Question

1. The intrinsic value of an asset (how much an asset should be worth) is defined as:

a. the total discounted value of its expected future profits.

b. the sum of its expected cash flows discounted at the required rate of return.

c. the value recorded on the issuing corporation's balance sheet.

d. the amount investors are willing to pay for it on the open market.

2. A bank purchases a three against nine $1,000,000 forward rate agreement to hedge an existing position. The agreement rate with the seller is 4.0%. Three months from today, the settlement rate is observed to be 3.8%. Who pays whom, when, and how much? Assume a 360 day year and 30 days per month.

a. The bank pays $981.35 at the end of 3 months

b. The bank pays $981.35 at the end of 9 months

c. The counterparty pays $981.35 at the end of 3 months

d. The counterparty pays $981.35 at the end of 9 months

Answer 1

              ANSWER TO THIS QUESTION

Intrinsic value is a core concept of value investors seeking to uncover hidden investment opportunities. The discounted cash flows (DCF) model is one commonly used valuation method used to determine a company's intrinsic value. The discounted cash flow model uses a company's free cash flow and WEIGHTED average cost of capital (WACC), which accounts for the time value of money, and then discounts all its future cash flow back to the present day.
1. The intrinsic value of an asset (how much an asset should be worth) is defined as:

a. the total discounted value of its expected future profits.

b. the sum of its expected cash flows discounted at the required rate of return.

c. the value recorded on the issuing corporation's balance sheet.

d. the amount investors are willing to pay for it on the open market.

ANSWER: b. the sum of its expected cash flows discounted at the required rate of return.

Forward rate agreements (FRA) are an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The FRA determines the rates to be used along with the termination date and notional value. FRAs are cash settled with the payment based on the net difference between the interest rate and the reference rate in the contract. The notional amount is not exchanged.

FRA payment = (((R - FRA) x NP x P) / Y) x (1 / (1 + R x (P / Y))).

FRA = the FRA rate

R = the reference rate

NP = the notional principal

P = the period, which is the number of days in the contract period

Y = the number of days in the year based on the correct day-count convention for the contract

2. A bank purchases a three against nine $1,000,000 forward rate agreement to hedge an existing position. The agreement rate with the seller is 4.0%. Three months from today, the settlement rate is observed to be 3.8%. Who pays whom, when, and how much? Assume a 360 day year and 30 days per month.

Solution:

FRA payment = (((4% -3.8%) x $1000000 x 180*) / 360) x (1 / (1 + 4% x (180 /360)))

                        =$981.25

*this is three against nine months forward rate agreement. Hence the period is to be taken six months, and paid after nine months from now.

If the payment amount is positive, the FRA seller pays this amount to the buyer. Otherwise, the buyer pays the seller. Hence in this case bank will purchases the contract hence counter party pays $981.25

a. The bank pays $981.35 at the end of 3 months

b. The bank pays $981.35 at the end of 9 months

c. The counterparty pays $981.35 at the end of 3 months

d. The counterparty pays $981.35 at the end of 9 months

ANSWER: d. The counterparty pays $981.35 at the end of 9 months