END OF SEMESTER EXAMINATION
MODULE TITLE: Global Finance & Capital MODULE CODE: FI6101 Markets
SEMESTER: Autumn ACADEMIC YEAR: 2012/13
PERCENTAGE OF TOTAL MARKS: 70 DURATION OF EXAM: 2.5 hrs

LECTURER(S): EXTERNAL EXAMINER:

INSTRUCTIONS TO CANDIDATES:

• Section A: Question 1 is Compulsory.

• Section B: Answer three questions.

• All questions carry equal marks.
SECTION A: Compulsory

Question 1

a) Briefly describe two functions of secondary markets
(5 marks)

b) The interest rates on one- to five-year bonds are currently 3.25%, 3.75%, 4.25%, 4.75% and 5.5%. The term premiums for one- to five year bonds are 0%, 0.25%, 0.35%, 0.40% and 0.50%

Based on this information predict what the one-year interest rate will be three years from now.
(5 marks)

c) Demonstrate how a change in the liquidity of a financial asset influences its price relative to other assets.
(5 marks)

d) How does Moral Hazard affect a firm’s choice between debt and equity contracts?
(5 marks)

e) Briefly describe two monetary policy tools used by the ECB.

(5 marks)
Total 25 marks

Section B

Question 2

Part a

Calculate the Duration of a €100 five-year 8% coupon bond when the market interest rate (yield to maturity) is 6%.

Using the duration calculated, above, estimate the approximate change in the bond price if the market interest rate increases to 7%

Explain how the duration of a bond is affected by the coupon rate. What does this relationship tell you about the link between a bond’s coupon and its interest rate sensitivity?
(8 marks)

Part b
Describe the Expectations Theory of term structure of interest rates. What facts about the term structure does the expectations theory explain? Does the Expectations Theory offer a complete explanation of the term structure?
(11 marks)

Part c
How does a change in expected inflation impact on the demand and supply of bonds?

(6 marks)

Total 25 marks

Question 3

Part a
Explain what aspects of the yield curve might lead it to being a leading indicator of economic activity? Outline any evidence of which you are aware of on the strength of this relationship.
(7 marks)

Part b
What problems does the presence of asymmetric information cause in financial markets? How do financial intermediaries reduce the impact of asymmetric information?
(11 marks)
Part c
Briefly explain how the mismanagement of financial liberalisation or innovation can play an important role in the initiation of a financial crisis
(7 marks)

Total 25 marks
Question 4 (long essay)

“The Crisis has shaken the very foundations of modern-day financial theory, which rested on the hypothesis that our financial markets were basically efficient. Financial writers and economists alike were ready to write obituaries for the “efficient market hypothesis”
(Malkiel, 2011)

Discuss what is meant by the ‘efficient market hypothesis’ (EMH). On what basis have critics argued that the recent financial crisis undermines the EMH? Do you believe that these critiques are based on a valid understanding of the EMH and are supported by the available evidence? Overall, in your opinion where does the EMH now stand following the financial crisis?
Total 25 marks

Question 5

Part a
Briefly outline the arguments for and against the independence of central banks?
(6 marks)

Part b
Explain the pros and cons of Inflation Targeting as monetary policy strategy to achieve price stability.
(10 marks)

Part c
Premier Ltd next dividend payment is expected to be 27c per share. The required rate of return on the firm’s shares is 11%. If you believe that the firm can maintain a dividend growth rate of 5%, what is the fair value of a share in the firm?
(3 marks)

Part d
The dividend discount model is prone to valuation errors. Briefly explain how these errors may arise in the context of practically using the dividend discount model to value shares.
(6 marks)

Total 25 marks

END OF SEMESTER EXAMINATION
MODULE TITLE: Global Finance & Capital MODULE CODE: FI6101 Markets
SEMESTER: Autumn ACADEMIC YEAR: 2012/13
PERCENTAGE OF TOTAL MARKS: 70 DURATION OF EXAM: 2.5 hrs

LECTURER(S): EXTERNAL EXAMINER:

INSTRUCTIONS TO CANDIDATES:

• Section A: Question 1 is Compulsory.

• Section B: Answer three questions.

• All questions carry equal marks.
SECTION A: Compulsory

Question 1

a) Briefly describe two functions of secondary markets
(5 marks)

b) The interest rates on one- to five-year bonds are currently 3.25%, 3.75%, 4.25%, 4.75% and 5.5%. The term premiums for one- to five year bonds are 0%, 0.25%, 0.35%, 0.40% and 0.50%

Based on this information predict what the one-year interest rate will be three years from now.
(5 marks)

c) Demonstrate how a change in the liquidity of a financial asset influences its price relative to other assets.
(5 marks)

d) How does Moral Hazard affect a firm’s choice between debt and equity contracts?
(5 marks)

e) Briefly describe two monetary policy tools used by the ECB.

(5 marks)
Total 25 marks

Section B

Question 2

Part a

Calculate the Duration of a €100 five-year 8% coupon bond when the market interest rate (yield to maturity) is 6%.

Using the duration calculated, above, estimate the approximate change in the bond price if the market interest rate increases to 7%

Explain how the duration of a bond is affected by the coupon rate. What does this relationship tell you about the link between a bond’s coupon and its interest rate sensitivity?
(8 marks)

Part b
Describe the Expectations Theory of term structure of interest rates. What facts about the term structure does the expectations theory explain? Does the Expectations Theory offer a complete explanation of the term structure?
(11 marks)

Part c
How does a change in expected inflation impact on the demand and supply of bonds?

(6 marks)

Total 25 marks

Question 3

Part a
Explain what aspects of the yield curve might lead it to being a leading indicator of economic activity? Outline any evidence of which you are aware of on the strength of this relationship.
(7 marks)

Part b
What problems does the presence of asymmetric information cause in financial markets? How do financial intermediaries reduce the impact of asymmetric information?
(11 marks)
Part c
Briefly explain how the mismanagement of financial liberalisation or innovation can play an important role in the initiation of a financial crisis
(7 marks)

Total 25 marks
Question 4 (long essay)

“The Crisis has shaken the very foundations of modern-day financial theory, which rested on the hypothesis that our financial markets were basically efficient. Financial writers and economists alike were ready to write obituaries for the “efficient market hypothesis”
(Malkiel, 2011)

Discuss what is meant by the ‘efficient market hypothesis’ (EMH). On what basis have critics argued that the recent financial crisis undermines the EMH? Do you believe that these critiques are based on a valid understanding of the EMH and are supported by the available evidence? Overall, in your opinion where does the EMH now stand following the financial crisis?
Total 25 marks

Question 5

Part a
Briefly outline the arguments for and against the independence of central banks?
(6 marks)

Part b
Explain the pros and cons of Inflation Targeting as monetary policy strategy to achieve price stability.
(10 marks)

Part c
Premier Ltd next dividend payment is expected to be 27c per share. The required rate of return on the firm’s shares is 11%. If you believe that the firm can maintain a dividend growth rate of 5%, what is the fair value of a share in the firm?
(3 marks)

Part d
The dividend discount model is prone to valuation errors. Briefly explain how these errors may arise in the context of practically using the dividend discount model to value shares.
(6 marks)

Total 25 marks