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Question: a)

When a known cash outflow in a foreign currency is hedged by a company using a forward contract, there is no foreign exchange rate risk. When it is hedged using futures contracts, the marking to market process does leave the company exposed to some risk. Consider whether the company is better off using a futures contract or a forward contract when the value of the foreign currency rises rapidly during the life of the contract.

Hedge position gains when foreign currency rises, forward is better Hedge position gains when foreign currency rises, futures is better Hedge position loses when foreign currency rises, futures is better Hedge position loses when foreign currency rises, forward is better b)

A German company, Metallgesellschatt (MG), sold a huge volume of 5 - to 10 -year heating oil and gasoline fixed-price supply contracts to its customers at 6 to 8 cents above market prices. The company then hedged its exposure using short-dated futures contracts that were rolled forward, a strategy known as 'Stack & roll", As the price of oil tell, there were margin calls on the futures positions. In the end, the company abandoned the foxed-price contracts with its customers and closed out all the futures hedge positions with a loss of billon. Which of the following is WRONG?

"Stack & roll" is a potential source of duration mismatch in hedging. "Stack & roll" is a good strategy as the short term futures contracts are very liquid. A hedging strategy could potentially create liquidity problems. MG's hedging disaster here is the mismatch of quantity of the underlying asset. c)

(Source: Citi's Q1 2009 report) "Citigroup reported ... its first quarterly net profit in nearly two years, .... It made a profit of binion US dollars compared with a loss of billion a year earlier. Revenues rose to billion. But it gained from an accounting rule that allowed the bank to post a one-time gain of billion ... a net positive CVA (Credit Valuation Adjustment) on derivative positions, ..., mainly due to the widening of Cit's CDS (credit default swap). spreads." Which of the Following is WRONG?

A widening of Citi's CDS spreads indicate a worsening of credit rating and a higher default probability of Citigroup. CVA and DVA are relevant only when the OTC derivative contract is uncollateralised and has a non-zero marked to market value. The greater the losses made in the OTC uncollaterised derivative contract, the higher the probability of own detault, the higher the DVA associated profit. The international accounting standards allows companies (including financial institutions) to take into account CVA but not DVA.

d)

Margin accounts help to reduce credit risk of derivatives. Which of the following is Not true?

lf the margin account falls below the initial level, the trader is required to deposit a further amount. The margin account acts as a guaranteed that the trader can cover any losses on the futures contract. Margin is money deposited by the trader with his or her broker for derivatives traded in an exchange. The marking to market process leads to margin account being adjusted dally. e)

A one-year forward contract on a non-dividend paring stock is entered into at fair value when the stock price is $82. The price of the stock is sis monts later, and at $72 at maturity The risk free interest rate is 8% per annum with continuous compounding. Which of the following is WRONG?

The terminal cash flow of the future 6 contract is . At contract initialisation, the strike price is . If interest rate has been on an increasing trend during this period, the terminal value of the sum of all cash flows of the futures contract will be lower If interest rate has been on an increasing trend during this period, the futures price will be lower. f)

The treasurer of a company might not hedge the company's exposure to a particular risk, because:

experience more risk if it does not hedge If there is a loss on the hedge and a gain from the company's exposure to the underlying asset, the treasurer might feel that he or she will have difficulty The shareholders might not work the company to hedge because the risks are not hedged within their portfolios more risk if it does not hedge

The current dollar/swiss franc spot exchange rate is S0= 1.10$/SF. The 90-day future price to buy or sell 1 million Swiss franc is = 1.08US$/SFr

Which of the following is NOT true?

The US$/SFr futures price follows a contango. For a trader who needs to long dollar, hedging using futures (instead of unhedge) will on average lead to higher input cost For a trader who needs to long Swiss franc, hedging using futures (instead of unhedge) will on average lead to a lower input cost. It is normally more expensive for a long hedge with the contango curve due to the positive cost of carry.

1. What is the beta of a portfolio with E(rp) = 18%, if rf = 6% and E(rM) = 14%? 2. You are a consultant to a large manufacturing corporation that is considering a project with the following net after-tax cash flows (in millions of dollars): Years from Now After-Tax Cash Flow 0 40 1 10 15 The project's beta is 1.8. Assuming that rf = 8% and E(rM) = 16%, what is the net present value of the project? What is the highest possible beta estimate for the project before its NPV becomes negative? 3. Are the following true or false? (a) Stocks with a beta of zero offer an expected rate of return of zero. (b) The CAPM implies that investors require a higher return to hold highly volatile securities. (c) You can construct a portfolio with a beta of 0.75 by investing 0.75 of the investment budget in bills and the remainder in the market portfolio. 4. Assume that the risk-free rate of interest is 6% and the expected rate of return on the market is 16%. A share of stock sells for $50 today. It will pay a dividend of $6 per share at the end of the year. Its beta is 1.2. What do investors expect the stock to sell for at the end of the year? 5. Assume that the risk-free rate of interest is 6% and the expected rate of return on the market is 16%. A stock has an expected rate of return of 4%. What is its beta? Why would anyone consider buying this risky asset which provides an expected return less than the risk-free rate? 6. In 1997 the rate of return on short-term government securities (perceived to be risk-free) was about 5%. Suppose the expected rate of return required by the market for a portfolio with a beta measure of 1 is 12%. According to the capital asset pricing model (security market line): (a) What is the expected rate of return on the market portfolio? (b) What would be the expected rate of return on a stock with = 0?

(c) Suppose you consider buying a share of stock at $40. The stock is expected to pay $3 dividends next year and you expect it to sell then for $41. The stock risk has been evaluated by = .5. Is the stock overpriced or underpriced? 7. True or False? (a) CAPM says that all risky assets must have positive risk premium. (b) The expected return on an investment with a beta of 2.0 is twice as high as the expected return on the market. (c) If a stock lies below the security market line, it is under valued. 8. If we regress the stocks' average risk premium (return minus the riskfree rate) on their betas, what should be the slope and the intercept according to the CAPM? 9. If we regress a stock's risk premium on the risk premium of the market portfolio, what should be the slope and the intercept according to the CAPM? 10. The risk-free rate is 5%, the expected return on the market portfolio is 14%, and the standard deviation of the return on the market portfolio is 25%. Consider a portfolio with expected return of 16% and assume that it is on the efficient frontier. (a) What is the beta of this portfolio? (b) What is the standard deviation of its return? (c) What is its correlation with the market return? 11. Your future father-in-law is 60 years old. He shows you his portfolio: Assets Holdings Cash $ 50,000 S&P 500 Index Fund 100,000 Analog Devices Inc. 200,000 He asks you to forecast how much the portfolio will be worth in 5 years when he retires. The risk-free rate is 6% per year, the average return on the market portfolio is 12%, the beta of the S&P index is 1.0, and the beta of Analog Devices is 1.5. (a) What is the expected rate of return on the portfolio, assuming the CAPM holds? (b) What is the forecasted portfolio value after 5 years?

Please answer the following questions which are based on QYLD:

QYLD - Global X NASDAQ 100 Covered Call ETF

Please describe the construction of QYLD. Please depict the theoretical payoff pattern of QYLD. Explain why QYLD may generate high dividends even though the stock market does not move at all. If the stock market crashes, QYLD will have massive losses. Do you agree? Please explain. QYLD should perform better than RYLD in the long run. Do you agree? (Provide your proof.) RYLD - Global X Russell 2000 Covered Call ETF

What are the advantages of the index model compared to the Markowitz procedure for obtaining an efficiently diversified portfolio? Use the case of 80 stocks to illustrate your point. Briefly describe the regression equation, the expected return-beta relationship, and the risk and covariance in the context of the Single Index Model. With the Single Index Model, please explain the "costs" of the simplification. Finally, explain briefly the diversification argument that is neatly highlighted by the Single Index Model (e.g., equation 8.16), employing the elements.

(c) Suppose you consider buying a share of stock at $40. The stock is expected to pay $3 dividends next year and you expect it to sell then for $41. The stock risk has been evaluated by = .5. Is the stock overpriced or underpriced? 7. True or False? (a) CAPM says that all risky assets must have positive risk premium. (b) The expected return on an investment with a beta of 2.0 is twice as high as the expected return on the market. (c) If a stock lies below the security market line, it is under valued. 8. If we regress the stocks' average risk premium (return minus the riskfree rate) on their betas, what should be the slope and the intercept according to the CAPM? 9. If we regress a stock's risk premium on the risk premium of the market portfolio, what should be the slope and the intercept according to the CAPM? 10. The risk-free rate is 5%, the expected return on the market portfolio is 14%, and the standard deviation of the return on the market portfolio is 25%. Consider a portfolio with expected return of 16% and assume that it is on the efficient frontier. (a) What is the beta of this portfolio? (b) What is the standard deviation of its return? (c) What is its correlation with the market return? 11. Your future father-in-law is 60 years old. He shows you his portfolio: Assets Holdings Cash $ 50,000 S&P 500 Index Fund 100,000 Analog Devices Inc. 200,000 He asks you to forecast how much the portfolio will be worth in 5 years when he retires. The risk-free rate is 6% per year, the average return on the market portfolio is 12%, the beta of the S&P index is 1.0, and the beta of Analog Devices is 1.5. (a) What is the expected rate of return on the portfolio, assuming the CAPM holds? (b) What is the forecasted portfolio value after 5 years?