Deck 12: Financial Engineering and Security Design

Question 1

Assume the spot price of pork bellies is 74.50 cents per pound and the 2-year forward price is 77.30 cents. Annualized 1-year and 2-year forward interest rates are 5.0% and 5.2%, respectively. For a commodity-linked note to sell at par, what is the annual coupon?

A) 2.309 cents
B) 2.409 cents
C) 2.509 cents
D) 2.609 cents

Answer 1

D

Question 2

A risky bond promises to pay $3,000 at the end of two years. The bond has a risk neutral probability of default of 10%. If in default, the bondʹs residual payout will be $2,500. If the risk free rate is 5%, what is the yield to maturity on this bond?

A) 5.00 %
B) 6.01 %
C) 7.09 %
D) 8.14 %

Answer 2

B

Question 3

Assume the price of Mary, Inc. stock is $56.00, interest rates are 4.8%, div yield = 0, and σ = 0.35. What is the price of a $1,000 par value 2-year price-participation note paying a 5.0% annual coupon and receiving 50.0% of all price appreciation above $65.00?

A) $896.44
B) $996.44
C) $1006.44
D) $1106.44

Answer 3

C

Question 4

Will, Inc. stock is $63.35 per share. The companyʹs quarterly dividend is forecasted as $0.10 per share, increasing 5.0% every quarter. A coupon equity-linked bond, promising to pay 1
One share of Will, Inc. in 2 ₂ years pays a semi-annual coupon of $0.20. If annualized
Interest rates are 8.0%, what is the price of the bond?

A) $59.55
B) $61.14
C) $63.12
D) $65.22

Question 5

A commodity linked bond is issued with an embedded call option. The current commodity price is $110, as is the exercise price on the call option. The call option is priced at $3.41. If the promised payment on the bond is the same as the issue price of $100, what is the implied coupon if effective interest rates are 3.0% and the bond has a 1-year maturity?

A) $0.66
B) $0.77
C) $0.88
D) $0.99

Question 6

Assume the spot price of pork bellies is 75 cents per pound, the 1-year forward price is 77 cents, and the annual interest rate is 4.5%. What is the price of a zero-coupon note paying 1 pound of pork bellies in one year?

A) 77.00 cents
B) 75.00 cents
C) 72.50 cents
D) 73.61 cents

Question 7

What is the price of a 2-year equity-linked CD under the following terms? No coupon is paid. At maturity the CD pays 80.0% of the S&P 500 index appreciation. The S&P 500 price = 900, div = 0.02, σ = 0.20, and interest rates are 5.0%.

A) $890.22
B) $990.23
C) $1064.20
D) $1110.55

Question 8

Wayne, Inc. stock is $40.00 per share. The companyʹs quarterly dividend is forecasted as $0.45 per share, indefinitely. A coupon equity-linked bond, promising to pay one share of Wayne, Inc. in 3 years pays a quarterly coupon of $0.50. If annual interest rates are 4.0%, what is the price of the bond?

A) $40.56
B) $42.60
C) $44.56
D) $46.60

Question 9

A risky bond promises to pay $1,000 at the end of the year. The bond has a risk neutral probability of default of 15%. If in default, the bondʹs residual payout will be $500. If the risk free rate is 6%, what is likely price of the bond today?

A) $871
B) $925
C) $943
D) $1,000

Question 10

In a single name CDS, the counterparty providing the credit insurance is called the .

A) Default protector
B) Insurer
C) Protection buyer
D) Swap writer

Question 11

In the following scenario, how much money does the protection buyer receive on this three year bond? The bond par value = $1,000. Bond market value = $872. Risk free interest rate = 4.0%. Non-defaulted bond value = $889.

A) $111
B) $128
C) $872
D) $889

Question 12

Assume the spot price of corn is $2.30 per bushel and the 3-year forward price is $2.45. Annualized 1-year, 2-year, and 3 year interest rates are 4.2%, 4.4%, and 4.6%, respectively. For a commodity-linked note to sell at par, what is the annual coupon?

A) $0.06
B) $0.16
C) $0.26
D) $0.36

Question 13

A commodity linked bond is issued with an embedded call option. The current commodity price is $52, as is the exercise price on the call option. The call option is priced at $5.56. If the promised payment on the bond is the same as the issue price of $40, what is the yield on the bond if effective interest rates are 4.0% and the bond has a 1-year maturity?

A) 2.24%
B) 2.80%
C) 3.50%
D) 4.0%

Question 14

Dawn, Inc. stock is $37.00 per share. The companyʹs semi-annual dividend is forecasted as $0.25 per share, increasing every 6 months by 20.0%. What is the price of a zero-coupon equity-linked bond, promising to pay one share in 4 years, given annual interest rates of 6.0%?

A) $32.29
B) $33.49
C) $34.39
D) $35.69

Question 15

Albert, Inc. stock is $42.00 per share. The companyʹs quarterly dividend is forecasted as $0.50 per share, increasing 10.0% at the start of every year. What is the price of a zero-coupon equity-linked bond, promising to pay one share in 3 years, given annual interest rates of 8.0%?

A) $32.60
B) $36.20
C) $42.60
D) $62.40

Question 16

Which CDO claim has the most risk?

A) Senior tranche
B) Mezzanine tranche
C) Junior tranche
D) All are the same.

Question 17

A risky bond promises to pay $4,000 at the end of three years. The bond has a risk neutral probability of default of 20%. If in default, the bondʹs residual payout will be $3,200. If the risk free rate is 6%, what is likely price of the bond today?

A) $ 3,108
B) $ 3,207
C) $ 3,358
D) $ 4,000

Question 18

We wish to cap participation in a 3-year equity-linked option at 50.0% return. Our profit alpha is 3.0%. The S&P 500 price = 950, div = 0.015, σ = 0.22, and interest rates are 4.8%. What is the implied participation rate?

A) 0.66
B) 0.76
C) 0.96
D) 1.16

Question 19

Mel, Inc. stock is $135.00 per share. The companyʹs semi-annual dividend is forecasted as $2.10 per share, indefinitely. What is the price of a zero-coupon equity-linked bond, promising to pay one share in 3 years, given annual interest rates of 5.0%?

A) $101.35
B) $110.26
C) $123.45
D) $155.22

Question 20

A risky bond promises to pay $1,000 at the end of the year. The bond has a risk neutral probability of default of 20%. If in default, the bondʹs residual payout will be $600. If the risk free rate is 4%, what is the yield to maturity on this bond?

A) 4.08 %
B) 6.92 %
C) 9.56 %
D) 13.13 %

Question 21

Instead of issuing a pure commodity-linked debt, why would the commodity producing firm consider a combining interest plus participation in the commodity price appreciation?

Question 22

What is the primary difference between an equity-linked bond and a currency-linked bond?

Question 23

What possible tax advantage exists in equity-linked notes?

Question 24

How does a coupon bond differ from an equity-linked bond?