Download Short Hedge - Economics of Financial Markets - Exam and more Exams Financial Accounting in PDF only on Docsity! 1 Ollscoil na hÉireann, Gaillimh GX_____ National University of Ireland, Galway Semester II Examinations 2010 Exam Code(s) 4FM2 Exam(s) 4th B.Sc. in Financial Mathematics and Economics Module Code(s) EC410 Module(s) Economics of Financial Markets Seminar I Paper No. 1 Repeat Paper Special Paper External Examiner(s) Prof. C. Ryan Internal Examiner(s) Prof. J. McHale C. Twomey Instructions: EC410 Students Answer 3 questions in Section A If you attempt MORE THAN the correct number indicate clearly those questions which you wish to be graded. The use of calculators is permitted - programmable calculators may not be used. Duration 2hrs No. of Answer Books 1 Requirements: Statistical Tables - Yes Department(s) Economics 2 SECTION A - Answer 3 Questions 1. (a) Explain, using a numerical example, when a short hedge may be appropriate using futures contracts. (11) (b) If U is the present value of all the storage costs that will be incurred during the life of a futures contract, S0 is the spot rate, r is the domestic risk-free rate, the futures price can be written as: Suppose that, instead of the equality holding, . As an arbitrageur, explain what strategy you can implement to profit from this situation. What are the likely effects of many arbitrageurs pursuing similar strategies? (10) (c) A trader owns gold as part of a long-term investment portfolio. The trader can buy gold for $890 an ounce and sell it for $880 per ounce. The trader can borrow funds at 4% p.a. and invest funds at 3.5% p.a. (both interest rates are expressed with annual compounding). For what range of 1-year gold futures prices does the trader have no arbitrage opportunities? Assume there is no bid-ask spread for futures prices. (12) 2. (a) A bank finds that its assets are not matched with its liabilities. It is taking floating- rate deposits and making fixed-rate loans. How can swaps be used to offset this risk? (9) (b) Explain the differences between a plain vanilla interest rate swap and a plain vanilla currency swap. Using diagrams, show how the comparative advantage argument may be made in both cases. (11) (c) A currency swap has a remaining life of 15 months. It involves exchanging interest at 4% on £20 million for interest at 2.5% on $30 million once a year. Assume the term structure of interest rates in the UK and US is currently flat and that if the swap were negotiated today the interest rates exchanged would be 3% in sterling and 2.25% in dollars. All interest rates are quoted with annual compounding. The current $/£ exchange rate is $1.65. What is the value of the swap to the party paying sterling? What is the value of the swap to the party paying dollars? (13)
