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Question 1

  1. According to the theory of finance, why do banks exist in modern society? (30 marks)
  2. How has banking changed in recent years? (30 marks)
  3. Can you explain why many of changes have led to significant problems for bank managers and stockholders? (40 marks)


Question 2

  1. ABC Bank has recorded the following financial data for the past three years (£ in millions)


Current Year      Previous Year    Two Years Ago

Interest revenues                                            £57                    £56                      £55

Interest expenses                                              49                      42                        34

Loans (excluding nonperforming)                 411                    408                      406

Investments                                                    239                    197                      174

Total deposits                                                 487                    472                      467

Money market borrowings                             143                    118                        96


Calculate the Net Interest Margins (NIM) for 3 years and explain the results of your calculations. (50 marks)


  1. The First National Bank has the following interest-sensitive gaps


  Coming Week Next 30 Days Next 31-90 Days More than 90 days
Interest £144 £110 £164 £184
Sensitive +29 +19 29 8
Assets £173 £129 £193 £192
Interest £232 £0 £  0 £  0
Sensitive 98 84 196 35
Liabilities 36 6 0 0
  £366 £90 £196 £35


Using the information above calculate the GAP and cumulative GAP and explain the implications of the cumulative GAP throughout the period. Explain how bank management may address the issue arising from the mismatching of assets and liabilities. (50 marks)


Question 3
Assume you are a trader with Deutscne Bank. From the quote screen on your computer terminal, you notice that Dresdner Bank is quoting €0.7627/$1.00 while Credit Suisse is offering SF1.1806/$1.00. You learn that UBS is making a direct market between Swiss franc and the euro, with a current €/SF quote of .6395. Show how you can make a triangular arbitrage profit by trading at these prices. Assume you have $5,000,000 with which to conduct the arbitrage. What happens if you initially sell dollars for Swiss francs? What €/SF price will eliminate triangular arbitrage? (100 marks)

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Question 4


  1. Explain banker’s acceptance and why firms make use of such money market security. (20 marks)
  2. Outline the defining features of commercial paper and explain why, from time to time, banking firms and other corporations make use of the commercial paper market. To what extent is the commercial paper market highly liquid? (40 marks)

  4. ED Electronics recently announced a commercial paper issue with 90 days to maturity. The underwriting investment bank indicates that the discount rate should be 7.8 percent. (i) Calculate the issue price, and (ii) the money market yield? (25 marks)
  5. The yield at issue on a 60-day commercial paper issued by ED Electronics is 6.595 percent. What was the discount rate? (15 marks)


Question 5

Outline and explain, using examples

  1. The preferred habitat theory of the term structure of interest rates. (25 marks)
  2. The risk structure of interest rates. (35 marks)

  4. The yields and term to maturity on UK Government securities are as follows


Security             Term (years)             Yield

1                        1                               10.5

2                        2                               11.8

3                        4                               12.6

4                        8                               13.7

5                        16                             14.0


  • Use the data to construct a yield curve.
  • Does the yield curve indicate inefficiencies in the market? Explain. (10 marks)

  • Are there any pricing inefficiencies that might yield profitable opportunities? Explain. (10 marks)
  • Let the annualized interest rate on a three year security of this day be 12 percent, while the annualized rate of interest on a two year security is 9 percent. Show that the one year forward rate two years from now is 18.25%. (10 marks)


Question 6


  1. List and explain the various FTSE indices.
  2. What are the purpose of the role of brokers and market makers in the buying and selling of stocks traded on the London stock market? Describe and illustrate how market makers are compensated for maintaining a liquid market.

  4. After first reporting earnings growth for most of the 1990s, the EAE Company began experiencing a 6 percent per year decline in its cash dividend growth rate for the latter half of the decade; this decline is expected to continue in 2000. EAS has a current dividend per share of £

  • If EAE’s required rate of return is 14.5 percent, what is a share of the stock worth?
  • On the assumption that conditions remain the same, what will EAE’s price be a years from now?




Question 7


  1. Describe the main defining characteristics of traded options, calls and puts, on stocks and explain how the availability of futures and options markets facilities the growth of an economy. (60 marks)


  1. Let Next stock be trading at £


Exercise price             Call                 Put






Indicate for each of the above calls and puts if the option is in-the-money, at-the-money, or out-of-the-money. (10 marks)


  1. Let current stock price be £50. An investor purchases from LIFFE one October call options on stocks at £38p, which has an exercise price of £4.65. The option is of the European variety. Hence explain whether or not the call option will be exercised if EAE stock price on the expiration date of the call option is:


  • £5.30
  • £60
  • £68
  • Calculate, in each of these cases, the profit of the call option writer. (30 marks)



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