Professional Documents
Culture Documents
1. When a company finances its short-term assets with short-term debt, this is known as the:
A: identical principle
B: equalisation theory
C: corresponding principle
D: matching principle
2. If a government’s income from tax receipts exceeds its expenditure, the government is
running:
3. All of the following statements about the issuing of a commercial bill are true EXCEPT:
4. An increase in the prices of goods and services causes the demand for funds to _____ and
market interest rates should _______.
A: fall; increase
B: fall; decrease
C: rise; increase
D: rise; decrease
A: $12 657.43
B: $16 275.00
C: $19 032.43
D: None of the above.
8. When a company has a deal with a bank lender that allows access to short-term funds, this
is called:
A: a debt facility
B: a credit facility
C: a debt provision
D: a liability provision
A: A debenture
B: An income bond
C: A mortgage bond
D: A fixed-charge debenture
10. Which type of financial claim is not satisfied until those of the creditors holding certain
senior debts have been fully satisfied?
A: mortgage bonds
B: unsecured notes
C: subordinated debentures
D: deferred interest debentures
11. Using the expectations theory of term structure, a negatively sloped yield curve indicates
that investors expect:
12. A $1000 face value bond with coupon rate of 8% paid annually has five years to maturity. If
bonds of similar risk are currently earning 6%, what is the current price of the bond?
A: $920.15
B: $1000
C: $1084.25
D: None of the above.
13. The type of lease where the costs of ownership and operation are borne by the lessee, who
agrees to make a residual payment at the end of the lease period, are:
A: a direct lease
B: a financial lease
C: an operating lease
D: a leveraged lease
16. If market interest rates move upwards after an investor buys a government bond, the
investor may:
A: liquidity requirements
B: interest rate expectations
C: funding requirements
D: All of the above.
18. Monetary policy in Australia is implemented by the Reserve Bank, and currently is
principally directed towards:
21. When the Australian Reserve Bank sells Commonwealth government securities, it:
22. If Japan imports more Australian goods, all else being equal, there will be an increased:
23. What type of option will an option buyer purchase if they believe a share price will rise?
A: call
B: put
C: warrant
D: swaption
26. If the Australian central bank wished to cause the AUD to appreciate, it would _______
AUD and _______ foreign currency.
A: buy; sell
B: sell; sell
C: sell; buy
D: buy; buy
27. Calculate the current exchange rate EUR/JPY, given these two quotes:
USD/EUR 0.9780-90
USD/JPY 119.20-30
A: EUR/JPY 116.57-79
B: EUR/JPY 116.67-70
C: EUR/JPY 121.86-88
D: EUR/JPY 121.76-98
A: the amounts payable depend on a specified principal that is exchanged at the outset
B: one party pays another party an amount calculated according to a floating interest rate
on a notional principal, in exchange for an amount calculated on the basis of a fixed
interest rate
C: only interest flows are exchanged until maturity, when the principal is exchanged
according to the difference in the interest rates over the lifetime of the swap
D: Both A and B.
29. The Reserve Bank increases interest rates to reduce the level of spending in the economy.
As the rate of growth in economic activity slows, the demand for funds also slows. This
impact of a change in interest rates is described as the:
A: inflation effect
B: liquidity effect
C: income effect
D: monetary effect
30. A tariff is a:
32. For the buyer of an option, the premium paid for the contract represents the:
A: transactions cost
B: maximum return
C: largest potential loss
D: yield
33. An investor holds long call options that may be exercised at any time over the next month.
The spot price of the underlying asset is $12.75; the strike price of the option is $15.10; and
the premium paid was $2.35. What is the value of the option to the holder?
A: -$2.35
B: zero
C: $10.40
D: $15.10
A: a long put
B: a short put
C: a long straddle
D: a vertical spread
A: $84 130.46
B: $92 350.21
C: $98 123.39
D: $98 148.62
37. An Australian export company wishes to sell its euro receipts, EUR 500 000, through an FX
dealer and receives the following quote: ‘Aussie mark spot is one-twenty-two fifty-five to
sixty five’. What is the value of the export receipt?
A: $407 664.09
B: $407 996.74
C: $612 750.00
D: $613 250.00
38. All of the following statements are advantages of a swap transaction, EXCEPT:
39. When a bond investor buys a credit default swap (CDS), they:
40. When a loan agreement contains actions for a borrowing company to comply with, these
are called:
A: accounting ratios
B: negative covenants
C: positive covenants
D: loan options
Question 1
A) A number of exchange rate regimes have evolved over time. Each country is responsible
for determining the exchange rate regime that will apply to its currency.
i. Briefly describe three of the main types of exchange rate regimes adopted by
major trading countries. For each regime provide an example of a country that has
adopted that regime. (6 marks)
Four regimes were covered in class, students only need to describe 3 of them.
1) Floating exchange rate – exists when the exchange rate for the currency of a country is
allowed to move as factors of supply and demand dictate. Major currencies such as the USD,
GBP, JPY, EUR, and AUD adopt floating exchange rate.
2) Managed float exchange rate – allow the currency to move within a defined range, or band,
relative to another major currency. The exchange rate is allowed to adjust providing such
movements do not adversely impact upon the economic objectives of the country. This
regime is used by China*, Singapore, Malaysia, and Indonesia.
3) Crawling peg exchange rate – allows the currency to appreciate gradually over time, but
within a limited range established by the government. Similar to a managed float, but
generally accepted in the markets that the currency is undervalued. Many commentators
would suggest that China operates this regime.
4) Linked exchange rate – a currency is directly linked to another currency; for example the
Hong Kong Dollar (HKD) is linked to the USD
ii. In 1992, George Soros reportedly made a $1bn profit by “shorting the pound”.
Outline the factors that determine whether a central bank is able to protect its
domestic currency from depreciation in the case that speculators are selling large
amounts of the currency. (4 marks)
The central bank is able to counteract the actions of speculators by a) buying its own currency,
b) increasing the level of interest rates in the domestic market, c) imposing restrictions on
capital flows.
The ability for this to work is limited by the size of foreign currency reserves, the ability to
increase interest rates (and maintain them at higher levels) given other economic factors, the
importance of international capital flows in funding the domestic economy, and the ability to
persuade the market that the measures can be preserved long enough to deter speculators.
Soros made money by selling pounds (lots of them) in order to profit by future devaluation.
The UK government tried buying the pound, and increasing interest rates but this ultimately
failed and the GBP left the ERM.
B) With the aid of a relevant diagram, explain how the equilibrium AUD/USD exchange rate
would change if there is a forecast increase in Australia’s inflation rate while the US
inflation rate remains stable. (10 marks)
Purchasing power parity contends that exchange rates will adjust to ensure prices on the same
goods are equal between countries.
A sustained surge in Australian inflation will increase the costs of local goods, US demand for
Australian goods will fall. Therefore, there would be a reduction in the demand for the
Australian Dollar (AUD). The demand curve would move from D0 to D1.
At the same time, Australians would be able to seek relatively cheaper goods for overseas. The
supply of the AUD would increase as importers purchased the USD. The supply curve would
move from S0 to S1.
The net result would be a fall in the equilibrium exchange rate – i.e. the AUD will depreciate.
The appropriate diagram would look like the following: (6 marks for explanation, 3 marks for
diagram, 1 mark for stating that net result is AUD depreciation / fall in equilibrium rate)
AUD/USD
S0
P0 S1
P1
D1 D0
C) An Australian exporter has entered into a contract under which it will receive payment in
Swiss Francs (CHF) in 6 months. The company is concerned at its exposure to foreign
exchange risk and decides to enter into a forward exchange contract with its bank.
i. Explain the particular risk that the exporter is concerned about. (2 marks)
The exporter is concerned about the value of its receipts falling; i.e. the exporter is concerned
that the CHF may depreciate relative to the AUD. (2 marks)
ii. Given the following data, calculate the forward rate the exporter will receive –
express this rate with the Australian Dollar (AUD) as the base currency. Assume
365 days a year in all cases.
USD/CHF: 0.8835-39
AUD/USD: 0.9241-43
1-month Australian interest rate: 2.64% p.a.
6-month Australian interest rate: 2.74% p.a.
1-month US interest rate: 0.15% p.a.
6-month US interest rate: 0.33% p.a.
1-month Swiss interest rate: 0.00% p.a.
6-month Swiss interest rate: 0.07% p.a. (8 marks)
The students first need to calculate the AUD/CHF spot rate.
0.9241 x 0.8835 = 0.8164; 0.9243 x 0.8839 = 0.8170; AUD/CHF = 0.8164-70 (3 marks)
In 6-months, the exporter will receive CHF and convert them into AUD (i.e. Sell CHF and Buy
AUD). Therefore the appropriate forward rate to place into the forward rate formula is 0.8170.
AUD is base currency so the formula should be as follows:
1+(0.0007×0.5) 1.00035
Forward Rate = 0.8170 [1+(0.0274×0.5)] = 0.8170 [ 1.0137 ] = 0.8088 (5 marks)
Question 2
A) The interest rate swaps market has grown exponentially since its inception in the early
1980s. Outline the main rationale for the existence of the interest rate swaps market as it
applies to the fixed interest rate and variable interest rate between different borrowers.
Propose why and under what circumstances it might be expected that borrowers could
have different comparative advantages in the debt markets? (8 marks)
The main concept / rationale for the existence of the market is ‘comparative advantage’. (1
mark)
That is, by borrowing in the market in which a firm had a comparative advantage and by
swapping their interest payment obligations, both parties achieve a cost of funds lower than
could be achieved without the swap. (3 marks)
Variations in the comparative advantage of a firm between the fixed and variable rate markets
may derive from the perceptions of different lenders in each of the markets; for example, in
the variable rate market the differential may come from the credit departments of bank
lenders, while in the fixed rate market the primary influence may be the respective credit
ratings issued by credit rating agencies. (4 marks)
B) In your role as an analyst, you are provided with the data given below. Distinguish in
which of the two scenarios it would be possible to arrange a profitable swap. Construct a
fully labelled diagram for the cash-flows of a direct swap in the profitable scenario.
Assume that the comparative advantage net differential is to be shared equally between
the two companies. (12 marks)
Borrower Fixed Rate Variable Rate
Scenario 1 A 5.80% BBSW – 0.50%
B 7.60% BBSW + 1.30%
Scenario 2 X 6.40% BBSW + 1.10%
Y 4.20% BBSW + 0.10%
Scenario 1:
Fixed Rate A = 5.80%, B = 7.60%, Differential = 1.80%
Variable Rate A = BBSW-0.50%, B = BBSW+1.30%, Differential = 1.80%
Net Diff. = Nil
Scenario 2:
Fixed Rate X = 6.40%, Y = 4.20%, Differential = 2.20%
Variable Rate X = BBSW + 1.10%, Y = BBSW + 0.10%, Differential = 1.00%
Net. Diff = 1.20%
Borrows Borrows
variable rate fixed rate
debt debt
Cash-flows:
Firm X Firm Y
Pay -BBSW + 1.10% Pay - 4.20%
Receive BBSW + 1.10% Receive +5.80%
Net Zero Net +1.60%
Pay -5.80% Pay -BBSW+1.10%
Net 5.80% Net BBSW+0.50%
Both parties have benefited by 0.60% (i.e. X pays 5.80% rather than 6.40%, Y pays
BBSW+0.50% rather than BBSW+1.10%) (7 marks)
C) As an analyst working within a major corporation you are responsible for managing a
portfolio of credit instruments. You are preparing a presentation to the Treasurer on the
structure of a credit default swap that you are considering purchasing for your portfolio.
Explain the purpose and structure of a credit default swap. In your explanation you should
include the different types of settlement that are possible. Evaluate whether the credit
default swap can eliminate credit risk from your portfolio. (10 marks)
A credit default swap allows one party to transfer credit risk to another party.
The buyer of a CDS pays a premium to the seller (writer) of the CDS. The premium is
usually a number of basis points relative to the credit protection amount. (1 mark)
The credit protection relates to debt issued by, or loans given to, a reference entity (the
borrower). (1 mark)
If default occurs by a reference entity, the CDS will specify how settlement will occur.
Physical settlement requires the protection buyer to deliver the notional value of the debt
of the reference entity in return for payment by the protection seller. (2 marks)
Cash settlement requires the protection seller to pay a net cash amount to the protection
buyer, being the difference between the face value and the current market value of the
underlying reference debt instruments. (2 marks)
The CDS will specify what represents a credit default event. These include bankruptcy,
obligation acceleration, obligation default, cash payment failure, repudiation and
moratorium of debt by a nation state. (1 mark)
CDS are generally available only on particular debt issues, or loans, on specific reference
entities. It may not be possible to purchase a CDS on all investments in the portfolio. Even
if this is possible, or you purchase a ‘basket’ CDS which insures against all credit risk in
your portfolio it will not eliminate your credit risk. Instead, the credit risk is transferred
from the reference entity to the seller of the CDS. (3 marks)