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2. (i) Explain the concept of opportunity loss, and show that the minimum opportunity loss is equal to the Expected Value of Perfect Information. (ii) The failure rate in a particular examination is estimated to be 40%. Construct a table showing the probabilities of 0, 1, 2 . . . 5 students failing in a sample of five. (iii) 150 graduate entrants are due to take their first professional accounting exam at the Institute of Certifiable Accountants. The probability distribution for the failure rate is estimated in the following table: Failure rate Probability 0.1 0.1 0.2 0.2 0.3 0.3 0.4 0.3 0.5 0.1 Each failing student is entitled to a f10 refund on professional fees. The Institute's senior tutor is confident that she could ensure a failure rate of 0.1 by holding an intensive revision course, at a cost to the Institute of $300. Advise the Institute on whether the revision course should take place. A tutorial test of five students resulted in no failures. Use this information to revise the failure rate probability distribution, and hence reassess the revision course. 3. 'Despite being a small local shopkeeper I can always beat the price that Woolworths charge for the same product. Woolworths must pay rent on its store while I own my shop and have no rent to pay.' Discuss. 4. A firm keeps a record of sales and prices over the past seven months, resulting in the following table: Price (f/ton) Sales (tons) Nov. 1985 7.5 84.5 Dec. 8.0 82.0 Jan. 1986 8.0 84.0 Feb. 7.2 92.0 March 7.0 95.0 April 8.0 92.0 May 8.5 91.5 Use these observations to estimate demand as a linear function of both price and time. Utilise this function to estimate demand for the following month, on the assumption that: (a) price remains unchanged, (b) price increases to f9/ton.E1. You are an A quality borrower, and you pay 10 percent on a five-year loan with one final amortization at the end. This is 1 percent above the spread paid by an AAA borrower. What will be the up-front fee for which your bank should be willing to lower the rate by 1 percent?Refer to the trader's calendar on the following page to answer the questions below. The calendar is open to the spot value date 1. List the regular forward value dates and number of days in each forward period. Date Days One month Two months Three months 1III1 Six months One year2. Critically examine the theoretical and empirical validity of the prot maximisation hypothesis. 3. The Hot-Bake shop sells only bread made that day. Each loaf produced has a variable cost of 30p and sells for 50p. Any bread unsold at the end of each day is thrown away. At the start of each day, the manager must decide how many loaves to produce. The table below records sales over the past month: Daily sales Frequency 1000 6 1200 10 not} 10 1600 4 (a) Fixed costs are estimated at X per day. Find the breakeven number of leaves produced and sold, and the number it expected daily prot was 50. (b) Find the number of loaves produced to minimise expected opportunity has. (c) Bread is produced by a fully automated machine which mixes the dough, divides it into 1 lb units, lls each baking tin and passes them through an oven. Out of each batch, some are rejected for being underweight or burnt. The proportion rejected has the probability distribution given below: Proportion rejected Probability 0.05 0.25 0.10 0.150 0.15 0.15 (i) Find the number of leaves produced if the expected num- ber of saleable loaves equals your answer to question (b). {ii} The services of a maintenance engineer would set the rejection rate equal to 0.05, but would cost 11 per day. Advise the manager on whether to engage the ennwr or not, if the desired daily production is 1300. (d) Comment on the assumptions underlying your answers, and discuss the relevance of other decision criteria. 4. 'Prot is the maximum value a company can distribute during the year and still expect to be worth as much at the end of the year as it was at the beginning.' Discuss this statement. and comment on its value in measuring prot for decisionmaking. True-False Questions 1. The abolition of the Interest Equalization Tax, Regulation M, the cold war, and the US and UK foreign exchange controls have taken away most of the reasons why euromarkets exist. As a result, we can expect these markets to decline in the near future. 2. Without the US trade deficit, the euromarkets would have developed more slowly. 3. With a floating-rate loan, the bank is free to adjust at every reset date the interest rate in light of the customer's creditworthiness. 4. One of the tasks of the lead bank under a syndicated bank loan is to make a market, at least initially. 5. The purpose of using a paying agent is to reduce exchange risk. 6. Caps and floors are options on interest rates. Because interest rates are not prices of assets, one cannot price caps and floors using an option pricing model that is based on asset prices. 7. Because euroloans are unsecured, the spread over the risk-free rate is a very reliable indicator of the borrower's general creditworthiness. 8. FRAs are not really a good hedge against future interest rates because one does not actually make the deposit or take up the loan. 9. A note issuing facility forces the borrowing company to borrow at a constant spread, while a revolving underwritten facility gives the borrower the benefit of decreased spreads without the risk of increasing spreads. 10. The fact that eurobonds are bearer securities makes this instrument less attractive to most investors. 1 1. Bond stripping is mostly done with a pair of scissors: you just clip off the coupons. 12. Disintermediation is the cause of the lower creditworthiness of banks, and has lead to capital adequacy rules. 13. Ignoring the small effects of marking to market, the standard quote for a curocurrency futures price is basically a forward price on a CD.(d) What is the Pareto-efficient level of output? Discuss how that level could be attained. What price would consumer pay, what price would producers receive? What would the consumers' and producers' sur- pluses be at this level? What would the total damage and total surplus be? By how much does the total surplus change given that the appropriate action has been taken by the authorities. 2p4. You do a swap which has a near date of July 25h and a far date of August 27, 2003. It is a: (a) short-dated swap (b) forward swap (c) it is called a
