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TERM 1 AY2008-09

Mid-Term Test
18th Oct 2008

FNCE102
FINANCIAL INSTRUMENTS, INSTITUTIONS AND MARKETS

INSTRUCTIONS TO CANDIDATES

1 The time allowed for this test paper is 2 hours.

2 This test paper contains 2 sections.

Section 1: 15 MCQ questions (1 mark each)


Section 2: 5 Short answer questions (5 marks each)

There are a total of Ten (10) pages including this instruction sheet.

3 You are required to answer ALL questions.


FNCE102

SECTION 1: MCQ

Please choose the correct answer from choices (A) to (E). (1 mark each)

For Questions 1 & 2:

On Nov 18, 2005, you invested in a Yen denominated CD of equivalent US$12mil at JPYUSD:
0.0075/80, yielding 15% pa.

Table: Exchange Rates on May 18, 2007


Rate A Rate B
EURUSD 1.0980 1.0990
USDJPY 122.10 122.25
GBPUSD 1.6723 1.6733
USDSGD 1.3960 1.3970

Qn 1
At the start, how much in foreign currency should you have after conversion of your domestic
currency?

A) JPY0.0075mil
B) JPY0.0080mil
C) JPY1,500mil
D) US$1,500mil
E) JPY1.5mil

Solution: C

Step 1

Convert US$8mil to Yen (Sell US$, buy Yen) = US$12mil / US$0.0080/JPY1 = JPY1,500mil

Qn 2
What is your US$ gain from the investment today, May 18, 2007?

A) US$3.03mil
B) US$6.03mil
C) US$12.03mil
D) US$1,500mil
E) US$2,500mil

Solution: A

Step 2

Earn interest of 15% pa, 18 months earn = 22.5%.


P+I = JPY1,500mil (1.225) = JPY1,837.5mil

Step 3

On May 18, 2007, Convert Yen back to US$

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(sell Yen, buy US$ at USDJPY ask rate 122.25)


= JPY1,837.5mil / JPY122.25 per US$1 = US$15.03mil

Gain = US$15.03mil – US$12mil = US$3.03mil

Question 3

A Financial Institution is going to liquidate some of its assets (listed below) at short notice, due to
an internal crisis. The sale values are listed in the table below. Calculate the 1 year liquidity index
for these assets.

Asset Face Value ($) 1 year sale value ($) Current sale value ($)
Stock A 25 million 30 million 20 million
Bond B 25 million 35 million 22 million
Loan C 60 million 65 million 45 million
Fixed asset D 20 million 30 million 15 million

A) 0.15
B) 0.65
C) 0.89
D) 1.57
E) 1.92

Solution: B

Liquidity Index
= (25/130)(20/30) + (25/130)(22/35) + (60/130)(45/65) + (20/130)(15/30)
= 0.6455

Question 4

Which of the following is false?

A) Singapore corporate bonds are actively traded in the secondary market.


B) Offshore corporate bonds, on the other hand, are thinly traded in the Asian Dollar
Bond secondary market.
C) Singapore companies would rather rely on the stock market and private placement of
bonds for capital expenditure programs, than public offering of bonds.
D) Treasury bills are quoted as discounts from par value.
E) In a competitive bid for SGS, the applicant wants to be allotted the yield specified in the
application.

Solution: A

A is false because:
Singapore corporate bonds are also inactively traded, as most are held till maturity.

The rest are true because:


C) More well-informed of the stock market and private placement of bonds is faster for
raising funds.

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Question 5

Figure (a) Figure (b)

Which of the following is true?

A) A reversal pattern is shown in Figure (a).


B) Figure (b) shows a head and shoulders continuous pattern.
C) Figure (a) shows a bear flag.
D) Figure (b) shows a wedge continuous pattern.
E) A downtrend breakout is shown in Figure (b).

Solution: C

The rest are false because:


A) Figure (a) is a continuous pattern.
B) Figure (b) shows a head and shoulders reversal pattern.
D) There is no wedge pattern here.
E) There is no downtrend breakout pattern here. A downtrend breakout is when the share price
penetrates the resistance line, showing the end of a downtrend.

Question 6

Which of the following is false?

A) Additional funds can be raised through rights issues, in which existing shareholders can
purchase new shares at the subscription price.
B) In a rights offering, the existing shareholder can reject the rights offer within a time period.
C) After employees of the firm are paid, shareholders are entitled to a claim on the firm’s
liquidated assets.
D) Raising funds through a private placement is faster than a public offering.
E) Shareholders must vote in proxy so as to ensure the firm is managed by capable personnel.

Solution: E

E is false because:
Voting can be done in person too.

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Question 7

Which of the following is false regarding the revamp of SGX’s listing rules?

(A) SESDAQ is transformed into a sponsor-supervised board.


(B) The Main Board’s focus will be both “Size” and “Quality”.
(C) A Full Sponsor may engage in both Introducing Activities as well as Continuing Activities.
(D) After the Sponsor determines suitability for listing, there are at least 10 other minimum
quantitative criterias on the listing applicant for Catalist.
(E) Catalist aims to attract both local and foreign growing companies to list.

Solution: D

Given that the Sponsor determines suitability for listing, there will be no minimum quantitative
requirement on the listing applicant, only to submit working capital statement.

Question 8

Happy Plant company announces a rights offering, under which it hopes to sell another 3 million
shares. Each shareholder will receive 0.5 right for each share owned. Share price of the company
before the rights offering is $20. If the right allows purchase of a share at a 30% discount after the
rights offering, what is the value of all your rights? (Assume 1 right can be exchanged for 1 share
in the new issue, your stake in the company is 0.5%. Company initially has 6 million shares
outstanding.)

A) $4
B) $20
C) $60,000
D) $90,000
E) None of the above

Solution: C

You own = 0.5% x 6mil = 30,000 shares


After rights offering: you receive = 0.5 x 30,000 = 15,000 rights to buy 15,000 new shares

Total Market Value of Company before rights = $20 x 6 mil shares = $120 mil
Total Market Value of Company after rights
= ($20 x 6 mil old shares) + ($14 x 3 mil new shares) = $120 mil + $42 mil = $162 mil

Share price after rights issue = $162mil/9mil shares = $18/share


Your Right allows you to buy new share (worth $18) at $14.
Hence, value of 1 Right = $4

Your ownership interest is unchanged:


Before (30,000/6mil) = 0.5%
After (45,000/9mil) =0.5%

Value of all your rights for 15,000 rights x $4 = $60,000

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Question 9

Which of the following is described as direct finance?

A) You borrow $85,000 from a relative.


B) You set up a credit line with a finance company.
C) You buy shares of common stock in the secondary market.
D) You invest in a unit trust.
E) You take out a mortgage loan from your local bank.

Solution: A

Only A has direct contact between deficit and surplus units.


For secondary markets, unit trusts, finance companies and local banks, there is no direct contact.

Question 10

Which are characteristics of Money market instruments?

(i) High default risk


(ii) Small denominations
(iii) High transaction costs
(iv) Liquid

A) i, ii only
B) i, iii only
C) iii only
D) iv only
E) All (i) to (iv)

Solution: D

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Question 11

The major types of Money market instruments traded in Singapore include:

(i) Treasury Bills


(ii) Negotiable certificates of deposits
(iii) LT convertible bond
(iv) Bills of exchange

A) i, ii only
B) i, ii, iii only
C) i, ii, iv only
D) i, iv only
E) All the instruments listed.

Solution: C

(iii) LT convertible bond is a LT capital market instrument.

Question 12

Which of the following can complete the following sentence?

Liquidity risk exposure _________________ .

(i) May lead to insolvency problems.


(ii) Is the risk of having insufficient cash on hand for a bank to meet deposit withdrawals & loan
demand.
(iii) Is the risk of obtaining additional borrowings at low cost.
(iv) Can be measured by ratio comparisons.

A) i, ii only
B) i, ii, iii only
C) ii, iii only
D) i, ii, iv only
E) All (i) to (iv)

Solution: D

(iii) is incorrect because:

(iii) Is the risk of obtaining additional borrowings at high cost.

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Question 13

Which of the following is false?

(A) When a board lot has 1000 shares, trading 800 shares is an odd lot trading.
(B) Shares on the former SESDAQ of SGX have high price volatility because they are majority of
small companies in the electronics sector.
(C) Former SESDAQ was set up to help small companies (SMEs) raise funds.
(D) One of the criteria for listing on SGX’s Main Board is minimum 5 years Operating Track
Record.
(E) In Singapore, share transactions can be conducted without a broker.

Solution: D

D is false because:

(D) One of the criteria for listing on SGX’s Main Board is minimum 3 years Operating Track
Record.

E is true because:

In Singapore, investors in shares can walk into any authorized trading centre located in selected
branches of local banks, and special counters operated by SGX stock brokerage firms to buy and
sell shares without going through a broker.

Question 14

In 1 year’s time, nominal interest rate in Britain is 8% pa, while that in US is 14% pa. Which of the
following is true, if we assume real interest rates are the same in both countries and purchasing
power parity holds. Spot exchange rate: US$1.6728/GBP1

A) Nominal interest rate spread between Britain & US is 8% pa.


B) GBP depreciates in 1 year’s time.
C) 1 year forward rate is GBP0.5640/US$1
D) Both GBP and US$ appreciates in 1 year’s time
E) 1 year forward rate is US$1.5724/GBP1

Solution: C

Spot exchange rate: US$1.6728/GBP1

Int (US) – Int (Britain) = 6% = Inflation (US) – Inflation (Britain)


= Change in Exchange rate/Spot Exchange rate
Change in Exchange rate = 6% x US$1.6728 = US$0.1004
New Exchange rate = US$1.6728 + US$0.1004 = US$1.7732/GBP1
= GBP0.5640/US$1

GBP appreciates, US$ depreciates.

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Question 15

Mr Mitsumoto plans to invest in either Japanese or British deposits. Assume British deposits pay
13% pa and spot exchange rate is JPY206.21/GBP1. 3 months forward rate is JPY200.00/GBP1.
If we assume interest rate parity holds and his investment horizon is 3 months, how much should
the Japanese deposits be paying?

A) 0.56% pa
B) 0.98% pa
C) 1.89% pa
D) 2.66% pa
E) 3% pa

Solution: A

Return on Japanese investment = Return on GBP (foreign) investment


1+IJPY = (1/Spot ex. Rate) x (1+IGBP) x (Forward ex. Rate)
1+IJPY = (1/206.21) x (1+3.25%) x (200) = 1.0014

IJPY = 0.14% for 3 months


IJPY = 0.56% for 1 year

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SECTION 2: Short Answer Qns


Please write your answers in the answer booklets provided. (5 marks each)

Question 1

a) A zero-coupon T-bill has a face value of US$55,000, with a bid quote of 2.8% pa, and a bid-
ask spread of 25 bp. Assume today (July 2, 2006) you invest in this bill, which will mature on Nov
16, 2006, how much are you paying for it? (bp = basis points) (2 marks)

Solution:

Bid quote = 2.8%


Ask quote = 2.8% - 0.25% = 2.55%

Use Discount Yield formula.

Id = [(P1 – P0) / P1] x 360/h

Where:

Id = 2.55%
P1 = US$55,000
P0 = ask price = US$54,466.27
h = 137 days to maturity = 29 + 31 + 30 + 31 + 16 = 137
360 calendar days is used because US$ denominated T-bills

b) Why are Singapore Government Securities issued in Singapore? (3 marks)

Solution:

1. To control money supply in the economy.


2. To develop Singapore’s capital markets and enhance investors’ knowledge on securities.
3. To help banks meet the regulatory liquidity requirements as SGS is a risk-free liquid asset.

Question 2

a) Explain the “sinking fund” condition for a bond indenture and how does it work? (4 marks)

Solution:

What is it?
This provides for a systematic retirement of a bond issue. This requires the issuing company to
call and retire a portion of its bonds each year. This is designed to protect the bondholders by
assuring that the issue is retired in an orderly manner. This type of bond is considered to be safer
& typically carry a lower interest rate.

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How it works?
 Firm deposits money with bond trustee periodically, who invests and uses the accumulated
sum to retire the entire bond issue at maturity.
 Firm handles sinking fund payments itself:
- Funds used to retire bonds periodically by the firm itself are pegged to the firm’s
earnings or sales, or
- A mandatory fixed amount is used periodically by the firm itself to retire bonds.

b) State one Restrictive Covenant found in a Bond Indenture. (1 mark)

Solution:

 the conditions under which the issuer can pay off the bonds prior to maturity,
 restrictions against dividend payments unless earnings meet certain specifications and,
 the level of interest payments must be kept below a certain ratio if there are additional debt
issues.

Question 3

Elaborate on any 2 of the 3 functions of Indirect Finance played by Financial Institutions.


(5 marks)

Solution:

3 functions of Indirect Finance played by FIs. (Refer Lecture 1 notes)


1. Reduce Transaction costs
2. Risk Sharing
3. Reduce Information Asymmetry problems

Question 4

a) Using graphs, show how is the Security Market Line different from the Characteristic Line.
(3 marks)

Solution:

Refer to Lecture 5.
Must explain that the slope of CL is Beta, but the x-axis of SML is Beta.

b) Using graphs, show examples of both a “continuous” and “reversal” stock price chart patterns
that are used in technical analysis. (2 marks)

Solution:

Continuous: Flag, Wedge, Triangle


Reversal: Head & shoulders, Breakout

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Question 5

a) For the next 2 years, ABC company’s dividends are expected to grow at a rate of 10% pa. In
the 3rd year, the growth is 15% pa. Thereafter, a constant growth rate of 8% pa is expected. The
company has just paid dividends of $1.10. Find the stock price today if we assume a required rate
of return of 12% pa. (3 marks)

Solution:

Step 1: Calculate the sum of the PVs of the dividends in the supernormal growth period.

D0 = $1.10
D1 = $1.10 (1.10) = $1.21
D2 = $1.21 (1.10) = $1.33
D3 = $1.33 (1.15) = $1.53

Sum of all PVs = PV (D1, D2, D3)


= $3.23 (A)

Step 2: Find the PV of the stock price at the end of Year 3.

P3 = D4 / (r – g) = [D3 (1 + g)] / (r – g)
= [$1.53 (1 + 8%)] / (12% - 8%)
= $41.25

PV of P3 = $29.36 (B)

Step 3: Sum (A) and (B)


Stock price today = $3.23 + $29.36 = $32.59

b) Explain the zero-growth dividend model. (2 marks)

Solution:

 Dividends are a constant amount.


 If stock is expected to pay dividends forever, each dividend has a smaller PV than the
preceding one.
 As time gets longer, PV of the future dividends approaches zero. Equivalent to a
perpetuity.

 Formula:
Stock Value = Dividend / Discount rate
Expected rate of return = Dividend / Stock Price

- End -

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