1. State whether it's possible to initiate the following positions with zero initial cost; consider that option premiums received may offset option premiums paid, and briefly explain why it is or is not possible for each.

a. Bear & Bull Call Spreads.

b. Bear & Bull Put Spreads.

c. Box Spread.

d. Butterfly Spread.

Write a brief summary of the explantation of the shape of the term structure of interest rates: The Pure Expectations Theory

Today is your first day at the investment banking firm of Dewey, Cheatum and Howe. They have offered you a choice between two different compensation arrangements. You can have a salary of $95,000 per year for the next two years, or you can have a salary of $84,000 per year for the next two years and a signing bonus $20,000 that is paid today. The bonus is paid immediately and the salary is paid in equal amounts at the end of each month. If the interest rate is 8 percent compounded monthly, which compensation program do you prefer? Explain why. If the interest rate is 18 percent compounded monthly, which compensation program do you prefer? Explain why. do not use excel or a calculator to solve

You are considering an investment that will pay you $3,000 for the next five years. That is, there will be five cash flows of $3,000, but the cash flows are paid at the beginning of the year. • Your opportunity cost of capital (r ) is 7.75%  Using the present value formula calculate the present value of each of the cash flows by 1. Discounting cash flows using annual compounding 2. Discounting cash flows using monthly compounding 3. Discounting cash flows using continuous compounding • How much would you be willing to pay for the investment using each of the three different compounding scenarios? That is, what is the present value of the cash flows from the investment using each of the three different compounding scenarios? Do not use excel or a calculator to solve

A two-year coupon-paying bond has a face value of $100 000, yield of 7.5% p.a. and coupon rate of 7.5% p.a. The interest rates are paid half yearly.

a) Calculate the price of the bond

b) Calculate the duration of a bond

c) Calculate the convexity of the bond.

d) The yield on the bond instantaneously increases from 7.5% to 7.7%.

*Please write down the formula instead of Excel format

In the following year, there is a 10% chance of a bear market, a 20% chance of a bull market, and a 70% chance of a neutral market.
Debt will return -2%, 5%, and 5% in the bear, bull and neutral market, respectively.
Equity will return -15%, 15%, and 8% in the bear, bull and neutral market , respectively .

What is the expected return of debt in %?  (round to 1 decimal place)

What is the volatility of equity in %? (round to 1 decimal place)

What is the covariance of debt and equity? (leave as a decimal; round to 5 decimal places)

What is the correlation of debt and equity?   (leave as a decimal; round to 3 decimal places)

What is the expected return of a risky portfolio made up of 70% bonds and 30% stock?  (units of %; round to 2 decimal places)  

What is the volatility of a risky portfolio made up of 70% bonds and 30% stock?    (units of %; round to 1 decimal places)   


What is the Sharpe ratio of the risky portfolio made up of 70% bonds and 30% stock? (round to 2 decimal places)

A hedge fund manager has a portfolio worth $50 million with a beta of 1.25. The manager is concerned about the performance of the market over the next two months He plans to uses three-month stock market index futures to hedge his market exposure. The current stock market index level is 2,500 and one contract is on 250 times the futures price. The continuously compounded interest rate is 3% and the dividend yield on the stock market index is 2%.

a) What is the fair futures (forward) price today?

b) What position should the fund manager take to hedge his market exposure?

c) Calculate the effect of the hedging strategy on the fund manager’s return if the index in two months is 2,250, 2,500, or 2,750. (Hint: For each scenario, compute the fair forward price with one month maturity left and same interest rate and dividend yield. Then, you can compute the total profits or losses he incurs on his hedging position.)

You are considering an investment that will pay you $1,200 in one year, $1,400 in two years, and $1,600 in three years, $1,800 in four years, and $11,000 in five years. All payments will be received at the end of the year. • Your opportunity cost of capital (r ) is 10.5% • Using the present value formula calculate the present value of each of the cash flows by 1. Discounting cash flows using annual compounding 2. Discounting cash flows using monthly compounding 3. Discounting cash flows using continuous compounding • How much would you be willing to pay for the investment using each of the three different compounding scenarios? That is, what is the present value of the cash flows from the investment using each of the three different compounding scenarios? • Which of the three present values is the largest (annual, monthly or continuously compounded returns)? Please explain why this is the case. do not use a calculator or excel to solve

What is the difference between risk aversion and loss aversion?

Provide an example of an asset and determine either it’s present or future value.

For example, one type of asset is cash. If I have $1,000 today this is it’s present value. If I purchase a certificate of deposit from my bank for one year at an interest rate of 10% compounded annually. It’s future value would be $1,100.

You can give examples of Bonds (present value at a current yield) or

Stocks (present value using the Constant Growth Model) or the present value of future cash flows at a specific interest rate.

Provide an example and explain.

You and your significant other are going to have a baby one year from now.

Of course your little pride-and-joy is going to be cute AND smart. After much consultation, your significant other and you have decided that you want the little one to go to a private four-year college in the United States. However, private colleges are very expensive. The average current cost is estimated to be around $43,921 per year, including tuition, fees, room, and board. You expect these costs to increase by 3% per year beyond the current annual rate of inflation of 2%.

Your child will most likely begin college eighteen (18) years after birth. Colleges tend to demand payment of the annual cost at the beginning of each year. You expect to invest your money in a manner that returns 7.50% per year over the foreseeable future. You want to start saving soon. In fact, you plan to invest money every year. To be precise, you will put away money once a year, starting when the baby is born, and ending one year prior to the beginning of your child’s first year in college.

A. Suppose you want to save the same (constant) amount each year in nominal dollars. How much will you have to save each year so that there is enough money to send your child to college?

B. (13 points) Now suppose that you want to save a constant percentage of your salary every year. Assume that your current household income is $100,000 per year, and assume that it will grow at the rate of inflation over the foreseeable future. What (constant) percentage of your salary will you have to save each year so that there is enough money to send your child to college? What is the constant amount you will save every year in real dollars, and what are the corresponding (increasing) amounts saved in nominal dollars each year?

Hint 1: For part A, verify your work by calculating the value of the savings account each year and make sure it starts at $0 and ends at $0.

Hint 2: Your answers to parts A and B must be the same in present value terms.

1 I.e., college costs will increase by (1+0.02)*(1+0.03)-1 per year for the foreseeable future.

KANASAS FOOD has 300,000 shares outstanding, debt of $9,000,000, and cash of $400,000. The firm is expecting fixed free cash flows of $2,000,000 for 2 years. After that, free cash flows are expected to grow by 7.0% per year. The weighted-average cost of capital for High Point Grill is 16.2%. Use DCF analysis to estimate the share price of KANSAS stock.

Assume the return on a market index represents the common factor and all stocks in the economy have a beta of 1. Firm-specific returns all have a standard deviation of 41%. Suppose an analyst studies 20 stocks and finds that one-half have an alpha of 4.3%, and one-half have an alpha of –4.3%. The analyst then buys $1.3 million of an equally weighted portfolio of the positive-alpha stocks and sells short $1.3 million of an equally weighted portfolio of the negative-alpha stocks.

a. What is the expected return (in dollars), and what is the standard deviation (in dollars) of the analyst’s profit? (Enter your answers in dollars not in millions. Do not round intermediate calculations. Round your answers to the nearest dollar amount.)

b-1. How does your answer for standard deviation change if the analyst examines 50 stocks instead of 20? (Enter your answer in dollars not in millions. Do not round intermediate calculations. Round your answer to the nearest dollar amount.)

b-2. How does your answer for standard deviation change if the analyst examines 100 stocks instead of 20? (Enter your answer in dollars not in millions.)

Howell petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.97 million. The marketing department predicts that sales related to the project will be $2.67 million per year for the next four years, after which the market will cease to exist. The machine will be depreciated down to zero over its four-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 25 percent of sales. The company also needs to add net working capital of $320,000 immediately. The additional net working capital will be recovered in full at the end of the project's life. The corporate tax rate is 35 percent. The required rate of return is 13 percent.

A/ What is the NPV for this project?

B/ Should the company proceed with the project?