Answers and some Explanations

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Answers and some Explanations

• Test 2-A, Spring 2005
• Financial Markets

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WSJ Questions

• 1. D
• 2. C and F
• 3. B
• 4. Milton Friedman strongly disagreed with
  Professor Siegal and believed that the stock
  market would not crash as a result of the baby
  boom generation retiring. He did think that
  corporations would pay more out in dividends,
  which would keep retirees satisfied without their
  having to sell much stock.
• 5. Professor Siegal thought that the one thing
  that might prevent a bear market according to his
  models is if foreigners came in and bought stock
  when the retirees were selling the stock.
• 6. First the IRS will try to recoup money from
  the bond issuers. However, if that fails, then
  the IRS will tax bondholders.

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Question 7
When not running a slide show, double click on
spreadsheet to see the formulas.
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Question 8
When not running a slide show, double click on
spreadsheet to see the formulas.
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Question 9
When not running a slide show, double click on
spreadsheet to see the formulas.
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Question 10

• Time 0 actionsThe arbitrageur would first
  borrow 100,000 bebits from Bs credit market.
  The arbitrageur would exchange those 100,000
  bebits for 340,000 abits, which it then would
  lend in As credit market. The arbitrageur would
  also enter into a 360-day forward contract to
  exchange 363,800 abits for 113,687.5 bebits.
• Time 1 (1 year from now) actionsThe arbitrageur
  would receive 363,800 abits on the 340,000 abits
  it loaned out at time 0. It would then exchange
  those 363,800 abits for 113,687.5 bebits using
  the 360-day forward contract it bought at time 0.
  The arbitrageur would then pay back the 107,000
  bebits it owes from the funds it borrowed the
  year earlier, which results in a profit of
  4,687.50 bebits.
• Profit 4,687.5 bebits

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More answers

• 11. E
• 12. A
• 13 (a) Sterling Savings will pay 7500 to Fannie
  Mae.
• 13(b) Fannie Mae will pay 8500 to Sterling
  Savings
• 14. (a) None since LIBOR is below the strike
  rate.
• (b) 1,000,000 (10-8)500,000
• (c) 500,000 (9-8)500,000

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15. Commercial Paper

• Commercial Paper is short-term debt that is
  usually unsecured and issued by an organization
  such as a corporation to the public.
• Commercial Paper in the U.S. almost never exceeds
  270 days because otherwise it must be registered
  with the SEC.
• Most Commercial Paper in the U.S. does not exceed
  90 days, because otherwise the Federal Reserve
  will refuse to discount it at its discount window.

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16. Option embedded in mortgage

• Silvia will have the right but not the obligation
  to pay off her loan early or to make payments
  that exceed her required payments. The bank is
  the writer of this implicit option and the Silvia
  is the holder of the option.

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17. Pipeline Risk

• Pipeline risk has to do with the risk a mortgage
  lender faces between when the lender agrees to
  lend the money and when the mortgage loan is
  agreed to.
• The price risk refers to the risk the mortgage
  lender faces that the interest rate will move to
  hurt the mortgage lender when it tries to sell
  the mortgage.
• The fallout risk is the risk the lender faces
  that the borrower wont go through with the loan.

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18. Bankers acceptances

• Bankers acceptances usually do not exceed six
  months because if they did, the Federal Reserve
  would probably consider those acceptances to be
  inelligible bankers acceptances, which would
  increase the banks reserve requirements.

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19. Cross rate

• A cross rate is any exchange rate that does not
  involve U.S. dollars. For example, the exchange
  rate between the British pound and the Euro would
  be a cross rate, 1.43 euros per British pound.