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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