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FIRST QUIZ FNCE 238/738 September 10, 2014 WRITE ALL ANSWERS ON THE TEST. IF YOUR ANSWER CONTINUES ON THE BACK, MAKE A NOTE OF IT ON THE FRONT. 45 PTS / 25 MINUTES NAME:_____________________________________________ SECTION (12, 1:30 or 3):__________________________________

1. (20 pts total) [ don’t worry about accrued interest for this question ] Fannie Mae funds some of its mortgage purchases by issuing straight debt securities that are functionally equivalent to Treasury securities. It is not clear, though, whether their credit risk is as low as that of Treasury securities. On June 18 th , 2014, we see the following prices for one Fannie Mae security with a 7.25% coupon, one Treasury bond with a 6.25% coupon, and a Treasury STRIP, all maturing 5/15/30: Issuer maturity coupon bid ask Fannie Mae May 15, 2030 7.25% 146.587 147.240 U.S. Treasury May 15, 2030 6.25% 140.531 140.578 U.S. Treasury May 15, 2030 0.00% 59.893 60.091 a. (5 pts) What is the portfolio of the Treasury securities that exactly replicates the cash flows of the Fannie Mae security? b. (5 pts) Is the Fannie Mae security cheap or expensive? Explain

c. (5 pts) Which would you expect to have the higher modified duration, the zero-coupon security or the 6.25-coupon security? Explain. d. (5 pts) Suppose you bought a portfolio of the zero and the 6.25 where the weighted- average modified duration of the portfolio was zero. What would this mean for the portfolio ’ s exposure to changes in yields? Explain.

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2. (10 pts total) Suppose Ben owns $50MM principal amount of the 0-coupon security from question 1, and Ben wants to finance this position using the repo market. Jerry agrees to take the other side of this repo at a 3% margin. a. (5 pts) How much can Ben finance with this repo? b. (5 pts) If yields go up, what happens to the profit/loss of Jerry, Ben ’ s repo counterparty? What considerations are important?

3. (15 pts total) From Bloomberg News: Money Fund Rules Seen Triggering Commercial Paper Jam By Sridhar Natarajan and Adam Janofsky Jul 31, 2014 6:09 AM ET Corporate treasurers say a crackdown on money-market funds threatens to squeeze their access to the short-term financing they use for everything from paying the rent to meeting their payrolls. Companies from pesticide maker FMC Corp. (FMC) to power generator Great Plains Energy Inc. (GXP) are preparing for investors to back away from the commercial-paper market after regulations passed last week requiring some money-market funds to let their net-asset values fall below the traditional $1 a share floor. The shift may trigger a retreat from prime funds that are big buyers of the short-term corporate IOUs, precipitating an increase in borrowing costs. … a. (5 pts) What explains the new regulations? b. (5 pts) Why would this reduce demand for commercial paper? What about demand for repos?

c. (5 pts) If this does trigger a sudden drop in demand for CP, would you expect this to cause a liquidity crisis for CP issuers? Why or why not?

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