ANswer all the questions correctly.

Task 01.

3 An Anticipated Output Shock [30 points] Consider a two-period small open endowment economy populated by a large number of households with preferences described by the lifetime utility function: 11 U = C 10 C 11 (1) Suppose that households receive exogenous endowments of goods given by Q1 = Q2 = 10 in periods 1 and 2, respectively. Every household enters period 1 with some debt, denoted B0, inherited from the past. Let B0 = 5. The interest rate on these liabilities, denoted r0, is 20 percent. Finally, suppose that the country enjoys free capital mobility and that the world interest rate on assets held between periods 1 and 2, denoted r, is 10 percent.

a (14 points) Compute the equilibrium levels of consumption, the trade balance, and the current account in periods 1 and 2. Do not forget to show step by step your algebraic calculations. Explain in detail your reasoning. No credit without an explanation.

b (16 points) Assume now that the endowment in period 2 is expected to increase from 10 to 15. Calculate the effect of this anticipated output increase on consumption, the trade balance, and the current account in both periods. Provide intuition. Do not forget to show step by step your algebraic calculations. Explain.

Section B.

Consider the following information for three stocks, Stocks X, Y, and Z. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1.)

stock expected return standard deviation beta

X 9% 15% 0.8

Y 10.75% 15% 1.2

z 12.50% 15% 1.6

Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.)

a. What is the market risk premium?

b. What is the beta of Fund Q?

c. What is the expected return of Fund Q?

Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk-free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?

You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks: (02)

Stock Investment Stock's Beta Coefficient

A $160 million 0.5

B 120 million 1.2

C 80 million 1.8

D 80 million 1.0

E 60 million 1.6

Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 6%, and you believe the following probability distribution for future market returns is realistic:

ProbabilityMarket Return

0.1 28%

0.2 0

0.4 12

0.2 30

0.1 50

a. What is the equation for the Security Market Line (SML)?

b. Calculate Kish's required rate of return.

Part 3.

A trader sells a put option with a strike price of $55 for $9. The trader's maximum gain and maximum loss on that position is:

Maximum gain is $9; maximum loss is $55

Maximum gain is $55; maximum loss is $9

Maximum gain is $9; maximum loss is $46

Maximum gain is $46; maximum loss is $9

Maximum gain is unlimited; maximum loss is $9

The way central counterparties (CCP) function, and one of their disadvantages are to:

Clear an over-the-counter derivative transaction, and overcollateralize the market

Clear over-the-counter derivative transactions, and concentrate centralized credit risks

Clear exchange-traded derivative transactions, and overcollateralize the market

Clear exchange-traded derivative transactions, and concentrate centralized credit risks

None of the above

You are an energy trader looking to hedge a WTI crude oil exposure until year-end using futures. The available delivery months in the futures market are March, June, September, and December. The contract with the following delivery month could best hedge your exposure:

March

June

September

December

Not available

You are a fixed-income manager of a portfolio that consists of many bonds. Your analyst has calculated the portfolio's overall duration and you are confident in the precision of that calculation. You can use that duration to accurately estimate your portfolio's:

Loss in value when yields rise by 25 bps across the entire curve

Gain in value when yields drop by 15 to 25 bps depending positioning in the yield curve

Gain in value when yields drop by 300 bps across the entire curve

Loss in value when yields rise by 300 to 400 bps depending positioning in the yield curve

Both B and C

You are an FX trader and just observed that both the spot and the six-month futures contract on the Euro are quoted at $1.2100 EUR/USD. The six-month risk-free rates are 1.0% in the United States and 0.5% in the Eurozone. The positions in the spot and futures market that you would take to profit from a potential arbitrage opportunity that might exist are:

Sell USD spot to buy EUR spot, and go short the six-month EUR futures

Sell EUR spot to buy USD spot, and go long the six-month EUR futures

Sell EUR spot to buy USD spot, and go short the six-month EUR futures

Either A or B

Do nothing; no arbitrage opportunity exists since the spot and futures prices are equal

The cost of carry for a stock index is ______, and for a commodity with storage costs _____:

Stock index: risk-free minus dividend yield, commodity: risk-free rate

Stock index: risk-free rate, commodity: risk-free rate plus the storage cost

Risk-free rate for both the stock index and the commodity

Stock index: dividend yield, commodity: storage cost

None of the above

You are an investor considering the purchase of equal amounts of a U.S. Treasury bond and a corporate bond on September 30, 2020. Both bonds pay a 7% coupon twice a year - on January 15 and July 15.The accrued interest that will be included in these transactions is:

Higher for the U.S. Treasury than the corporate bond, and payable to the seller

Higher for the U.S. Treasury than the corporate bond, and receivable from the seller

Lower for the U.S. Treasury than the corporate bond, and receivable from the seller

Lower for the U.S. Treasury than the corporate bond, and payable to the seller

The same for the U.S. Treasury and the corporate bond and payable to the seller

Company A is the floating-rate payer in an interest rate swap with company B. The value of the swap is now negative for company A. Credit and market risk exposures are as follows:

A is exposed to credit risk, A to market risk

A is exposed to credit risk, B to market risk

B is exposed to credit risk, A to market risk

B is exposed to credit risk, B to market risk

Both A and B are exposed to credit and market risk

Company A requires a fixed-rate investment; company B requires a floating-rate investment. The two companies have been offered the following annual rates of return:

Company

Fixed Rate

Floating Rate

A

6%

LIBOR

B

7%

LIBOR

A bank charges 0.4% per year to structure a swap equally attractive to companies A and B. The swap enables the companies to earn the following annual rates of return:

A: 6.3%; B: LIBOR + 0.3%

A: LIBOR - 0.3%; B: 8.3%

A: 6.6%; B: LIBOR + 0.6%

A: LIBOR - 0.7%; B: 8.7%

None of the above

You, your friend, and your professor invested in a Mortgage-Backed CDO on July 23, 2006. You bought a portion of the CDO's senior tranche; your friend bought an equal amount from the mezzanine tranche; and your professor an equal amount from the equity tranche.

On May 5, 2011, your investments are likely worth:

Yours is lower than your professor's, and your friend's is worthless

Yours lower than your friend's, and lower than your professor's

Yours is higher than your professor's, and lower than your friend's

Yours is higher than your friend's, and your professor's worthless

All the same

The option position, its maximum loss and its maximum gain of the option position that has the following payoff diagram upon expiration is:

A long put with a maximum gain of $46 and maximum loss of $4

A short put with a maximum gain of $4 and unlimited maximum loss

A long call with a maximum gain of $46 and maximum loss of $4

A short call with a maximum gain of $4 and an unlimited maximum loss

None of the above

You are holding shares of S&P Global Inc. (US ticker: SPGI). Exchange-listed options on SPGI trade on a January, April, July, and October monthly cycle. On June 9, you have a bullish 12-month view on SPGI. On July 22, you are concerned after a research analyst warns of high volatility around SPGI's forthcoming quarterly earnings announcement. The option positions you are looking to enter to express your investment views are:

Covered call with an April expiration, protective put with an April expiration

Covered call with a January expiration, short naked put with an April expiration

Long call with a January expiration, protective put with an April expiration

Covered call with an April expiration, short naked put with an October expiration

Long call with an April expiration, protective put with an October expiration

You have just paid $1,500 to buy one call option contract on Alibaba Group Holding Ltd. (US ticker: BABA) with a strike price of $210 per share expiring on June 18, 2021. BABA closes at $218 on the expiration date. Your profit & loss, and action on that date are:

Profit of $800, and you do not exercise your out-of-the-money call option

Loss of $700, and you do not exercise your out-of-the-money call option

Loss of $700, and you exercise your in-the-money call option

Profit of $800, and you exercise your in-the-money call option

Profit of $700, and you exercise your in-the-money call option

The price of a non-dividend paying stock is $57 and the premium of a six-month European put option on the stock with a strike price of $60 is $5.40. The risk-free rate is 2% per year.

The premium of a six-month European call option on the stock with a strike price of $60 is:

$3.00

$3.60

$5.40

$6.00

Cannot be determined using the data provided

For questions 15-17: Microsoft Corp. (US ticker: MSFT) is expected to release its Q3 earnings on October 21. MSFT is currently trading at $57.50. Premia on the November $55, $57.50 and $60 MSFT call options are currently $7.00, $4.50, and $3.00, respectively. And on the November $55, $57.50 and $60 MSFT put options, premia are currently $3.50, $5.00, and $7.00, respectively.

Based on your fundamental analysis, MSFT should moderately beat Q3 consensus EPS expectations. The best option strategy to maximize profit from your MSFT view is:

A $55 - $57.50 bull put spread

A $55 - $57.50 bull call spread

A $57.50 - $60 bull put spread

A $57.50 - $60 bull call spread

A $55 - $60 bull call spread

An analyst you follow and trust has issued a sell recommendation for MSFT on a weak Q3 EPS forecast. The best option strategy for you to maximize profit from her MSFT view is:

A $57.50 - $55 bear put spread

A $57.50 - $55 bear call spread

A $60 - $57.50 bear put spread

A $60 - $57.50 bear call spread

A $60 - $55 bear call spread

Your quantitative model is pointing to heightened MSFT stock price volatility around the Q3 earnings announcement but cannot determine the stock price's post-earnings direction. The best option strategy to profit from your model's output on MSFT with minimal exposure is:

A long $57.50 straddle

A short $57.50 straddle

A short $55 - $60 strangle

A long $55 - $60 strangle

A $55 - $57.50 strangle

For questions 18-19: You are holding 750 shares of Infosys Ltd. (US ticker: INFY) and you would like to hedge it in a delta-neutral way. The INFY call option you select has a delta of 0.60.

What position in the INFY call option, and the underlying stock, is a delta-neutral portfolio?

A long position in 1,500 call options

A short position in 1,500 call options

A short position in 1,250 call options

A long position in 450 call options

A short position in 450 call options

Due to the INFY call option's gamma, an increase in the underlying stock's price has caused the option's delta to increase to 0.75. How would you restore the portfolio's delta neutrality?

Sell to open an additional 250 INFY call options

Buy to close 250 of your short INFY call options

Buy an additional 200 INFY shares

Sell 100 of your INFY shares

None of the above

You write n at-the-money covered call option expiring in one year with a theta of -1.0. Three months later, both the underlying stock's price and the option's implied volatility are the same. What is the percent change in the option's premium during the elapsed time?

-50%

-25%

0%

+25%

+50%

Profit (8) 2 0 Stock Price ($) 10 -1. 2 -5 graph for 11th Question