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FNE311 Assignment 4 Ans

This document contains 6 questions and answers about financial markets and institutions. 1) It explains the difference between a hostile takeover, where the target firm does not want control to pass, versus a merger where both sides work together. 2) It describes how margin trading works, calculating a 14% return for a trade that closes at a higher price than the opening price. 3) It shows how limit orders are filled from a limit order book based on example market and limit orders received. 4) It calculates the impact on interest income for a bank's mortgage when the interest rate drops after 6 months, showing a 5.5% reduction in interest income. 5) It defines the interest

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225 views

FNE311 Assignment 4 Ans

This document contains 6 questions and answers about financial markets and institutions. 1) It explains the difference between a hostile takeover, where the target firm does not want control to pass, versus a merger where both sides work together. 2) It describes how margin trading works, calculating a 14% return for a trade that closes at a higher price than the opening price. 3) It shows how limit orders are filled from a limit order book based on example market and limit orders received. 4) It calculates the impact on interest income for a bank's mortgage when the interest rate drops after 6 months, showing a 5.5% reduction in interest income. 5) It defines the interest

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charles03281991
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Financial Markets and Institutions

Chuhai College of Higher Education


2013
Exercise 4
1. What is the difference between a hostile takeover and a merger?
Ans:
In a hostile takeover, the target firm does not want control to pass to the acquiring
firm, and so its management makes every effort to prevent the takeover from
happening. In a merger, both sides work together to expedite the union of the
firms.
2. You want to buy 100 shares of a stock currently trading at $50 per share. Your
brokerage firm allows margin sales with 50% opening margin and a maintenance
margin of 25%. What does this mean? If you close your position with the shares at
$53.50, what is your return?
Ans:
The value of the shares you want to purchase is 100 $50 $5,000. With a 50%
opening margin, you can give your broker $2,500, and your broker will lend you
the rest.
A25%maintenancemarginmeansyourequitypositioncannotfallbelow25%.
Thequestionishowlowthepricecanfallbeforeyoumustdepositadditional
funds.Tofindthis,solveforthepriceXasfollows:
100 X 2500
0.25,orX$33.33.Ifthepricefallsbelow$33.33,amargin
100 X

callwilloccur.
Ifyoucloseyourpositionataprice$53.50,thevalueif100$53.50$5,350,
oragainof$350.Sincethisonlyrequired$2,500fromyou,thepercentagegain
is350/250014%.
3. The limit order book for a security is as follows:
Unfilled Limit Orders
Buy Orders
Sell Orders
25.12
100
25.20
500
25.23
200
25.36

300

25.37
200
25.41
200
The specialist receives the following, in order:

Market order to sell 300 shares

Limit order to buy 100 shares at 25.38

Limit order to buy 500 shares at 25.30


How, if at all, are these orders filled? What does the limit order book look like
after these orders?
Ans:
(1)[email protected]@25.20
(2)[email protected]
(3)isnotfilled,andgoesintothebook
Afterthese,thebooklookslike:
UnfilledLimitOrders
Buy

Orders

Sell

Orders

25.12

100

25.36

200

25.20

400

25.38

200

25.30

500

25.41

200

4. A bank issues a $100,000 variable-rate 30-year mortgage with a nominal annual


rate of 4.5%. If the required rate drops to 4.0% after the first six months, what is
the impact on the interest income for the first 12 months?
Ans:
At4.5%,therequiredpaymentiscalculatedas:
PV100,000,I4.5/12,N360,FV0
ComputePMT.PMT506.685
Ifrateremainat4.5%,themortgagebalanceafter12monthsis:
PMT506.685,N348,I4.5/12,FV0
ComputePV.PV98,386.71,or$1,613.29ofthepaymentswenttoward
principal.
Thetotalpayments506.68512$6,080.22.
Interestincomefortheyearis$6080.22$1613.29$4,466.93
Ifratesdropto4%forthelast6monthsoftheyear:
First,calculatetheinterestforthefirstsixmonths:
PMT506.685,N354,I4.5/12,FV0
Compute PV. PV 99,202.38, or $797.62 of the payments went toward

principal.
Thetotalpayments506.6856$3,040.11.
Interestincomefortheyearis$3040.11$797.62$2,242.49ofinterest
income. Next,calculatetheinterestforthelastsixmonths:
At4.0%,therequiredpaymentiscalculatedas:
PV 99,202.38, I 4.0/12, N 354, FV 0
ComputePMT.PMT477.772
PMT477.772,N348,I4.0/12,FV0
ComputePV.PV98,312.41,or$889.97ofthepaymentswenttoward
principal.
Thetotalpayments477.7726$2,866.63.
Interestincomefortheyearis$2866.63$889.97$1,976.66ofinterest
income.
Totalinterestincome$2,242.49$1,976.66$4,219.15
Interestincomehasfallenby$247.78,or5.5%,belowwhatitwouldhavebeen
hadtheinterestratenotfallen.
5. Calculate the income gap for a financial institution with rate-sensitive assets of
$20 million and rate-sensitive liabilities of $48 million. If interest rates rise from
4% to 4.8%, what is the expected change in income?
Ans:
GAPRSARSL
$20million$48million
$28million
I GAPi
$28million0.008
$224,000million

6. The manager for Tyler Bank and Trust has the following assets to manage:
Asset
Value
Duration (in Years)
Bonds
$75,000,000
9.00
Consumer loans
$875,000,000
2.00
Commercial loans
$700,000,000
5.00
Liability
Value
Duration (in Years)
Demand deposits
$300,000,000
1.00

Saving account
??
0.50
If the manager wants a duration gap of 3.00, what level of saving accounts
should the bank raise? Assume that any difference between assets and liabilities
is held as cash (duration = 0).
Ans:
DURa(9.0075/1650)(2.00875/1650)(5.00700/1650)3.59
AssumethattheSavingAccountsvalueY.
DURl[1.00300/(300Y)][0.50Y/(300Y)]
DURgapDURa(L/ADURl)
3.003.59[(300Y)/1650][1.00300/(300Y)0.50Y/(300Y)]
Y1347

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