Get premium membership and access revision papers, questions with answers as well as video lessons.
Financial Risk Management Question Paper
Financial Risk Management
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2010
UNIVERSITY EXAMINATIONS: 2010/2011
THIRD YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 306: FINANCIAL RISK MANAGEMENT (SATURDAY)
DATE: DECEMBER 2010 TIME: 2 HOURS
INSTRUCTIONS: Answer question ONE and any other TWO questions
QUESTION ONE
Differentiate between interest rate swap and currency swap. (4 marks)
State and explain the relationship between a call options price and the following determinants;
1. the underlying stock price
2. the exercise price
3. the time to maturity
4. the risk free rate (4 marks)
The following data relate to call options on two shares A and B
Calls
A B
Months to expiration 3 9
Risk free rate 10% 10%
Standard deviation of stock returns 40% 40%
Exercise price sh 55 sh 55
Stock price sh 50 sh 50
Required
1. Calculate the price of call option A if a dividend of sh 5 is due in the next 3 months.
(8 marks)
2
2. Of the two call options which would you expect to have a higher price ignoring the dividend
payment? Why? ( Do not compute) (2 marks)
Define the term hedging and explain the role of hedging in the firm ( 7 marks)
Explain the risk encountered in the use of financial derivatives by firms ( 5 marks)
QUESTION TWO
Explain two ways in which a bear spread can be created. (5 marks)
When is it appropriate to for an investor to purchase a butterfly spread? (5 marks)
Call options on a stock are available with strike prices of sh 15, sh 17.5 and sh 20 and expiration dates
in three months. Their prices are sh 4, sh 2 and sh 0.5 respectively. Explain how the options can be
used to create a butterfly spread. Construct a table showing how profit varies with stock price for the
butterfly spread. (10 marks)
QUESTION THREE
PZP limited wishes to raise sh 15m of floating rate finance. The company’s bankers have suggested
using a five year swap. PZP limited can raise fixed rate finance at 11.35%, or floating rate at LIBOR
plus 0.6. Foreten Ltd can raise fixed rate finance at 12.8% or floating rate at LIBOR plus 1.35%.
A five year interest rate swap on the sh 15m loan can be arranged with Gigbank acting as intermediary
for a fee of 0.25% per annum. PZP will only agree to the swap if it can make annual savings of at least
0.4%. LIBOR is currently 10.5%.
Required;
a) Evaluate whether or not the swap is likely to be agreed. (5 marks )
b) Show by use of a diagram how the swap can be arranged. (10 marks)
c) State and explain the advantages of using interest rate swaps ( 5 marks)
QUESTION FOUR
a) Suppose you enter into a six month forward contract on a non dividend paying stock when the stock
price is sh 60 and the risk free rate with continuous compounding is 12% per annum. What is the
forward rate? (5 marks)
3
b) A stock index currently stands at 700 .The risk free rate is 8% per annum with continuous
compounding and the dividend yield on the index is 4% per annum. What should the futures price
for a 4 month contract be? (5 marks)
c) A currency is currently worth 0.80 dollars over each of the next two months it is expected to
increase or decrease by 2%. The domestic and foreign risk free interest rates are 6% and 8%
respectively. What is the value of the value of a two month call European call option with a strike
price of 0.80 dollars? (10 marks)
QUESTION FIVE
State and explain the limitations of the black and Scholes option pricing model. (6 marks)
Distinguish between forward and future contracts (6 marks)
Consider a one year futures contract on gold. Suppose that it costs sh 3 per ounce per year to store
gold, with the payment being made at the end of the year. Assume the spot price is ah 450 and the risk
free rate is 9% per annum for all maturities, determine the future price of the gold. (6 marks)
Differentiate between a European and American option (2 marks)
More Question Papers
Popular Exams
Return to Question Papers