Question 1 (20 marks)

a) What are the basic functions of a financial system? Why is financial system important for improving economic welfare and promoting economic growth?

(5 marks)

b)What are the major differences between direct financing and indirect financing?(5 marks)

c) What is the "impossibility trinity" in foreign exchange markets? Discuss with reference to the foreign exchange regime in Hong Kong.

(10 marks)

Question 2 (15 marks)

Sakamoto Inc. need to raise fund to finance a residential construction project. A coupon bond of $1,000 face value, 5% coupon rate, paying annual coupon, and 5 years to maturity, was offered to the public on 4-Nov-2018. The yield-to-maturity of the bond was 2% on the same date. The bond is rated AAA by a major credit rating agency.

a) What is the market price of the bond on 4-Nov-2018?(5 marks)

b)What is the duration of this bond on the same date?(5 marks)

c)Six months later, the credit rating agency downgrade the rating of this bond to AA. How would the yield rate of this bond change? Briefly explain your answer.(5 marks)

Question 3 (10 marks)

A mutual fund is holding a portfolio consists of four bonds. Duration of Bond A is 1.22-year, of Bond B is 2.75-year, of Bond C is 3.11-year, of Bond D is 5.16. The proportion of Bond A in the portfolio is 30%, Bond B is 25%, Bond C is 15%, and the rest goes to Bond D.

a) Which bond in the portfolio is exposed to the lowest interest rate risk? Briefly explain. (5 marks)

b) What is the duration of the portfolio?(5 marks)

Question 4 (10 marks)

a) In the first trading day of 1998, Hang Seng Index closed at 10680.60, while in the last trading day of 2017, it closed at 29919.15. What is the average annual growth rate of Hang Seng Index in this 20-year?(5 marks)

b)The following yield curve is observed of the U.S. Treasury securities on 28th October 2019:

Maturity (Year) Yield Rate (%)

1 1.60

2 1.64

3 1.65

Suppose the pure expectation theory is correct. Forecast the expected one-year yield rate of one year later and of two years later respectively. (5 marks)