q1fall13 answers

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University of Pennsylvania *

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238

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Finance

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Nov 24, 2024

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FIRST QUIZ FNCE 238/738 September 11, 2013 WRITE ALL ANSWERS ON THE TEST. IF YOUR ANSWER CONTINUES ON THE BACK, MAKE A NOTE OF IT ON THE FRONT. 30 PTS / 25 MINUTES NAME:_____________________________________________ SECTION (12, 1:30 or 3):__________________________________
1. In homework 1 we saw the following prices for the 3.75% note maturing 11/15/18: Date Bid Ask Bid Yield Ask Yield 9/05/13 109-05 7/8 109-06 5/8 1.884 1.879 9/06/13 109-21 7/8 109-22 3/4 1.785 1.780 ( note that there are 184 days from 5/15/13 to 11/15/13, and 113 days from 5/15/13 to 9/5/13) a. (4 pts) Suppose you bought $25MM principal amount on 9/5/13. How much of the purchase price could you have financed with a one-day repo, if the margin had been 0.5% and the repo rate had been 0.1%? Bid price + accr. int. = 109 + 5.875/32 + (113/184)(3.75/2) = 110.3351 So $25MM principal amount = ($25MM/$100)($110.3351) = $27,583,772 So loan amt @ 0.5% margin = (0.995)($27,583,772) = $27,445,853 b. (3 pts) Consider the perspective of the counterparty on the other side of the repo from part a, i.e. the one who bought the bond on 9/5 and then sold it back on 9/6. What would this counterparty’s profit/loss have been? What considerations are important? P/L is just the interest, ($27,445,853)(0.1%)(1/360) = $76.24 If you failed to buy back as promised on 9/6, then the counterparty would have been exposed to a loss if the bond had gone down in value. As it happens, the bond went up.
c. (3 pts) On 9/5, the yield at the ask was 1.879%. In words, what does that mean? It means that, as of 9/5, the present value of the bond’s future cash flows, discounted at 1.879%, equaled the market price of the bond, i.e. the quoted ask plus accrued interest. Students could have mentioned Bond pays 3.75/2 every six months until 11/15/18, and repays principal of 100 on that date Quoted ask plus accrued interest is 109 + 6.625/32 + (113/184)(3.75/2) Other details of the ytm formula These are relevant but not necessary for full points.
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2. (10 pts) From Asset International CIO How Fast Could You Get Out of Your Hedge Fund? By Elizabeth Pfeuti (August 2, 2013) -- Investors may have to wait more than a year to redeem anything more than three quarters of their net assets from the largest US hedge funds, the Securities and Exchange Commission (SEC) has revealed. Hedge funds with more than $5 billion in assets are compelled to report their liquidity and leverage profiles to the SEC under the recent Dodd Frank Act. Figures shown to the US Congress last week indicated just 7% of assets held in these funds could be liquidated in one day or less; with fractionally more—9%—available to be sold and returned in one week or less. A quarter of assets could take a month to be sold, while 43% of assets were estimated to take up to 90 days to be traded back in to the market. If investors were prepared to wait six months, they should be able to take back 59% of their capital, and within a year some 74% of assets would be expected to be returned. The rest—26%—investors would have to wait more than a year for, the hedge fund managers told the SEC. However, the story is not as simple is just asking for the money back. More than half of the funds reported may be subjected to a gate to restrict withdrawals, which may be implemented by a manager or fund governing body. While more than three quarters—77%--of these funds may be subjected to a total suspension of investor withdrawals or redemptions, the SEC reported hedge fund managers as telling them…. What does this tell you about 1) the exposure of hedge funds to runs, and 2) their defenses against runs? It shows that hedge funds have large positions in securities that would take a long time to liquidate at a good price. Thus, liquidations to meet excess redemptions can impose losses on those that do not redeem, encouraging investors to leave if they expect others to leave. It is also relevant that hedge funds are likely to liquidate their most liquid investments first, making the fund as a whole less liquid, which also encourages investors to leave. We didn’t cover this much in class so I’m not holding out for it. Regarding defenses against runs, locking investors up for long periods keeps them from running, and gates to lower upon excessive withdrawals serve to suspend convertibility. We discussed in class how gates at some funds can amplify withdrawals at other funds, due to redemptions from funds of funds, but I’m not holding out for that either.
3. (5 pts) From an August 2013 Moody’s press release: Moody's assigns Prime-2 rating to Plains All American commercial paper Moody's Investors Service assigned a Prime-2 rating to Plains All American Pipeline, L.P.'s (PAA) commercial paper program. Moody's also affirmed PAA's Baa2 long-term debt rating with a stable outlook. PAA will issue commercial paper for general corporate purposes and to fund working capital and short-term inventory positions related to its optimization activities… RATINGS RATIONALE PAA's Baa2 and Prime-2 ratings reflect its solid operational and financial positioning as a leading midstream master limited partnership (MLP), as well as sound risk management and liquidity practices… Still, PAA is showing consistent growth in EBITDA and cash flow, as well as cash retention and equity issuance to support its capital spending. The ratings also factor in PAA's experienced management team, effective risk management practices in merchant marketing, and tailoring of cash distributions to growth in underlying core operational cash flows. Given its MLP distributions, working capital needs and periodic acquisitions, we view conservative and attentive liquidity management as paramount for PAA. The company has adequate liquidity and a policy to maintain unused committed bank facilities sufficient at all times to backstop the $1.5 billion maximum commercial paper outstanding…. Suppose you manage a money fund and you’re considering a purchase of PAA’s paper. What does it mean to you that PAA has this backstop? It means that PAA can pay down my paper in case of a market meltdown, so I am defended against a run on the CP market. It does not mean an unconditional guarantee of my paper.
4. (5 pts) In our model of bank runs, the consumers are risk averse. In words, what role does this play in the argument that the risk of runs is a result of the role banks play in consumer welfare? Because they are risk averse, consumers prefer insurance against surprise cash needs before their investments pay off, so they can benefit from bank deposits that pay them more in the short term than long-term investments liquidate for, at the expense of getting less than the investments pay at maturity. So banks pay depositors more than investments can be liquidated for in the short term, and this is what makes it impossible for the bank to pay everybody in the short term, and therefore, is what encourages depositors to run if they think others will run.
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