q2fall13

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School

University of Pennsylvania *

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Course

238

Subject

Finance

Date

Nov 24, 2024

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pdf

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5

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SECOND QUIZ FNCE 238/738 September 25, 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. Consider a stock that is worth 4 today, and in one period will be worth either 6 or 3, each with probability ½. The risk-free rate is zero. a. (5 pts) What is the value today of a European put option on this stock, expiring in one period, with strike price 5? b. (5 pts) What is the value today of a European call option on this stock, expiring in one period, with strike price 5?
2. (6 pts) Clipped from an editorial in the September 2 nd Traders Magazine: The problem with so much volume migrating off-exchange is that displayed market makers constantly find that, despite the stock trading at their limit price, their limit orders often remain unexecuted. This is because a large number of market orders, which would have normally interacted with the market maker's limit orders, are now routed to over-the-counter market makers that trade directly against that order flow. They simply match or slightly beat the displayed quotation, without having to display any quotes of their own. With so many orders being executed off-exchange, many liquidity providers feel like they are simply setting the price, taking the risk and not reaping the rewards of getting the execution. Couple that with the increased adverse selection risk, and you have a market in which many participants are hesitant to quote. What is the adverse selection risk faced by liquidity providers, and why would the practice described here make it worse?
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3. (8 pts) You are an entrepreneur with two potential projects, A and B , which each cost 100, and which have the following payoffs in Depression ( D ) and Prosperity ( P ), each of which has probability ½: D P A 60 140 B 80 130 You want to raise money toward the cost of 100 by issuing a bond with face value 100, to be paid out of the project’s payoffs. Whatever the bond issue doesn’t raise, you will pay in yourself, and you get the equity claim on the project. You cannot commit to which project you will choose after issuing the bond. You are considering adding a clause to the bond contract which allows the bondholders to liquidate the project immediately after you choose it, and pay themselves off out of the proceeds. Would such a clause help? What considerations are important? Be precise.
4. (6 pts) From the September 15 th Daily Tribune: More still needs to be done to let global banks be wound down without harming the wider economy, Swiss National Bank Chairman Thomas Jordan said in a newspaper interview published yesterday. "The too-big-to-fail problem is not yet fully solved," Jordan told Finanz und Wirtschaft. Authorities have been grappling since the collapse of U.S. investment bank Lehman Brothers five years ago with the question of how banks regarded as systemically important, or too-big-to-fail, can be recapitalised without causing panic or needing taxpayer cash. After Switzerland's biggest bank UBS had to be bailed out by the government in 2008, Swiss regulators have implemented tough new capital requirements for banks, which go beyond the rules stipulated by Basel III. "If the winding down isn't possible then the buffers will have to be raised accordingly," said Jordan, adding there were several possibilities including contingent-convertible bonds. Regarding the last point, what problems do contingent convertibles solve and how?