Posted: September 18th, 2017

FIN 441 Practice Final

(Must show calculations in detail to earn credit)

1. The price of a put option decreases when interest rates rise. Explain why. (9 points)

2. A stock price is currently $100. Over each of the next years it is expected to go up by

4.88% or down by 2.53%. The risk-free interest rate is 2.5% per annum. What is the

value of a two-year American put that has a strike price of $100? (18 points)

Answer: $0.79

3. Would an American call be worth more than its European counterpart if the

stock (a) does not pay dividend and (b) does pay dividend? Explain. (9 points)

4. Would an American put be worth more than its European counterpart if the

stock (a) does not pay dividend and (b) does pay dividend? Explain. (9 points)

5. Why do higher interest rates lead to higher call price but lower put prices? (9 points)

6. If the futures price is lower than the spot price plus carrying cost, is there an arbitrage

opportunity? If so, design a trading strategy. (9 points)

7. Under the terms of an interest rate swap, CAT Financial has agreed to receive 12%

per annum and to pay three-month LIBOR in return on a notional principal of $200

million with payments being exchanged every three months. The swap has a

remaining life of 6 months. The three-month LIBOR is 13% per annum for all

maturities. The three-month LIBOR at the last payment date was 11% per annum.

What is the value of the swap to CAT Financial? (15 points)

Answer: VFX = $198.844m; VFL = 198.929m

8. Companies A and B have been offered the following rates per annum on a $20

million five-year loan:

___________________________________________

Fixed Rate Floating Rate

___________________________________________

Company A 13.00% LIBOR + 0.4%

Company B 15.00% LIBOR + 0.8%

__________________________________________

Company A requires a floating-rate loan; Company B requires a fixed-rate loan. A

bank, acting as intermediary, will net 0.2% per annum in a swap. What rates of

interest will A and B end up paying after the swap? (10 points)

Answer: A LIBOR – 0.3% B 14.30%

9. Explain the difference between a recombining and non-recombining tree. Which one is

more desirable? Explain why? (10 points)

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