Index Effect - Economics of Financial Markets - Exam, Exams of Financial Accounting

Download Index Effect - Economics of Financial Markets - Exam and more Exams Financial Accounting in PDF only on Docsity! EC362 Semester 2 2011 Page 1 of 6 Ollscoil na hÉireann, Gaillimh GX_____ National University of Ireland, Galway Semester 2 Examinations 2011 Exam Code(s) 3BA1, 3BA5, 4BA4, 3BC1, 4BC2, 4BC3, 4BC4, 3FM2, 1EM1, 1OA1, 1EK2, 1EK3 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, HDip. Economic Science 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. J. McHale C. Twomey Instructions: Section A – answer all questions (25 marks) Section B - answer 3 out of 5 questions (75 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 2011 Page 2 of 6 SECTION A Answer all questions. This section is worth 25 marks. Each question is worth 2.5 marks. NB: Write your answers in the answer book, not on the exam paper. 1. Portfolio risk is reduced by combining securities with: a) high standard deviations. b) low standard deviations. c) less than perfect correlation. d) perfect correlation. 2. The “index effect” refers to: a) a positive abnormal return from the announcement of an addition to the FTSE100 Index. b) the larger capitalisations of FTSE100 Index firms. c) the pressure of firms in an index to increase dividends. d) the higher returns earned by indexed portfolio compared to actively managed portfolios. 3. If four shares (A, B, C and D) have coefficients of variation of 1.80, 2.00, 1.55 and 1.35, which one has the most attractive risk/return relationship? a) A b) B c) C d) D 4. When AXP is at 44, a strike price 40 put option is: a) in the money. b) at the money. c) out of the money. d) none of these. 5. A P/E ratio of 25 implies: a) a dividend yield of 4%. b) an earnings yield of 4%. c) a ROE of 25%. d) a ROA of 25%. EC362 Semester 2 2011 Page 5 of 6 B3. “Behavioural finance endeavours to bridge the gap between neoclassical finance and cognitive psychology,” as quoted in ‘Behavioural Finance: Quo Vadis?’ by DeBondt et al (2008). Outline the key building blocks of behavioural finance and critically discuss any two applications of behavioural finance to investing in financial markets. (25 marks) B4. Several valuation methods can be applied to assess whether stock markets are fairly valued or not. Consider the data on stock market ratios and 10-year government bond yields from the Financial Times, February 11th, 2011. Dividend Yield Price /Earnings 10-year Govt. Bond Yields S&P Ratings France 3.2 16.2 3.67 AAA Germany 2.4 16.0 3.30 AAA Ireland 1.5 20.3 9.10 A- Greece 2.9 20.1 11.47 BB+ Portugal 3.6 5.8 7.38 A- Japan 1.8 15.7 1.31 AA- UK 2.8 14.8 3.88 AAA US 1.7 17.7 3.65 AAA (a) The FT table above includes data on the P/E ratio and dividend yield. Explain clearly how you would each of these two methods as a valuation tool for stock markets and briefly outline what the current data indicate for the US stock market as compared to Portugal and Ireland. Are there limitations to these metrics? (8 marks) (b) Define the bond-equity yield ratio. Using the 10-year government bond yield data, calculate the bond-equity yield ratio for Ireland and Germany. (5 marks) (c) Explain briefly any 4 factors which Standard & Poor’s would have used to rate Germany as AAA versus Portugal as A-. How are these ratings differences reflected in the bond market? (5 marks) (d) What is the difference between investment-grade and speculative-grade bonds? Explain briefly how this distinction may explain the differences in bond yields shown in the table above. Why are bond ratings alone not sufficient to explain the variation in 10-year government bond yields? (7 marks) EC362 Semester 2 2011 Page 6 of 6 B5. (a) Explain briefly the difference between hedging and speculating using financial derivatives. (9 marks) (b) Below are UK equity options data from February 11th 2011 (Financial Times). CALLS PUTS Option Feb Mar Apr Feb Mar Apr AstraZeneca 3000 47.5 86.5 109.5 20.5 59 79 (*3026.5) 3100 8.5 41 62 82.5 113 131.5 Aviva 450 11 19 19.5 3.75 12.25 22.75 (*456.8) 460 5.25 13.5 14.25 8 16.75 29 BP 470 10 17 22 3 10 14.5 (*476.7) 480 4.5 11.75 16.75 7.5 14.75 19.25 i. Illustrate, using diagrams, the difference between a call option and a put option, using an example of each from the table above. ii. Identify and describe the two main components of option value. Calculate both components for the following options: • AstraZeneca 3000 Mar call • BP 470 Apr put iii. Based on the data above for Aviva, suppose you buy one Mar 450 call and sell one Mar 460 call. Calculate your maximum potential profit and loss at expiration and illustrate it using a diagram. Is this a bearish or bullish position? (16 marks)