Questions

1. Exposure to Interest Rate Risk. Is the cost of funds obtained by finance companies very sensitive to market interest rate movements? Explain?

2. Regulation of Finance Companies. Describe the kinds of regulations that are composed on finance companies.

3. Liquidity Position. Explain how the liquidity position of finance companies differs from that of depository institutions such as commercial banks.

4. Exposure to Interest Rate Risk. Explain how the interest rate risk of finance companies differs from that of savings institutions.

5. Exposure to Credit Risk. Explain how the default risk of finance companies differs from that of other lending financial institutions.

6. Risk of Treasury bond Funds. Support or refute the following statement: Investors can avoid all types by purchasing a mutual fund that contains only Treasury bonds.

7. Exposure to Exchange Rate Movements. Explain how changing foreign currency values can affect the performance of international mutual funds.

8. REITs. Explain the difference between equity REITs and mortgage REITs. Which type would likely be a better hedge against high inflation? Why?

9. How Private Equity Funds Can Improve Business Conditions. Describe private equity funds. How can they improve business condition? Money that individual and institutional investors previously invested in stocks is now being invested in private equity funds. Explain why this should result in improved business conditions.

PROBLEM.

1. Currency Call Options. Use the following information to determine the probability distribution of net gains per unit from purchasing a call option on British pounds.

· Spot rate of the British pound is $1.45.

· Premium on the British pound option is $0.04 per unit.

· Exercise price of a British pound option is $1.46.

· Your expectation of the British pound spot rate prior to the expiration of the option is.

Possible outcome for future Probability

spot rate

$1.48 30%

1.49 40

1.52 30

2. Covered Interest Arbitrage. Assume the following information.

· British pound spot rate=$1.58

· British pound one-year forward rate=$1.58

· British one-year interest rate=11%

· U.S one-year interest rate=9%

Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 9%. What would be their yield? Explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.