FIN3020

Exam Time Table

Code FIN3020

Approved calculators only permitted

LEVEL 3

EXAMINATION OF THE DEGREE OF BACHELOR OF SCIENCE

(Finance)
Friday, 14th August 2020 9:30 AM - 11:30 AM

Examiners: Prof Barbara Casu and the internal examiners

Answer any TWO questions from SECTION A AND any TWO questions from section B
Allocation of marks within questions is shown
You have TWO hours to complete the paper (one additional hour is provided for
downloading questions and uploading your answers)
DEADLINE Your answers must be submitted by 12:30 on Test Date. This is a strict deadline which
must be adhered to.

UPLOADS Your answers should be submitted via https://canvas.qub.ac.uk

If you need to use handwritten answers there are several options:

• Submit individual photos directly to Canvas using your phone browser at https://canvas.
qub.ac.uk (this may work better than using the Canvas app); or

• Download the Microsoft Lens app to your phone to produce a PDF, and upload this to Canvas
via your OneDrive (https://community.canvaslms.com/docs/DOC-10560-4212675755); or

• Email yourself the photos to compile them on your computer, and then submit via Canvas

CONTACT DURING THE TEST

If you have queries during the test you can email declan.french@qub.ac.uk. If you have broadband
issues and need to use the phone, you can contact the Management School office on 028 9097
4200. If you have technical queries, such as around accessing Canvas, you can contact the Exams
Office at exams@qub.ac.uk

STATEMENT OF INTEGRITY
By submitting the work, I declare that:

1. I have read and understood the University regulations relating to academic offences, including
collusion and plagiarism:
http://www.qub.ac.uk/directorates/AcademicStudentAffairs/AcademicAffairs
/GeneralRegulations/Procedures/ProceduresforDealingwithAcademicOffences/

2. The submission is my own original work, and no part of it has been submitted for any other
assignments, except as otherwise permitted;

3. I give my consent for the work to be scanned using a plagiarism detection software.

4. I agree to complete an oral assessment if requested to do so.

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Answer any TWO questions from SECTION A,

AND any TWO questions from section B

SECTION A
Question 1. .

(a) Suppose that a bond with a par value of $100 is purchased between coupon
periods. The days between the settlement date and the next coupon period
is 115. There are 183 days in the coupon period. Suppose that the bond
purchased has a coupon rate of 7.4% and there are 10 semiannual coupon
payments remaining.

(i) What is the dirty price for this bond if a 4.3% discount rate is used?

(ii) What is the accrued interest for this bond?

(iii) What is the clean price?

(60 marks)
(b) What is meant by coupon stripping in the UK Gilts market? Illustrate the
process by considering the example where 500 million pounds of a 10-year
fixed-principal gilt with a coupon rate of 5% is stripped to create zero-coupon
gilts.
(40 marks)

Total 100 marks

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Question 2. .

An investor plans to retire in 10 years. As part of the retirement portfolio, the

investor buys a newly issued, 12-year, 7% annual coupon payment bond. The
bond is purchased at par value, so its yield-to-maturity is 7.00% stated as an
effective annual rate.

(a) Calculate the approximate (effective) Macaulay duration for the bond, using
a 1 bp increase and decrease in the yield-to-maturity and calculating the
new prices per 100 of par value to six decimal places.

(60 marks)

(b) Calculate the duration gap at the time of purchase.

(10 marks)

(c) At the time of purchase, does this bond entail the risk of higher or lower
interest rates? Interest rate risk here means an immediate, one-time,
parallel yield curve shift.

(30 marks)

Total 100 marks

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Question 3. .

Use the table below, showing breakeven annual swap rates to answer the following questions.

Maturity Coupon
1 3.20%
2 3.40%
3 3.55%
4 3.70%
5 3.80%

(a) Bootstrap the swap curve to calculate discount factors for each of the 5 years.
(40 marks)
(b) Calculate the breakeven rate for a 3Y swap beginning in one year’s time.
(30 marks)
(c) What is the present value of a swap with four years to maturity and a fixed leg
rate of 5%?
(30 marks)

Total 100 marks

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SECTION B
Question 4. .

(a) A corporate bond portfolio manager was overhead asking: Why do I need a
credit risk model ? I can get information about the probability of default from
credit ratings. How would you respond to this portfolio manager?
(50 marks)
(b) Explain the concept behind the Merton model.
(50 marks)

Total 100 marks

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Question 5. .

(a) The Mercury Company is a fixed-income management firm that manages the
funds of pension plan sponsors. For one of its clients it manages $200 million.
The cash flow for this particular clients portfolio for the past three months was
$20 million, -$8 million, and $4 million. The market value of the portfolio at the
end of three months was $208 million. Answer the below questions.

(i) What is the dollar-weighted rate of return for this clients portfolio over the
three-month period?
(ii) Suppose that the $8 million cash outflow in the second month was a result
of withdrawals by the plan sponsor and that the cash flow after adjusting
for this withdrawal is therefore zero. What would the dollar-weighted rate
of return then be for this clients portfolio?

(50 marks)
(b) Explain the challenges faced by portfolio managers attempting to fund a series
of future liabilities.
(50 marks)

Total 100 marks

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Question 6. .

(a)

(i) A bank offers a 10 year loan to a company for $5m charging quarterly
interest rate payments of LIBOR + 125bps. A feature of the loan is that
they promise never to charge more than 6%. How can such a product be
structured by the bank, and how will it impact the terms on which the loan
is offered?
(ii) The customer from the previous question would like to reduce their
borrowing costs. How might the bank accommodate such a request
without reducing their profit margin?

(50 marks)
(b) A company is planning to borrow money in one year for a 10 year period. It
may or may not require the funds, but knows it can borrow at 3M LIBOR +
75bp. For budgeting, the company would be more comfortable with a fixed
rate and therefore intends to use a swap but is also worried about rising rates.
Explain how the company may use a swaption in this situation. Explain also
how to value a swaption.
(50 marks)

Total 100 marks