Answers

1
Answers Explanations

• Test 1-A, Spring 2005
• Financial Markets

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WSJ, Question 1
A student answered this very eloquently. I am
putting this in anonymously, until and unless she
gives my permission to give her name. I also
took the liberty to correct for a few spelling
and typographical errors that naturally would
have occurred in this test situation.

• A specialist is supposed to match buyers to
  sellers in the market without interfering. If
  there is no match of a buyer or seller, the
  specialist is supposed to step in and act as
  either the buyer or the seller to complete the
  match. Interpositioning is when a specialist
  interferes even though there is a match between a
  buyer and a seller. An example would be if there
  was a seller offering 3.50 a share and a buyer to
  match, but the specialist steps in and buys on
  their company account for 350 and turns around
  and sells it to the buyer for 3.53.

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Other WJS questions

• 2. D
• 3. B
• 4. E
• 5. A
• 6. C

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Problem 7

• Travis is not in compliance with his margin
  requirement as his equity of 6599 is 22.57 of
  the total security value of 28,800. Travis must
  therefore sell 156 shares.

Total value 28,800 Borrowings 22,300 Equity
6,500
28,800
Value of securities to be sold 2,800
2,800 divided by 18 equals 155.56. Round up to
156 shares.
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Problem 8
Note these stock are then returned to the broker
because the arbitrageur owes the shares to the
broker. Remember that the arbitrageur borrowed
shares from his/her/its broker when the
arbitrageur sold those shares short.
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Question 9

• The definition of basis is the difference between
  the cash or spot price and the futures price. In
  other words,
• Basis cash price futures price
• Basis 48.25-48.74 - .49

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Problem 10

• On Monday nobody paid anything to anybody.
• On Tuesday, the buyer Jason paid 900 to the
  buyer, Talia.
• On Wednesday, the seller, Talia, paid 550 to the
  buyer, Jason.

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Problem 11
This H ratio is 1.0 since no matter what the
option will be in the money at expiration.
In the money at expiration
See the next slide for these hedge ratios.
Out of the money at expiration
These H ratios all equal zero since no matter
what, the option will be out of the money at
expiration
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Work for Problem 11and Problem 12
Problem 12 Answer 1.60
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Problem 13
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Problem 14

• The money does go into an account at the brokers
  under Jennifers name. She cannot use this money
  to pay off her credit-card debt. Instead, the
  broker will keep the money as collateral for the
  shares Jennifer owes the broker. She can direct
  her broker to put these funds into T-bills.
• Michael, although Jennifer will pay the amount of
  the dividends to Bob through her broker.
• Jennifer will need to buy 1000 shares at 44 to
  pay back her broker. She can use the funds she
  had in the collateral account at her brokers to
  do so. This fund will have included much more
  than the 42,000 because of margin requirements.
  She will though experience a loss of around
  2,000. In addition, she also had to pay 250 of
  dividends to Bob. She would have also earned
  interest on the 42,000. Also, since she is an
  individual investor, she will probably have to
  pay interest on the stock she borrowed.

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Problem 15

• The arbitrageur will exchange the 100,000 pesos
  for 84,940.12 reals at the Argentinean Bank. It
  will then exchange those 84940.12 reals for
  102,845.52 pesos at the Brazilian Bank. The
  profit it makes is 2,845.52 pesos.

100,000 pesos divided by 1.1773 pesos/real
84,940.12 reals. 84,940.12 reals divided by .8259
reals/peso 102,845.52 pesos.
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Problem 16, 17, and 18

• Problem 16 (a) 1.15, (b) 1.75-1.150.60
• 17. B
• 18. D

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Essay 19

• There are three differences between a perpetual
  warrant in IBM stock and a put option in IBM
  stock.
• 1. IBM issues the warrant, whereas anyone other
  than IBM can write an option on an exchange.
• 2. The perpetual warrant has no expiration date,
  whereas a put option on an exchange does have an
  expiration date.
• 3. A warrant is in essence a call option not a
  put option.

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Essay 20

• The primary market is were securities are
  initially issued such as a corporation issuing
  stock in that corporation. Such issues can be
  IPOs or secondary offerings.
• The secondary market is where securities that
  have already been issued are traded between
  investors usually other than the corporation
  itself.

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Essay 21

• Unit bond trusts have lower costs since the bonds
  in those trusts stay the same once the trust is
  established. With closed-end funds, the
  management team often reallocates the funds among
  the different bonds in the fund.

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Essay 22

• A guaranteed investment contract is normally
  issued by insurance companies, usually life
  insurance companies. This is primary a debt of
  the insurance companies. The guarantee is merely
  an obligation of the insurance company, not that
  it is guaranteed by anyone else. The credit risk
  on these contracts is that the insurance company
  will not be able to meet its obligation.

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Essay 23

• Mutual funds do not normally have to pay taxes,
  although those receiving income or capital gains
  distributions will normally pay taxes. In order
  that mutual funds not have to pay taxes, they
  must qualify as a Regulatory Investment
  Corporation, which requires that the mutual fund
  distribute at least 90 of its income to the
  mutual fund shareholders.