Plus set N =, I/Y = 3.5, PMT = - 40 and FV = -00. CPT PV = The accumulation of the reinvested coupon payments is (N =, I/Y =3.25, PMT = -40 and PV =0. CPT FV = ) Total investment is = Total accumulation is = Annual effective yield is ( / ) 1 = Answer D 21. F S e e r rt.5r 0, T = = 1300 =.0305

12 12 Practice Exam 1 Exam FM / Exam 2 rt 22. The forward price is F0, T = S0e = 1300e = The long forward profit is S F0, = S T T T The put profit is ( T) ( ) ( ) ( T) max 0,1320 S 81.41e max 0,1320 S =. Assume that S T < Then the equality of prices implies that S = 1320 S S = T T T 23. By put-call parity T C P = S e δ Ke 0 rt e δ = 26 e r =.03 ( ) 24. Buying the index and buying a put with strike 10 creates a floor. The floor has the same profit function as a long call with strike 10. The minimum profit on the floor is the (negative) loss of the future value of the call premium when the call expires unexercised. By parity the value of the call premium is The minimum profit is e = Answer A 25. The profit from the put option is.035(.5) 0,000 max(0,1.52 x).12e = 0,000max(0,1.52 x) 12, The total profit for the hedged position is ( x ) 0,000x 144, ,000max(0,1.52 ) 12, ,211.85, x < 1.52 = 0,000x 156,211.85, x 1.5

13 The calculations are in the table below. Values are given in millions. With Short Forward at 85 Price Price Pre-tax op income -6 Income from Forward Taxable Income % 2 2 After Tax Income ( r δ) T ( δ) F0, T = S0e = 25e ln δ 25 = δ =.006 Answer B STOCK - ZERO COUPON BOND = LONG FORWARD Thus you buy the index for 00 and sell a zero coupon bond for 00 (borrow the money to buy the stock.). 29. We will use the general formula P n ( 0, i) 0 ( i) P t f t ( 0, ti ) ( ) + ( ) + ( ) + ( ) i= 1 = = = n i= 1 P The guaranteed interest rate is the three year par coupon bond rate. 1 P ( 0,3) c = = =.0162 P 0,1 + P 0,2 + P 0, ( ) ( ) ( ) The net rate paid to you will be =.0018 Answer D

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