ACCOUNTING AND FINANCE

This coursework needs to be returned via the moodle online submission box by 16:00

on 26th January 2024 - to be safe try to submit at least 15 minutes earlier. You are

1.

A Treasury bond with £100 maturity value has a £6 annual coupon and 4 years

left to maturity.

i. What price will the bond sell for assuming that the 4-year yield to maturity

in the market is 7%.

(4 marks)

ii. What would be your answer to part (i) if the 4-year yield to maturity in the

market is 9%.

(4 marks)

iii. What does your answer to parts (i) and (ii) tell you about the relationship

of bond prices, term to maturity and changes in bond yields? (2 mark)

[Total 10]

2.

i. Calculate the Macaulay Duration for a £7 annual coupon bond with an

original face value of £100. This means the annual coupon yield is 7%. The

bond has 4 years left to maturity and a current yield to maturity of 8%.

(3 marks)

ii. What is the modified Duration of the bond? (2 marks)

iii. If 4 year yields to maturity were to suddenly to increase from 8% to 8.5%

and the bond in problem (i) was selling for £96.69 at 8% yield, what

would you expect the bond price to be after the yield increases to 8.5% ?

(2 marks)

[Total 7 marks]

5.

Assume that the following data represent all risky securities in the economy.

i. What is the market portfolio ie what percentage of each security must be

invested to achieve the market portfolio? What is the standard deviation of the

market portfolio?

(3 marks)

ii. If the risk free rate of return is 4% and the expected return on the market

portfolio is 7%, what are the Capital Market Line and Security Market Line

equations?

(3 marks)

iii. A pension fund that you are advising wishes to have an expected rate of return

of 5%. How should the fund invest to obtain this? What would be the standard

deviation and the beta of the pension fund’s portfolio?

(3 marks)

[Total 9 marks]

You are an equity analyst working for an investment bank. You are analyzing

Company ABC shares. The last year dividend (Do) was 30 pence. You are

predicting 12% dividend growth for the next 2 years and 8 % for the following 2

years, and thereafter dividend growth is assumed to slow for the foreseeable

future to 4%. The required rate of return on equity is deemed to be 12%.

i. Calculate the fair value price of the share.

(5 marks)

ii. What is the fair value of the share at the end of year 4?

(3 marks)

[Total 8 marks]

7.

Complete the following table for the expected rate of return on equity for

different rates of profit (p) on combined debt and equity and levels of primary

gearing assuming that the rate of interest on debt is 10%

(4 marks)

What can you conclude about the impact of primary gearing on the variability

of the return on equity?

(2

marks)

[Total 6 marks]8.

The policy-making committee of Bank ABC recently used reports from its

securities analysts to develop the following efficient portfolios.

1

8%

5%

2

10%

6%

3

15%

8%

4

20%

13%

5

25%

18%

i. If the risk free rate of interest is 3% which portfolio is best? (2 marks)

ii. Assume that the policy-making committee would like to earn an expected rate

of return of 10% with a standard deviation of 4%, is this possible?

(2 marks)

iii. If a standard deviation of 12% was acceptable to the investment committee,

what would be the expected return and how could it best be achieved?

(2 marks)

iv. What is the expected rate of return on a combined portfolio made up of all the

above 5 portfolios with an equal weighting given to each portfolio? Would the

standard deviation of this combined portfolio be higher or lower than that of

portfolio 3 or is it not possible to say?

(2 marks)

[Total 8 marks]9.

You are given the following data on the 3-month sterling interest rate futures

contract. The contract has a notional size of £1 million.

September 2024 97

i. Explain what the sale of such a contract implies.

(2 marks)

ii. If you think 3-month interest rates in September 2024 will be 2% would you

buy or sell the contract? Explain your reasoning and the profits you can expect

if you are correct. (2 marks)

iii. Briefly explain how a corporate Treasurer who is looking to lend £1 million

of funds for 3 months from September 2024 might use the above contract to

hedge interest rate risk.

(2 marks)

[Total 6 marks]

10.

The December 2024 FTSE 100 stock index futures contract is reading 5850 while

the cash index is reading 5800. The futures contract is worth £10 per point.

i. Explain why the FTSE futures contract is at a forward premium.

(1 mark)

ii. You have £10 million of funds invested in FTSE 100 stocks under management

and are concerned about a fall in the market by December expiration to 5500.

Describe the hedging strategy that you may adopt to protect your fund against

such a fall.

(3 marks)

iii. You are pessimistic about the market prospects and predict that the FTSE 100

index will be reading 5400 by expiration. Describe the speculative strategy that

you would adopt and the risks that you run. (3 marks)

[Total 7 marks]11. You are given the following information about the stock of Company A:

Share price $60 risk free rate of interest is 10%, time to expiration is 3 months,

annualised standard deviation is 0.4 and annualised variance is 0.16 and

exercise price is $65.

i. Calculate the appropriate call value of the stock according to the Black-Scholes

option pricing formula.

(4 marks)

ii. Calculate an appropriate put premium. (Show your workings in full)

(3 marks)

[Total 7 marks]

12.

The dollar/pound ($/£) exchange rate is currently $1.62/£1 and the following

options and futures prices exist for September 2024.

$1.60/£1

$1.60/£1 $0.04 $0.02

You are a speculator and expect the spot rate on expiry in September 2024 to be

$1.70\£1. Discuss the relative merits of using the futures or options contracts to

speculate on your predicted currency movement. In your answer consider a

range of possible future spot rates for sterling and the resulting profits/losses.

[Total 6 marks]13.

You are given the following data on call and put premiums in pence per share for

Company ABC shares which are currently priced in the market at 311 pence. Each

contract refers to 1000 shares.

i. You expect the share price to rise to 400 pence. Discuss a speculative strategy

and the profits/losses at a range of different prices for the underlying share in

September.

(3 marks)

ii. You own 1000 shares in Company ABC and fear that the share price might fall

to 200 pence. Discuss a hedging strategy using the above contracts and the

approximate value of your net hedged position at a range of different prices for

the underlying share in September.

(3 marks)

[Total 6 marks]

14.

Briefly discuss the relationship between a call premium and the 5 determinants of

the call premium according to the Black-Scholes option pricing model.

[Total 5 marks]

15.

State which of the following statements are TRUE and which are FALSE.

i. A call premium for a strike price of 300 pence is 15 pence and the share is

currently priced at 290 pence. The time value for the call premium is greater than the intrinsic value.

ii. The holder of a put option breaks even as soon as the price of a stock falls below

the exercise price. iii. For an option writer the risk of writing a call option is reduced if the writer has a short position in the underlying stock. iv. If implied volatility rises, other things being equal, call premiums will rise. [Total 4 marks]