1. (a) Explain the meaning of the following interest rate concepts (short explanation: 1. Spot-interest rate, 2p ii. Forward interest rate, 2p iii. Implicit forward interest rate, 2p iv. "Yield-to-maturity". 2p v. Effective interest rate, 2p (b) Explain (briefly) the difference between: i. Coupon bonds and Zero-coupon bonds, 3p ii. Fixed-rate bonds and Floating-rate bonds, 3p ii. Nominal bonds and Real bonds, 4p. 2. Explain the following concepts (a) Buying on the margin Ip. (b) Short-selling 4p (c) Put-call parity Aps (d) Random walk dp (e) Weak-form markort efficiency 4p. 3. When interest rates increase, unexpectedly, it is usually the case that prices of stocks go down, at the same time. This happens because fixed interest bearing assets such as bonds have become relatively more attrac- tive as investments. Consider a firm (firm Z) which is financed by equity capital only, so the cashflow that it can pay out to stock holders is not affected by an increase in the level of interest rates. The expected divi- dend per share (DPS) from firm Z is equal to DPS = 10SEK, which is assumed to be constant over all future time periods. The covariance of the rate of return on firm Z:s shares with a "markort portfolio of risky assets, is equal to ozn = 0.15, the variance of the rate of return on the risky market portfolio is or=0.20, while the expected rate of return on this portfolio is 12%-points above the risk-free nominal interest rate. (a) What is the required rate of return on the firm 7:s equity when the risk-free interest rate is 1%? 6p (b) What is the price of one share of equity in firm Zt op (c) Assume now that inflationary expectations increases by 1%-point (from zero expected inflation initially) but the real interest rate re- moins unchanged. The rate of inflation is expected to remain at that level for the forseeable future. If firm Z cannot increase the price of the product it produces, we may assume that the dividends per share stays unchanged at 10SER. The covariance and the variance of the risky markort portfolio may change however, let's assume that they 2 change to ozn = 0.18 and x = 0.30, respectively. The expected rate of return on the market portfolio decreases by 2%-points. Will the stock price of firm Z go up or down in this case? 8p 4. (a) Discuss how the price of share/stock in a publicly traded company is determined in theory. Explain how data from the firm's accounts are combined with market variables, in this process. Tp (b) Sometimes newly founded firms enter the stock market, with very little history of sales, costs and profits, but still are traded at high prices. Furthermore, often they do not pay any dividends and the recorded profits are negative. Discuss how a price/value of the firm's shares are determined in this case. Tp (c) Explain why shareholders in high-growth firms are happy (or at least not very disappointed) if they do not receive any dividends for the current year. Explain why it may not be in their interest to receive any dividends in certain situations. 6p 5. This year oil-prices increased sharply at the end of the summer and early fall. In earlier episodes of large oil price swings it has been common to put the blame on evil speculators in financial markets, but not so much this time. The main explanation is the combination of rising demand as the pandemic was seem to approach its end, and lingering bottle-necks in the so called "supply chain". To actually speculate in oil price changes, if you don't own any, would require you to buy the oil today and hold it off the market to prop up the price, but this requires very expensive storage of oil. (a) If you wanted to speculate in rising oil prices but didn't own any oil explain how you could to this by trading in so called derivative financial instruments related to oil? (Oil being the underlying asset). 4p (b) Assume that the expected price of a barrel of crude oil in six month time is $80, it does not cost anything to keep the oil in the ground, but the real (yearly) interest rate foregone by doing so is r = 0.25%. Use this information to find the spot price (i.e. the price of oil for immediate delivery) of one barrel of oil. Assume that the market is in equilibrium in the sense that there is no expected profit in buying a six-month future oil contract and that the expected rate of inflation over the next six months is 0.875%. 4p (c) Assume the same numbers as in a), what is the strike price, K, on a six-month crude oil future contract? Explain. 4p (d) If the price of oil is $70 three months into the contract period, what is the value of the future contract to the buyer and to the seller (or writer)? 4p (e) Discuss the difference between futures and options. What factors determine the price of an option? 4p