Problem Set 3 of EF 4331 Instructor: Dr.Du Du Select the best answers for questions 1-12 (2 pts each) 1. Which of the following is/are the benefits of quantitative easing in terms of stimulating the economy? i) QE drives down the home currency valuation which facilitates export ii) QE drives down price levels of domestic products and services which encourages consumption. iii) QE provides corporations with easy access to bank loans which encourages investment. A) i) and ii) only B) i) and iii) only C) ii) and iii) only D) none of the above 2. In the US, which of the following belong to monetary base but NOT to money supply? i) cash in circulation ii) bank reserves with Fed iii) vault cash A) i) only B) i) and ii) only C) i) and iii) only D) none of the above 3. Which of the following belong to the M0 measure of money supplyi) vault cash and cash in circulation ii) funds held in checking account iii) funds held in savings account A) i) and ii) only B) i) and iii) only C) ii) and iii) only D) none of the above 4. Which of the following is/are correct about moral hazard and adverse selection when it comes to deposit insurance? i) Moral hazard is when those without prudent banking practices will choose to be insured whereas those who are strong will choose not to be insured. A) i) and ii) only B) i) and iii) only C) ii) and iii) only D) none of the above 6. Which of the following statements related to money creation is/are correct? i) In the U.S. Under Basel II agreement.. the US Fed can add to the asset category of its balance sheet by purchasing either government bonds from treasury department or toxic assets from commercial banks iii) In Hong Kong. iii) An effective way to deal with moral hazard is to make deposit insurance mandatory to all banks. ii) Adverse selection is when the insured bank takes on more risk at the presence of deposit insurance than when there is no insurance. which of the following does NOT belong to Tier I capital for bank? A) Common stock B) Qualifying subordinated debts C) Retained earning . the Fed has the sole sovereignty to print out USD by crediting commercial banks with extra reserves ii) To balance the expanded liability due to money creation. HKMA has the sole sovereignty to print out HKD by crediting note issuing banks with extra certificates of indebtedness A) i) and ii) only B) i) and iii) only C) ii) and iii) only D) none of the above 5. ii) CCC+ rated debt of $2 million with a risk weight of 150%. B) is external to any government. Which of the following is true about forward and the futures contracts? i) both forward and futures contracts specify today a certain amount of the underlying at a certain price which is to be transacted at some future date .000 10.2 million B) $3.D) Preferred stock 7. the minimum of Tier I capital is 4% of the risk-weighted bank assets. the spot rate of the three month LIBOR is 6%. Consider bank A whose assets consist of i) AAA rated debt of $1 million with a risk weight of 20%.2 million C) $0. At the expiration date of the futures contract. The minimum Tier I capital required for bank A is A) $0. Suppose you enter into the long position of a Eurodollar interest rate futures with the futures price of 96. C) a country like North Korea D) none of the above 9. According to Basel II agreement.000 D) you gain $5. An Offshore banking center is A) a country whose banking system is organized to permit external accounts beyond the normal economic activity of the county. What is your profit/loss from holding this futures position? A) you lose $50 B) you gain $50 C) you lose $5.256 million 8.128 million D) $0. frequently located on old oil drilling platforms located in international waters. 405$/€ and 1. respectively. the spot and the futures exchange rate are 1. and each euro futures contract is written on €12.500. respectively. 12. Consider both a call option and a put option written on euro. The total profit/loss for the option writer is thus A) $1875 B) $687. which of the following statements is correct? A) the call option becomes cheaper whereas the put option becomes more expensive B) the put option becomes cheaper whereas the call option becomes more expensive C) both the call and the put become cheaper D) both the call and the put become more expensive.4$/€. At expiration of the option contract.15/€ and $1. Consider a put futures option written on one euro futures contract.ii) both forward and futures contracts are marked-to-market on a daily basis iii) both forward and futures contracts have standardized contract size and maturity date A) i) and ii) B) i) and iii) C) ii) and iii) D) none of A). Suppose the option premium and the strike price are $0.5 C) $625 D) $-625 .5/€. When the euro exchange rate becomes less volatile. B) or C) is correct 11. Your margin account currently has a balance of $1.1/AU$ in one year. You have a short position in one contract. Suppose the exchange rate changes to $1.5% and r¥ = 6%. Compare your result with that in a): what conclusion can you draw? 15. Consider the following two strategies.3133. b) (3 points) Calculate your profit/loss (quoted in USD) from strategy B. 13. (6pts) Assume today’s settlement price on a CME EUR futures contract is $1. you borrow one million USD and use the proceeds to buy one million AUD. a) (2 points) Calculate your profit/loss (quoted in USD) from strategy A. In strategy B.3049. and the exchange rate is $1/AU$.Questions 13-17 are quantitative problems: you need to show both the final results and the procedure with which you obtain the final results. respectively. (please round the numbers in the final results to three significant digits only) (hint: convert all exchange rates in American terms before using the Black-Scholes formula) . (8pts) Suppose today the (annualized) interest rates on USD and AUD are 0% and 4%. The strike price is $1 = ¥100. In strategy A.000.3140/EUR. r$ = 5. and the contract size is EUR125. Suppose the next three days’ settlement prices are $1. and $1. Calculate the balance of your performance bond account from daily marking-to-market for each of the next three days 14.000/F instead. $1. (10 pts) Use the European option pricing formula to find the value of a six- month at-the-money (ATM) call option on Japanese yen. where F denotes the forward exchange rate calculated in b).700.3126. and the maintenance performance bond level is $1000. you long a one-year forward contract which is written on one million AUD. The investment horizon is one year and interests are only paid at the end of the one-year horizon. The volatility is 25 percent per annum.000. (Hint: first determine the forward rate using the strict form of IRP) c) (3 points) Repeat b) when a forward contract is written on AUD 1. 16.3%. If you were an investment banker.3% LIBOR+0.6%.5 pts) Suppose firm A can issue fixed-rate debt of the same maturity at 10. compute the net borrowing position for both firms and the percentage returns for the international banker.2%) Investment banker A B Market/public .3% or floating-rate debt at LIBOR+0.3% Suppose that A prefers to issue fixed-rate debt whereas B prefers to issue floating-rate debt.7%. In addition. and LIBOR+0. Firm B can issue fixed-rate debt at 9.1%. 9.3% or floating-rate debt at LIBOR+0.3% LIBOR+0. A Fixed Floating 10.5% B 9. (10. LIBOR+0. how could you arrange an interest rate swap between A and B to make everybody happy? Write in the figure the cash flows with arrows to describe your answers.5%. (Hint: you may use the following numbers: 9. (8 pts) Suppose you buy a call option with C0 =$0. ii) $1.5/￡.5/￡ at the same time.17.5 pt each) what is your profit (loss) when the pound exchange rate one year later is i) $1.5 pts) draw the profit profile on this portfolio one year later b) (1.03/￡ and X = $1.5/￡. In addition.3/￡ .6/￡. suppose that contract sizes are ￡1m a) (3. and buy a put option with P0 =$0. iii) $1.02/￡ and X = $1. Both options are written on pounds and will expire in one year.