15.

437

Spring 2014
J.C. Cox

15.437 MIDTERM EXAM

Please answer any four of the five questions. If you answer all five
questions, please indicate the four that you want to have graded.
question is worth twenty-five points.

Each

Partial credit will be given for

incomplete answers. Be sure to write clearly and explain your answers. You
are free to use the text, your notes, and any other materials from the course,
but you should not discuss the exam with anyone.

1)

Your firm is considering a two-year swap with semiannual payments.

The party that pays the fixed rate will thus make four payments during the
life of the swap. A special feature of the swap is that the party that pays the
floating rate will make no payments during the first year of the swap.
Instead, that party will pay twice the floating rate during the second year of
the swap.
The current zero coupon bond prices implied by swap rates are shown
in the table below.
Years to Maturity

.5

1.0

1.5

2.0

Zero Coupon Price

.99

.98

.97

.95

What is the proper fixed rate for this swap?

2)

Three years ago your company entered into an eight-year swap with

semiannual payments and a principal of $100,000,000. Your firm receives a

fixed rate of 5% and pays the floating rate. The swap now has five years
remaining. The current fixed rate for newly initiated five-year swaps with
semiannual payments is 4%. The current price of a five-year zero coupon
bond is $.82. What is the current value of your firms swap?
3)

You now own a thirty-year par bond paying 10% annual coupons and

having a principal of $100. The current forward price for a one-year forward
contract on this thirty-year bond is $98. The current price of ABC stock is
$50 per share. The stock does not pay dividends. The current forward price
for a one-year forward contract on one share of stock is $54. Both forward
contracts are cash settled. Explain carefully how you could use the forward
contracts to effectively transform your $100 fixed income investment into a
$100 equity investment over the next year while continuing to hold the bond.

One year from now your portfolio should have the same value that it would
have if you sold the bond today and invested the $100 in ABC stock.
4)

Two types of forward contracts on oil are available. Each has three

years until the delivery date. One type is a standard forward contract. With
this contract, the seller delivers 100 barrels of oil and receives from the buyer
a payment equal to the forward price for each barrel delivered. The other
type provides the seller with some flexibility. Here the seller may deliver any
amount from 75 barrels to 125 barrels in fulfillment of the contract.

As

before, the seller receives from the buyer an amount equal to the forward
price for each barrel delivered. With each type of contract, the forward price
is set so that no money changes hands initially.
Three-year European options, each covering one barrel of oil, can be
bought or sold on the following terms:
Striking Price

Call Price

Put Price

80

40

24

100

32

32

120

28

44

Based on this information, what is the proper forward price for the standard
forward contract? What is the proper forward price for the flexible forward
contract?
5)

There is a market in special puts and calls on DEF stock with an

expiration date one year from now. These options are identical to ordinary
European options except for one feature. Their striking prices, instead of
being fixed, are equal to the value of one share of XYZ stock. The current
price of DEF is $90 per share, and the current price of XYZ stock is $100 per
share. Neither stock pays dividends. The current price of a zero coupon bond

maturing one year from now is $.90. If the put is selling for $15, what should
be the price of the call?