Expectations Theory - Economics of Financial Markets - Exam, Exams of Financial Accounting

Download Expectations Theory - Economics of Financial Markets - Exam and more Exams Financial Accounting in PDF only on Docsity! EC362 Semester 2 2009 Page 1 of 6 Ollscoil na hÉireann, Gaillimh GX_____ National University of Ireland, Galway Semester 2 Examinations 2009 Exam Code(s) 3BA1, 3BA5, 4BA4, 3BC1, 4BC2, 4BC3, 4BC4, 3FM2, 1EM1, 1OA1 Exam(s) B.A., B.A. (Public & Social Policy), B.A. (Economic & Social Studies), B.Comm., B.Comm. International, 3rd B.Sc. in Financial Mathematics and Economics, Erasmus, International Students Module Code(s) EC362 Module(s) ECONOMICS OF FINANCIAL MARKETS Paper No. 1 Repeat Paper Special Paper External Examiner(s) Prof. C. Ryan Internal Examiner(s) Prof. E. O’Shea C. Twomey Instructions: Section A – answer all questions (12 marks) Section B - answer 4 out of 6 questions (88 marks) There are 100 marks in total. All questions will be marked equally. If you attempt MORE THAN the correct number indicate clearly those questions which you wish to be graded. Duration 2hrs No. of Answer Books 1 Requirements: None No. of Pages 5 Department(s) Economics EC362 Semester 2 2009 Page 2 of 6 SECTION A Answer all questions. This section is worth 12 marks. NB: Write your answers in the answer book, not on the exam paper. A1. If the interest rate is 9 percent on euro-denominated assets and 11 percent on peso- denominated assets, and if the euro is expected to appreciate at a 3 percent rate relative to the peso, then A) euro-denominated assets have a higher expected return than peso-denominated assets. B) the expected return on euro-denominated assets in pesos is 6 percent. C) the expected return on peso-denominated assets in euros is 8 percent. D) both (a) and (b) of the above will occur. E) both (a) and (c) of the above will occur. A2. According to the expectations theory of the term structure A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds. B) interest rates on bonds of different maturities move together over time. C) buyers of bonds prefer short-term to long-term bonds. D) all of the above. E) only (a) and (b) of the above. A3. You would be less willing to purchase Irish government bonds, other things equal, if A) brokerage fees for trading on stock markets decline. B) you expect interest rates to rise. C) gold becomes more liquid. D) any of the above occurs. E) either (b) or (c) of the above occurs. A4. The Economist’s Big Mac index offers an informal guide as to whether currencies are at their correct levels, according to the notion of purchasing-power parity. Assume the U.S. price of a Big Mac was $3.54 in February 2009. Country Big Mac Price Actual Exchange Rate Denmark 29.50 Kr 5.82 KR/$ Russia 62 Rouble 35.7 Rouble/$ The percentage under- or over-valuation of each currency versus the U.S. dollar according to the Big Mac version of purchasing-power parity is as follows: A) Denmark: +64%; Russia: -45% B) Denmark: +30%; Russia: -104% C) Denmark: +43%; Russia: -51% D) Denmark: +43%; Russia: -49% E) Denmark: +30%; Russia: -51% EC362 Semester 2 2009 Page 5 of 6 B4. (a) At year-end 2008, the City of London expected Tesco’s dividends would grow at 8% for 3 years, after which growth would fall to a long-term rate of 4%. Analysts also projected a required rate of return of 10% for the UK equity market and that the UK T-Bill rate would be 1.5% and that Tesco had a beta of 0.9. As an equity analyst, suppose that you decide to use the following two-stage dividend growth model: 4 31 2 1 2 3 3 ( ) (1 ) (1 ) (1 ) (1 ) D DD D k g P k k k k ! = + + + + + + + Explain the logic behind the above equation to calculate Tesco’s share price. Using the data in the table below and the above formula calculate the implied fair price of Tesco shares using the dividend growth model. (8 marks) (b) Define the price-earnings (P/E) ratio. Using the data in the table below, calculate Tesco’s historic price-earnings ratio and the price-earnings ratio relative to the FTSE 100 index as of December 31, 2008. Tesco plc Selected Financial Data Year Ending December 31, 2008 Earnings per share £0.25 Dividends per share £0.12 Other Data on Tesco Common shares outstanding (M) 7200 Closing share price 3.25 FTSE 100 Index Closing value (price) 4007 P/E ratio (average) 14.29 (3 marks) (c) The Prospective P/E ratio uses next year’s (forecasted) earnings, E1 as follows: P0 / E1 = [d1 /E1] / (k -g) For 2009, assume the payout ratio is the same as 2008 and that k is as given in part (a). If the analyst expects earnings per share to grow by 5% in 2009, calculate the prospective P/E ratio for Tesco. (4 marks) (d) Using your answers from parts (a) to (c), discuss whether Tesco’s shares appear to be a good investment as of December 31, 2008. (3 marks) (e) State one advantage and one disadvantage of both the dividend valuation and the price- earnings valuation methods used to value Tesco shares. (4 marks) EC362 Semester 2 2009 Page 6 of 6 B5. Explain in detail any approaches that can be used by currency traders to analyse short-run movements in the four major international currencies, namely the euro, US dollar, British pound sterling, and Japanese Yen. Which method(s) would you prefer? (22 marks) B6. Below are some US$ denominated bonds from the Financial Times on February 12, 2009. (a) What is the difference between investment-grade and speculative-grade bonds? Explain how credit rating agencies would evaluate a supermarket chain such as Wal Mart. (8 marks) (b) Based on the data above, explain the limitations of credit ratings for investors deciding on which bonds to buy. (7 marks) (c) Suppose that S&P and Moody’s downgrade Daimler Chrysler to speculative-grade. Why might this downgrade occur? Explain, using a diagram, what effect this ratings downgrade would have had on the interest rate (yield) spread between Daimler Chrysler corporate bonds and US government bonds. (7 marks)