FIN 564 FINAL EXAM
Answer 14 of the 15 questions in the space provided. Mark the one that you want to omit
by putting an “X” through the question.
1. Should countries forgo using their own currency and adopt as legal tender a stable foreign
currency? Address the following in your answer:
a. Give two advantages and two disadvantages of dollarization.
Advantages: Lower cost of foreign credit; enhance credibility of government policy; stability;
international trade.
Disadvantages: lose seignorage; lose lender of last resort; lose control of monetary policy.
b. Does a country need permission to dollarize? No
c. Would dollarization be reversible? Yes – but difficult.
2. What are the differences in the structures of the New York and Nasdaq exchanges? How
are stocks traded on each? What role (or roles) does a specialist or market maker play in
the two exchanges?
NYSE: physical trading floor; auction market; specialist is charged with maintaining a fair and
orderly market.
NASDAQ: over-the-counter, electronic market; dealer market; multiple market-makers make a
market in stocks.
3. Barr Bank has just purchased bonds for $106 million that have a par value of $100
million, three years remaining to maturity, and an annual coupon rate of 14 percent. It
expects the required rate of return on these bonds to be 12 percent one year from now.
a. At what price could Barr sell these bonds one year from now?
N=2; FV=100; PMT=14; i=12%; PV=?=103.38 million.
b. What will be the duration of the bonds in one year?
Duration = (14*1/1.12 + 114*2/(1.12)2)/Price = 1.8877 years.
c. What is the bond’s current yield today? 14/106=13.21%
4. Define the term “duration” in the context of fixed income securities. What is meant by
the terms “price risk” or “interest rate risk”? What is the relationship between “interest
rate risk” and duration? Duration is a measure of a bond’s maturity that takes into
account both coupon and principal payments. Price risk and interest rate risk refer to
price fluctuations due to changes in interest rates. The longer the duration – the greater
the interest rate risk.
5. “Municipal-Bond Fans Get a Rude Awakening” (WSJ 2/8/05) Summary: Last week
brought losses of 15% or more for a group of bonds with a solid triple-A rating. The
losses occurred when New York City exercised the call feature on some of their
municipal bonds. A call feature allows the issuer to redeem the bond early at a set price
(usually a few percentage points above par value).
a. What is a municipal bond? Why would an investor prefer a municipal bond to a
non-municipal one? Municipal bonds are issued by state and local governments
and are exempt from federal taxes.
Answer 14 of the 15 questions in the space provided. Mark the one that you want to omit
by putting an “X” through the question.
1. Should countries forgo using their own currency and adopt as legal tender a stable foreign
currency? Address the following in your answer:
a. Give two advantages and two disadvantages of dollarization.
Advantages: Lower cost of foreign credit; enhance credibility of government policy; stability;
international trade.
Disadvantages: lose seignorage; lose lender of last resort; lose control of monetary policy.
b. Does a country need permission to dollarize? No
c. Would dollarization be reversible? Yes – but difficult.
2. What are the differences in the structures of the New York and Nasdaq exchanges? How
are stocks traded on each? What role (or roles) does a specialist or market maker play in
the two exchanges?
NYSE: physical trading floor; auction market; specialist is charged with maintaining a fair and
orderly market.
NASDAQ: over-the-counter, electronic market; dealer market; multiple market-makers make a
market in stocks.
3. Barr Bank has just purchased bonds for $106 million that have a par value of $100
million, three years remaining to maturity, and an annual coupon rate of 14 percent. It
expects the required rate of return on these bonds to be 12 percent one year from now.
a. At what price could Barr sell these bonds one year from now?
N=2; FV=100; PMT=14; i=12%; PV=?=103.38 million.
b. What will be the duration of the bonds in one year?
Duration = (14*1/1.12 + 114*2/(1.12)2)/Price = 1.8877 years.
c. What is the bond’s current yield today? 14/106=13.21%
4. Define the term “duration” in the context of fixed income securities. What is meant by
the terms “price risk” or “interest rate risk”? What is the relationship between “interest
rate risk” and duration? Duration is a measure of a bond’s maturity that takes into
account both coupon and principal payments. Price risk and interest rate risk refer to
price fluctuations due to changes in interest rates. The longer the duration – the greater
the interest rate risk.
5. “Municipal-Bond Fans Get a Rude Awakening” (WSJ 2/8/05) Summary: Last week
brought losses of 15% or more for a group of bonds with a solid triple-A rating. The
losses occurred when New York City exercised the call feature on some of their
municipal bonds. A call feature allows the issuer to redeem the bond early at a set price
(usually a few percentage points above par value).
a. What is a municipal bond? Why would an investor prefer a municipal bond to a
non-municipal one? Municipal bonds are issued by state and local governments
and are exempt from federal taxes.
