Financial Markets

This document discusses various topics related to financial markets, including yield rates, coupon rates, loanable funds market, and the impact of interest rates on exchange rates. It also provides calculations and analysis for investment options and risk management strategies. Explore the world of financial markets with Desklib.

FINANCIAL MARKETS

Q1.)
a) Yield rates in Europe have been negative and that of US have been positive. Positive yield
on treasury bonds signify that there has been a positive return on investment. However, it
may not be the case always as the central bank of US Fed does not cut rates below zero as its
policy rate is to stay positive. Yields on Treasury bonds going negative means there is a
supply crunch where cash is needed by companies and as US auction rules prevent rates
going below zero, the treasury bills can generate negative yields if traded in secondary
markets.
b) Coupon rate = central government bond yield + 1.86 p.a.
Central government bond yield rate for four year’s maturity = -0.74
Rate of coupon = -0.74 + 1.86 = 1.12% p.a.
Annual payment = 1000 * 1.12% = 11.2
Current market price of a bond = (2.3 / 1+4.5)1 + (11.2 / 1+4.5%)2 + (11.2 / 1+4.5%)3 +(11.2
/ 1+4.5%)4 + (8.4/1+4.5%)5
=35109.66
c) Change in demand for capital and Loanable funds market
It shows how an increase in demand by companies for capital can influence the market of
loanable funds. An increase in the technical improvement can increase the capital’s marginal
product, changing the capital’s demand curve. Firms are to give money for increase in capital
acquisition by asking for funds which are loanable and leading to rise in rate of interest. Thus, in
market capital’s demand is greater leading to higher interest rates (Guo and et.al.,. 2018).
Change in loanable funds market of loanable funds and capital demand
Second example can be when events in the market affect the capital firms hold. If customer
increase consumption which supplies less of funds at any rate of interest. Consumer preferences’
change affects the loanable funds’ supply.
d) Changes in rate of interest are to affect likely the rate of exchange as rate of interest, inflation
and exchange rates are highly related with each other. On manipulation of rate of interest, central
bank may influence over inflation and rate of exchange and interest rate change can affect

currency values. Higher interest rate give lenders a high return comparing with other countries. If
rate of interest is high, it can bring in foreign capital and increase the exchange rates. Impact of
interest rate being high is slowed if inflation in the country is high, comparing to others.
Opposite relation is existing for decrease in rates of interest which is lower rate of interest
influence to decrease rate of exchange.
Q2.)
i) It can be seen that Australia and New Zealand Banking Group have interest rate as 0.75%
which is on daily compounding basis. Thus, calculating the same, we get
Time period= 4 years= 4*365= 1460
Rate of interest=0.75%
Interest on one day= 0.75% of 15000= 112.5
Interest on whole time period= 112.5*1460= 164250
Total sum earned= 15000+164250=179250.00.
ii) If the interest is earned frequently in each year, it will add up to the investment horizon. This
is true that if interest is earned at a compounding rate of interest then it will add up to the amount
because at simple rate of interest one cannot get the amount as it is done only on the principal
and not the interest. In compounding rate of return, money will be compounded on the interest
earned daily and thus it will help in increasing the yield amount after the time period
(Macapinlac, 2018).
c) In this question, Compound Interest method can be used to calculate which option should be
suitable.
Formula for Amount= Principal*(1+r/100)^n
Here, Principal= Cash flow or earnings
R= compounding rate of interest
N= time period
Amount Calculation

Year 1 Cash flow Amount
1 700000 917557
2 750000 918782
3 800000 915920
4 850000 909500
Total=3661759
Computation has been done in the manner:
For year 1, amount=700000*(1+7/100)^4=917557
For year 2, amount=750000*(1+7/100)^3=918782
This implies that time period decreases as year pass on. Same has been followed in other
computations.
Amount
Year Cash flow Amount
1 800000 1048636
2 800000 980034
3 750000 858675
4 700000 749000
Total= 3636345
Amount
Year Cash flow Amount
1 750000 983097
2 775000 949408
3 775000 887297
4 775000 829250
Total= 3649052

These are all the amount value computation keeping in mind the interest on money and using rate
of interest as 7% being the factor to find the total value of money. It can be seen that Richmond
football club has the highest amount value and thus the correct option.
Q3.)
(A)
(1)
Moneyness contains three different options. All options contain different call premium
and the put premium. Every individual contain its own individual significance and benefit of
approaching the option. The first option contain the 30 as a strike value and contain 3.05 as a call
premium and the 2.33 as a put premium. The second option is 34.5 of strike carry 3.9 as a call
premium and 4.5 as a put premium. The third one is 38 as a strike, 3.2 as a call premium and the
7 as a put premium. All three options carry different situations. The option should be approached
that can provide the best level of financial outcome to the entity. Among all the option the
financial outcome is almost similar but the third option carry the maximum possible opportunity
to earn financial gain in the respective market (Xue and et.al., 2018). This option has a bright
possibility of earning potential return against making up investment. Every company seek such
investment option that carries the both long term and short term growth or profit making
opportunities in the respective market. This is stated as the best possible outcome against making
or taking up the investment decision in the market.
(2)
Moneyness has been suggested to go for the third option contains a 38 as a strike value.
This option or the choice carries the best possible opportunity to gain the financial gain against
taking up the investment decision. This option carry the 38 as a strike value and also the
difference between the call premium and the put premium is effective that make this option as a
most favourable among all other option (Tao and et.al., 2021). The aim of the investor is always
to choose or select an investment choice that can provide the best possible financial outcome or
benefits against taking up the investment decision in the market. This option would allow the
best possible investment opportunity that can provide the both long term and short term financial
growth or the profit making opportunity.

(3)
In case the 100000 shares are purchased than it would cost to 3800000. This is a huge
funds that would allow the company to gain a huge potential return against investing inn the
option. The huge investment always undertakes risk of financial loss. Stock market is totally
based on the financial risk that also contains opportunity to gain the financial profit or the return
against investing in the option.
B
(1)
Both the companies have done a investment choices for 9 months time. Even if the
options are selected for the 6 month time buy the tenure is 9 months. This would certainly cost
the interest based on the 9 months tenure. This involves the interest rate of .9% based on the term
and condition of the investment made. It can certainly demonstrated that the interst would be
allocated as a part of the agreement and would be deal by the both the companies engaged in the
contract.
(2)
Compensatory payment:
50000000 * .15% (.96% - .81%) * 9 / 12
= 56250
This would be allocated between both the parties involved in the contract. This would be
segregated into both the parties involved in the contract in against to undertake the financial risk.
Investment is always require to segregate the risk involve in the investment choice is made. This
can be done with support of strategic alliances or the contract made by the parties involved in the
agreement.
c)Derivatives to hedge risks of various types
Companies use a manoeuvre known as hedge which can lessen the risk which is involved in
interest rate risk. Hedge takes place when risk of interest rate gets decreased because of
implementing the derivative instrument. Derivative is instrument which has value got from other
assets. The assets can be stocks, currencies or bonds (Guo and et.al.,. 2018). If the Australian
mining company wants to remove the interest rate risk, company needs implementation of
perfect hedge with a type of derivative instrument. Example of instruments which can be used by

company for combating interest rate risk are forward rate agreements, futures and option
contracts, interest rate swaps etc.
Forward rate agreements
Company can make use of the forward rate agreement for reducing interest rate risk by coming
in a contract with other party for buying commodity. This contract goes into effect in a future
date with price agreed on making contract. Thus, hedging against the risk can be done by
engaging in this instrument where an investor wants to see on the interest rate while purchasing
the bond simultaneously.
Future contracts
Futures is used when a product is a stock exchange traded contract made between parties. In case
of the Australian company a risk is there that market factors can reduce bond’s value and thus
through this instrument risk can be hedged by getting in a future contract with investor
(Hernández and Benavides, 2019).
To confront the exchange rate risk, currency swap is the financial instrument or derivative which
can be used to mitigate the risk. It has involvement of interest exchange in a currency for same in
another one.
It may be used by the mining company where currency swaps can be used. They consist of two
principals which are exchanged in starting and agreement’s end. The principals are amount
already determined on which the exchange interest payment is based. Principal here is only used
as a base for calculating the interest rate payments.
For dealing with oil rate risk, purchase of current oil contracts helps serve as a derivative for risk
mitigation. Purchase of call option is another derivative which gives buyer right to make
purchase of a commodity on a given price and a given date. If company buys a call option, it
shall mean buying the right for purchasing oil in future at a price agreed on today.

Q4.)
A
On 7th April Fitch rating downgrade the Australia is 4 biggest bank credit rating. This
simply means that I'm the credit rating of the banks have decreased and this will affect the
borrower was lenders and the financial institutions to a great extent. This is pertaining to the fact
that if the credit rating will not be good than the borrower was will not borrow the money from
that Bank. Hence this will reduce the operational value of the bank as there will not be more
people taking loan from the bank. The lender that is the bank will also be affected to a great
extent. The reason pertaining to the fact is that when there will not be any borrower then the
lenders will also be not having the people to lend the money (Torre-Torres, Galeana-Figueroa
and Álvarez-García, 2021). Hence the operational cycle of the bank will be affected to a great
extent. in against of this The financial institutions will be affected in the positive manner. The
reason underlying this fact is that when banks credit rating will be lower than the people will go
to other financial institutions to take loans. Hence this will improve the operational capacity of
the financial institutions. The major implication of the downgrade to the health of the financial
system will be that now the people will not prefer to go to those banks in order to take loans.
Hence in case the biggest bank of Australia will be downgraded then this will affect the whole
financial system and its effective working.
B
i
Annual return of the market (ASX/ S&P 200) is as follows-
Annual return= (final value of investment – initial value of investment) / initial value of
investment * 100
Annual return = (7030.301 – 5550.398) / 5550.398 * 100
= 26.66 %
The proxy for the risk-free rate in Australia is being used as a 7%. This is pertaining to the fact
that with respect to the current marketing conditions of Australia it is assumed that the risk free
rate over the different investment options and their performance will be around 7%.
ii
Coefficient of variation
Coefficient of variation= (SD / mean) * 100

Fund SD Mean Coefficient of
variation
Fund A 10.75 24.61 44.22
Fund B 14.82 24.61 60.22
Fund C 12.33 24.61 50.11
Sharpe and Jensen indices of performance
Sharpe ratio= PR – RFR/ SD
Where,
PR = portfolio return
RFR = risk free rate
SD = Standard deviation
Fund PR RFR SD Sharpe ratio
Fund A 19.50 7 10.75 1.16
Fund B 28.65 7 14.82 1.46
Fund C 25.70 7 12.33 1.51
Jensen measure
Jensen alpha= PR – CAPM
Where,
PR = portfolio return
CAPM = risk free rate + β (return of market risk- free rate of return
Fund PR Risk free rate Beta Jensen indices
Fund A 19.50 7 0.873 11.627
Fund B 28.65 7 1.251 20.399
Fund C 25.70 7 1.005 17.695
C
The colonial first state wholesale imputation fund is a type of fund which provides
investors with exposure to Australian equity ISM which are having the possibility of resulting in
capital growth for linger period of time and increase in tax income with help of dividend

payment method (Trinks and et.al., 2018). The major objective of this fund is to provide long-
term capital growth including some tax effective income. The main aim of this fund is to perform
better than the ASX 300/ S&P accumulation index..
In against of this the Vanguard emerging market share index fund is a type of fund which
results in tracking up the return relating to the MSCI within the emerging market index. This
type of fund provides a exposure relating to low cost which listed company within the emerging
market. This allows the investor to participate within the long-term potential investment options.
In addition to this type of fund results in different values which frequently fluctuates depending
on the foreign exchange currency.
The risk involved within the colonial first state wholesale imputation fund is high. In
against of this the risk involved within the Vanguard emerging market share index fund is
comparatively low.
In against of this the colonial first state imputation fund is suitable for the investors who
are looking for straight forward returns which are subject to investment risk which can include
the loss of income and capital as well (Mohamadi, Mohamadi and Esmaili Kia, 2021). In contrast
to this the Vanguard emerging market stock index fund is appropriate for different types of
investors which have the objective of returns benefitting for longer term. This also involves high
degree of risk tolerance capability within the person so that they can have high exposure to high
gains.

REFERENCES
Books and journals
Guo, J., Gang, J., Hu, N. and Utham, V., 2018. The role of derivatives in hedge fund
activism. Quantitative finance, 18(9), pp.1531-1541.
Hernández, W. and Benavides, J.B., 2019. A new perspective for the use of financial derivatives
to hedge foreign exchange rate: L-BFGS perspective to assess the strikes and principals
of plain vanilla options. Revista Activos, 17(2), pp.159-175.
Macapinlac, R., 2018. Analyzing Financial Markets.
Elwood, S.K., 2017. Accounting For Asymmetric Information And Screening In Market Models
Of The Loanable Funds And Labor Markets. Journal for Economic Educators, 17(1),
pp.14-24.
Torre-Torres, O.V., Galeana-Figueroa, E. and Álvarez-García, J., 2021. A Markov-Switching
VSTOXX Trading Algorithm for Enhancing EUR Stock Portfolio Performance.
Mathematics, 9(9), p.1030.
Trinks, A., and et.al., 2018. Fossil fuel divestment and portfolio performance. Ecological
economics, 146, pp.740-748.
Mohamadi, Y., Mohamadi, A. and Esmaili Kia, G., 2021. The Effect of Macroeconomic
Variables on Stock Portfolio Performance Based on Traditional and Modern Network.
Advances in Mathematical Finance and Applications, 6(3), pp.1-25.

Tao, Z. and et.al., 2021. Review and analysis of investment decision making algorithms in long-
term agent-based electric power system simulation models. Renewable and Sustainable
Energy Reviews. 136. p.110405.
Xue, W. and et.al., 2018. Pythagorean fuzzy LINMAP method based on the entropy theory for
railway project investment decision making. International Journal of Intelligent
Systems. 33(1). pp.93-125.

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