Final Assessment- Financial Markets | Solutions

There are only 4 questions for this online exam but it will take only 2 hrs. Later I will send you lecture slides and tutorial questions.

FINAL ASSESSMENT COVER SHEET
Student Name:
Student Number:
EXAM DETAILS
Course Code: BAFI1005
Course Description: Financial Markets
Exam Date 21/04/2020
Release time: 9:00 am SGP Time
Submission cut off time: 11:30 am SGP time
Exam Duration: 2 hours + 15 min reading time + 15 additional
minutes for download and submission
Total number of pages: 11 pages
INSTRUCTIONS TO CANDIDATES
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The assessment consists of a series of 4 problems with scenario analysis.
You must complete all problems and each component of the problem. The
assessment is worth a total of 50 marks.
2 This is an OPEN BOOK assessment.
3 You are expected to answer the questions within the scope of this course
covering Topic 1 to 8.
4 Please write your answers in the space provided on this assessment paper
after each question.
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This exam paper adds to 50 marks and comprises 50% of the total marks
allocated in this course. To obtain a pass in this course, you must achieve at
least 50 % overall in course assessment
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Submission:
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This assessment must be submitted electronically via Canvas in .doc
or .docx format only and must constitute your own work. Submission for this
assignment is via Turnitin, therefore it is automatically checked for any form of
plagiarism, resulting in academic misconduct if plagiarism occurs. You are
required to upload the file in .doc or .docx format only; not as .pdf. If the file is
uploaded in any other format that is not recognised via Turnitin and you don’t
receive a similarity score – the assessment will not be marked and a grade of
zero for the assessment will be applied.
2 You can only submit once as your final answer.
3 Name your answer file as: surname_studentID before submission.
4
As this is a final assessment, late submissions will not be accepted. If
circumstances occur that prevent you being able to undertake the
assessment on the due date – you will have to apply for special
consideration: This webpage provides instructions about how to go about
this: https://www.rmit.edu.au/students/student-essentials/assessment-and-
exams/assessment/special-consideration
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The submission window will close exactly at the cut-off time. Please
submit well before cut-off time to ensure that nothing impedes your ability to
upload the assessment, such as internet/wifi issues. This will not be a
sufficient excuse to grant extensions – you are responsible for ensuring that
you are able to submit the assessment on time.
Answer Requirement:
1 Where mathematical calculations are required you must state the equation
used as well as each step in your calculations.
2
Please write answers in the spaces provided. You can extend the space to fit
your answers, but please label the sub-question number clearly.
The format is detailed below:
Font type: Arial
Font size: 12pt
Spacing: 1.5 line spacing
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Assessment Declaration
This is an individual piece of assessment. That means it must be your own
work and you can’t copy or have someone else complete any part of the work
for you.
By submitting this assessment, you are declaring that you have read,
understood and agree to the content and expectations of the Assessment
declaration.
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Final Assessment Questions
The final assessment comprises four (4) questions. You are required to answer all
four (4) questions. This section is worth a total of 50 marks, with marks for each
question specified at the end of the question.
Question1
On 16th March 2020, the Federal reserve in the US announced that it will lower the
primary credit rate by 150 basis points to 0.25 percent to support the US economy
amid the coronavirus outbreak, effective March 16, 2020.
Jack is a new investor. He read the above news but could not figure out how the
“Federal Reserve could support the economy by cutting interest rates”. You are his
financial advisor, so he asked for your help.
REQUIRED:
a. Please explain in detail the reasoning or theories behind the statement -
“Federal Reserve could support the economy by cutting interest rates”.
b. Please introduce the main instrument used by Federal Reserve to achieve its
targeted interest rate.
c. Please explain how it works in detail.
(5+2+5=12marks)
a) The FED is well deciding on reducing the interest rate level that is by 150 basis
point and the actions have been well taken by the FED in order to revive the
economy that is going into a global recession. Now the set of actions taken by the
government has been particularly taken down for the purpose of reducing the
borrowing cost or finance cost that is there in the economy so that business entities,
corporations and individuals are able to see cheap availability of finance which in
turn helps them meet their business operational as well as investment needs.
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b) Cash Rate is the Key Instrument that is used by the Federal Reserves to achieve
its targeted interest rate. There are other instruments and operations as well that are
carried like changes in reserves ratio and buying and selling of bonds via Open
Market Purchase to increase liquidity and to push the economy.
c) A reduction in the interest rate helps business entities, organisation and
individuals to lower down the cost of finance, which lowers down the cost of
operations in turn. After, the outbreak of COVID-19 people would be relatively would
not be willing to spend much on business expansion programs and investments due
to global recession which in turn would be reducing the revenue or cash flows that
they have expected. Now what the Federal Reserves have actually done in reduced
the interest rate, now considering the fact that finance cost plays a major and
significant role a reduction in the finance cost would somehow offset the loss in the
expected cash flows and business entities would be induced to invest into projects
and finance due to cheap availability of finance. Now, these actions would not only
boost the economy by increasing business activities, but would see a surge in the
employment levels, transactions level operating and all on an overall basis would be
helping the US Economy revive. However, there are other key business and
economic factors, which too play a significant role while analysing and
conceptualizing these set of idea which must be considered and noted.
Question 2
As a financial advisor, you have been asked a lot of questions recently on yield
curves. So, you decided to hold an online seminar for your clients to explain the
following questions using US yield curve as an example. You downloaded the data
of Daily Treasury Yield Rates of the U.S from the website of U.S. DEPARTMENT OF
THE TREASURY as below. (Mo=month, Yr=Year, Date format is Month/Date/Year)
Table1: Daily treasury yield rates of the US treasury bill and bond
Time to maturities of US Treasury bill and bond
Date 1 Mo 2 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr
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08/15/19 2.08 1.97 1.91 1.86 1.72 1.48 1.44 1.42 1.47 1.52 1.8 1.98
08/16/19 2.05 1.95 1.87 1.85 1.71 1.48 1.44 1.42 1.49 1.55 1.82 2.01
03/16/20 0.25 0.25 0.24 0.29 0.29 0.36 0.43 0.49 0.67 0.73 1.1 1.34
REQUIRED:
a. Explain what a yield curve is by using the US treasury yield curves data on
15th Aug. 2019 and 16th March 2020 as an example. (Note: no diagrams of
yield curves are required since it may be difficult to draw in Word)
b. Further specify what is the shape of the yield curves on 15th Aug. 2019 and
16th March 2020 respectively? Please explain the potential reasons for that
shape.
c. Looking at the two US yield curves, what do you think is the implied
market outlook of them respectively? Please explain the reasons in detail.
(3+5+5=13 marks)
a) A yield curve is a curve that well reflects down the path of interest rate or yield that
it is approaching across a set of maturities. The curve well tries to show a key
relationship as observed from the table presented above between time (maturity)
and interest rate (yield).
b) The data for the 15th August 2019 shows an Upward Sloping Yield Curve and this
was potentially because, when the forecast for the economy was good interest rate
were stabilized and there was no such social or economic impact on the US
Economy. However, the data for 16th March 2020 goes to well show that the yield
curve for the period is down ward sloping showing the investors and market are well
assessing that there will be a slowdown into economy and changes, in social and
economic factors would be affecting the growth of economy.
c) By looking at the two yield curve we can well analyse the follow points:
16th March 2020 (Market Outlook): The data presented for the US Treasury yield
across various set of maturities goes to well show that the shape of the yield curve is
downward sloping. The same has been well analysed by reviewing the interest rate
which has shown a downward trend of interest rate across various level of maturities
stated.
The slope of an yield curve is an important aspect to analyse and in this case
it goes to well says that the direction of the future short-term interest rate is
downward sloping signalling that the economy can well go into a recession. This also
goes to shows that the expectation of future interest rate is lower in the future. The
graph below well shows the movement of yield across maturity and can be well
related:
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15th August 2019 (Market Outlook): The data presented for the US Treasury yield
across various set of maturities goes to well show that the shape of the yield curve is
upward sloping. The same has been well analysed by reviewing the interest rate
which has shown a upward trend of interest rate across various level of maturities
stated. This has been particularly due to positive expectation about economy and
social factors on a whole.
Question 3
You are now a fund manager. Your boss asks you to prepare a report regarding
following questions:
a. Please calculate the issuing price of U.S. 10 Year Treasury bond on 16th Aug.
2019 and 16th March 2020 respectively with information given below.
US 10-year Treasury Notes Fact Sheet
Issuing date 16th Aug. 2019 16th March 2020
Bond expiration date 16th Aug. 2029 16th March. 2030
Face value 100 100
Coupon rate (annual) 1.50% 1.50%
Coupon payment semi-annual semi-annual
Tips: the market yield of 10-year treasury notes can be found in the data provided in Question 2
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b. Compared to the price on 16th Aug. 2019, how has the issuing price of US 10
Year treasury bond changed after the Federal Reserve’s rate cutting on 16th
March 2020? Please explain the potential reason for this.
(6+6=12 marks)
a) The price for each of the bond is calculated as follows:
US 10-year Treasury Notes Fact Sheet
Issuing Date 16th Aug. 2019 16th March 2020
Bond Expiration Date 16th Aug. 2029 16th March. 2030
Face value 100 100
Coupon rate (annual) 1.50% 1.50%
Coupon payment semi-annual semi-annual
Time Period (In Years) 10 10
Market Yield 1.55% 0.73%
Price (Present Value) $ -99.54 $ -107.41
b) The issue price for the 16th August 2019 has well changed from 16th March 2020
due to change in the interest rate that has been observed it can be well said by
looking at the data point given. The calculated price for the bond has been around
$99.54 when the market yield was 1.55% in the year 2019 however the price has
well increased to around $107.41 and this has happened due to fall in the interest
rate level of the bonds. It can be well said that it is primarily because Interest Rate
and Bond prices have an inverse relationship and the same can be well explained in
this case.
Question 4
As a hedge fund manager, you have a bearish view on Tesla Inc. shares (NASDAQ:
TSLA) for the following 2 months given the uncertainties related to the Covid-19.
Assuming Tesla Inc is currently trading at $467.00, the put options with a maturity
of two month and an exercise price of $442 per share, have a premium (cost) of
$1.5 per share. The call option with a maturity of two month and an exercise price of
$487 per share, have a premium (cost) of $3 per share.
a. Calculate the cost if you purchase 1,000,000 of the above put options.
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b. Determine the share price for Tesla shares at which you would choose to
“exercise” the above put options.
c. Determine the share price for Tesla shares at which the decision to purchase
the above put options effectively “breaks even” for the fund manager.
d. If you don’t own any shares, but you still want to make profits during this
period. How can you use put and call options to take advantage of the fall in
the share price?
(2+2++3+6=13 marks)
a) Cost of Put Option: 1,000,000*1.5
Cost of Put Option: $1,500,000.
b) The share price at which we would choose the above the put option would be at a
price which is below the strike price that is the when the stock price is below the
strike price of $442.
c) Breakeven Point: $442-$1.5
Breakeven Point: $440.5
d) Selling Call at a rate of $487 and simultaneously buying put option at the level of
$442 will involve a profit of $1.5 for the investor that is $3-$1.5: $1.5.
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