UNIVERSITY OF CAPE TOWN

DEPARTMENT OF FINANCE & TAX

FTX3045S FINANCE IIB

135 MARKS 3 HOURS

PLEASE READ THE FOLLOWING INSTRUCTIONS CAREFULLY
1. Please fill in the attendance slip and complete your personal details on the
examination answer books before the start of the examination. No time is allowed for
this at the end of the examination.
2. Please fill in your personal details on the attendance slip and leave this on your desk
with your student card.
3. Ensure that your name and student number appear on the cover pages of ALL answer
booklets.
4. All cell phones must be switched off for the duration of your examination and placed
with your other possessions out of sight underneath your chair.
5. The duration of this examination paper as indicated includes reading time.
6. Answer EACH section in a separate answer book. Please ensure that you submit all
answer books at the end of the examination even if you do not use all of them.
7. No questions will be answered by the invigilators during the exam. Make whatever
assumptions you deem appropriate and clearly state these in your answer.
8. Please do not answer questions in pencil, pencil workings will not be marked.
9. Answer ALL THREE sections in this paper
Topics Marks Suggested time
Section A Combined MCQs, Bonds 74 98 minutes
Section B Derivatives 35 47 minutes
Section C International Finance 26 35 minutes
135 180 minutes

This exam paper consists of 14 pages, including the cover page, formula sheets and
the cumulative normal distribution table.

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SECTION A: [74 MARKS]

This section consists of two parts - Part A: MCQs and Part B: Bonds

PART A: MULTIPLE CHOICE QUESTIONS

3 marks for a correct answer, 0 marks for incorrect and unanswered questions.
Negative marking does not apply.
For MCQs do not present your workings.
Present your answers clearly in a vertical format.

1. A bond has a yield-to-maturity of 6.75%, a Macaulay duration of 15 years and a 20-

year maturity. By what percentage will the bond's price change if market interest
rates decrease by 0.75%? (Choose the closest answer)
A. +11.25%
B. +10.54%
C. +0.750%
D. -11.25%

2. A coupon bond is quoted an offer price of R1,130 in the Business Day newspaper. If
the last interest payment was made four months ago and the coupon rate is 12%
(paid semi-annually). Determine the all-in price if the par value is R1,000. (Choose
the closest answer)
A. R1,100
B. R1,110
C. R1,170
D. R1,160

3. The table below presents the term structure of interest rates based on 6-month
government bonds (Interest rates are quoted per annum).
Maturity period(years) Interest rate
0.5 4%
1 3%
1.5 6%
2 8%
Determine the arbitrage free value of a 2-year bond that pays a coupon of 12% with a
face value of R1,000. The bond pays coupons twice a year. (Choose the closest answer)

A. R1,301.32
B. R1,078.06
C. R1,152.48
D. R1,155.95

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4. Which of the following statements is most correct?
A. Other things held constant; a callable bond would have a lower required rate
of return than a vanilla/straight bond
B. Other things held constant; a corporation would rather issue noncallable
bonds than callable bonds.
C. For a bond with the following features: time to maturity- 10-years, face value
– R1,000, Coupon rate – 0%, yield-to-maturity – 10%. If interest rates drop to
the point where the yield-to-maturity is 5%, we could be sure the bond would
sell at a discount to the face value.
D. Reinvestment rate risk is worse from a typical investor's standpoint than
interest rate price risk.

5. If the number of compounding intervals/periods are increased within a year, it will

A. increase or decrease the effective annual interest rate depending on the
coupon rate.
B. not affect the calculation of the annual interest rate.
C. decrease the effective annual interest rate of a low coupon bond.
D. increase the annual effective interest rate.

6. Consider a put option that expires in 4 months, with an exercise price of R120 on a
stock that has a current price of R150 and a standard deviation of 20%. The risk-free
rate is currently 5%. Which of the following statements are true?

(i) The option is approximately 22% out of the money.

(ii) If the standard deviation increases to 25%, all else equal, the value of the put
option would decrease
(iii) If the risk-free rate decreases to 4,5%, all else equal, the value of the put would
increase
(iv) The intrinsic value of the put option is R30.
(v) If the current price of the stock decreases to R100, all else equal, the value of the
put would increase.

A. ii, iv
B. iii, v
C. i, iii, v
D. i, ii, iv

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7. As an expert analyst you speculate a fall in the stock price of Murray & Roberts (M&R).
You are however against naked option positions and therefore decide to take out a
spread strategy so that you can benefit from the price decrease, while also reducing
the cost of the option strategy. You are provided with the following information
below. Calculate the cost of the most appropriate option strategy?
Murray & Roberts (MUR) Underlying stock price: R6,62
Expiration Strike Call Put
December 21, 2022 R5 R2,50 R1,20
December 21, 2022 R8 R1,80 R2,20

A. R1,20
B. R0,7
C. R3,40
D. R1,00

8. Consider the following interest rate swap: Company A has issued 5,8% fixed-rate debt
and enters a swap to pay the dealer JIBAR and receive a 5,6% fixed rate. Company B
has issued floating-rate debt paying JIBAR and enters a swap to pay the dealer a 5,85%
fixed rate in return for JIBAR.
The swap dealer realizes a cash flow each period equal to ______ of notional principal?

A. JIBAR + 0,2%
B. 5,85%
C. 0,2%
D. 0,25%

9. An active manager believes that the stock of Tiger Brands Ltd (TBS) is undervalued.
She is however also concerned about a broad market downturn. She would therefore
like to make a market-neutral bet on the stock. Suppose she purchases R565 000
worth of TBS stock and the beta of the stock is 0,85. Suppose further that a 2% drop
in the broad market, would entail a profit to a short futures position of R2 000 per
contract for an INDI 25 futures contract, with a contract multiplier of 10.
How many INDI 25 futures contracts should she short in order to hedge her market
risk? (Round up to the nearest contract)

A. 2 contracts
B. 10 contracts
C. 5 contracts
D. 7 contracts

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10. Suppose that a portfolio manager has a R2 million bond portfolio with a modified
duration of 8 years. She is concerned that market interest rates are going to increase.
An analyst that she consults with predicts that the bond portfolio’s yield could rise by
50 basis points. Calculate the PVBP of the portfolio?
A. R1 600 per basis point
B. R8 000 per basis point
C. R4 000 per basis point
D. R1 000 per basis point

11. When referring to Direct Exchange Rates, which statement is true?

(i) The variation in the exchange rate is inversely related to the value of the domestic
currency.
(ii) The variation in the exchange rate is positively related to the value of the domestic
currency.
(iii) It is also known as Price Quotation.
(iv) It is also known as an Quantity Notation.
(v) It is also known as an European Notation.
(vi) It is also known as an American Notation.

A. ii, iv and v
B. i, iii and vi
C. i, iv and vi
D. ii, iv and vi

12. Assume that Pick ‘n Pay is in the market for a 3-year loan of BWP100m. At the same
time New African Properties, a listed company on the Botswana Stock Exchange, is in
the market for a 3-year SA Rand equivalent loan of BWP100m. Assume the swap bank
takes 0.3% of the savings in the interest rates and savings are shared equally between
the two firms.

South African Rand Botswana Pula

Pick n Pay 6.0% 8.0%
New African Properties 8.0% 8.5%

Which of the following statements is incorrect

A. Both parties will take out loans in their respective countries. P ‘n P will take out a
R80m loan at 6% interest in South Africa and New African Properties would take out
a BWP100m loan at 8.5% in Botswana.

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 B. Pick n Pay has an absolute advantage and New African properties has a comparative
advantage.
C. Over the three-year period P ‘n P would pay interest of 5.4% on the BWP loan and
New Africa Properties would pay interest on the SA Rand loan of 7.9%
D. Over the three-year period P ‘n P would pay interest of 7.4% on the BWP loan and
New Africa Properties would pay interest on the SA Rand loan of 7.9%.

13. If the $/ £ bid and ask prices are $1,50 and $1,51, respectively, the corresponding £/$
bid and ask prices are:

A. £0,667 and £0,6623

B. £1,51 and £1,50
C. £0,6623 and £0,6667
D. $0,6667 and $0,6623

END OF SECTION A PART A

PART B : BONDS [35 MARKS]

Question 1 [15 Marks]

The table below presents the features of two bonds, Bond A and Bond B

Bond A Bond B
Issuer Sappila Ltd Sappila Ltd
Face Value R10,000 R15,000
Time to maturity 13 12
Coupon rate (paid twice a year) 16% 6%
Yield to maturity 5% 7%

Required
1.1) Without calculating the bond values, which bond would generate higher capital gains
if interest rates declined? Justify your answer.
[6]

1.2) If interest rates remain constant for the next 20-years, what will be your capital
gain/(loss) on Bond A. Assume you buy the bond today and hold it until maturity. State
and explain the source of the capital gain/(loss).
[6]

1.3) Specify three circumstances that should prevail for you to realise the promised annual
return of 7% for Bond B over the 12-year period.
[3]

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Question 2 [5 Marks]
Discuss the similarities and differences between the two approaches of constructing an
indexed bond portfolio (pure indexing versus the stratified sampling/cellular approach).

[5]

Question 3 [12 Marks]

The table below presents a schedule of amounts that will be paid by a pension plan. The
current interest rate is flat at 11% across all maturities.

Amount Payment date

R10,000 8th November 2023
th
R12,000 8 November 2024
R7,000 8th November 2025

Required

3.1) Specify the features (price, time to maturity and face value) of the zero-coupon bond
that you will buy to immunise these obligations. Hint: You are immunising with one
bond.
[9]

3.2) State two challenges associated with an immunisation strategy implemented in the
previous question.
[2]

3.3) State the key objective of bond immunisation strategy.

[1]
Question 4 [3 Marks]

On the 22nd September 2022, the Reserve Bank of South Africa increased the repo rate from
5.5% to 6.25%. Bond yields (for both short- and long-term bonds) did not experience a
significant change in response to this repo rate hike – an indication that it was largely
anticipated by market participants, and it was already priced or incorporated into short term
bond yields.

Required:
Explain in detail how the expectation or anticipation of the repo rate hike was priced into
short-term bond yields in the days leading up to the rate hike decision.
[3]

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THIS IS THE END OF SECTION A - START SECTION B IN A NEW ANSWER BOOK. QUESTIONS
TO SECTION B START ON THE NEXT PAGE

SECTION B: DERIVATIVES [35 MARKS]

Show all your workings.
Do not answer in pencil.
Round off two 2 decimal places, unless stated otherwise.
QUESTION 1 [21 Marks]

Russia's invasion of Ukraine has caused food and fuel prices to soar, as war and sanctions
disrupt supplies from two of the world's major agriculture and energy exporters. The two
countries together account for roughly a quarter of global wheat exports, according to the
U.S. Department of Agriculture.

Salma, a Grain Miller in Minnesota, is worried about the price of wheat increasing due to the
Russia-Ukraine conflict. She decides to take out a long futures position in wheat futures listed
on the Chicago Board of Trade and is provided with the following information:

1.1) Would you classify Salma as a hedger or speculator? Provide a reason for your answer.
[2]

1.2) Calculate the value of the March futures contract.

[2]

1.3) Suppose the initial margin on the March futures contract is 12% and the maintenance
margin is 5%. Calculate the margin that Salma must post when the contract is taken
out?
[2]
1.4) What change in the futures price would immediately trigger a margin call?
[3]

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1.5) Over the next four trading days, the March futures contract evolves as follows:
Day Futures Price

1 522.25

2 520.35

3 517.65

4 520.00

Calculate the balance on Salma’s margin account at the end of the fourth trading day.
Show all workings, including the daily marking-to-market.
[8]
1.6) Wheat, like most agricultural commodities, cannot be expected to be stored and has
a seasonal price pattern. Suppose then that the beta of wheat is -0.37, the T-bill rate
is 3% and the historical market risk premium is 9%. Suppose further that the expected
spot price for wheat 4 months from now is $9.53 per bushel. Calculate the equilibrium
futures price for wheat? Show all your workings. (Round off to 4 decimal places
throughout).
[4]

QUESTION 2 [6 Marks]

The JSE Top 40 Index has a dividend yield of 3% per annum. The current index level is 55 000.
The risk-free rate is 7% per annum. The maturity of a JSE Top 40 index futures contract is six
months. Suppose that after one month, the index level is at 47 000.The multiplier for the JSE
Top 40 is 10. Calculate the cash-flow from the mark-to-market proceeds on the contract?
Assume that the Spot-Futures parity condition holds exactly.

[6]

QUESTION 3 [8 Marks]

3.1) In your own words, explain how a protective put option strategy provides a form of
insurance policy on an asset.
[2]

3.2) Suppose a portfolio is currently valued at R100 million. Suppose further that an at-the-
money put option has a delta of -0,4. If the stock portfolio falls by 3%, show and
explain how one can create a “synthetic” protective put position.
[6]

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THIS IS THE END OF SECTION B - START SECTION C IN A NEW ANSWER BOOK. QUESTIONS
TO SECTION C START ON THE NEXT PAGE

SECTION C: INTERNATIONAL FINANCE [26 MARKS]

QUESTION 1 [5 Marks]

1.1) Distinguish between transaction exposure and translation exposure in foreign

exchange risk.
[2]
1.2) Explain what is meant by privatisation in globalisation and list two benefits of going
private.
[3]

QUESTION 2 [11 Marks]

Consider a small Canadian company(domestic) that has exported goods to a U.S. customer
and expects to receive US$50,000 in three months. The Canadian CEO views the current
exchange rate of US$1 = C$1.10 as favorable and would like to lock it in since they think that
the Canadian dollar may appreciate over the three months ahead. The Canadian company
can borrow US$ at 4% for one year and can receive 6% per annum for Canadian-dollar
deposits.

2.1) Explain how the money market hedge is set up and how much it will receive in
Canadian dollars after three months?
[6]
2.2) Why would the Canadian company use the money market hedge rather than an
outright forward contract?
[1]
2.3) Assume that the Canadian company uses the options market to hedge the
Canadian dollar value of the debt that arises out of this order from the US
company, should the Canadian company exercise its right to receive $50 000 at
the agreed strike price or should it allow the option to lapse if the spot rate of
exchange in 3 months is US$1 = C$1.25 ? Support your answer with appropriate
calculations to illustrate the benefit of the decision the Canadian company should
take.
[4]

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QUESTION 3 [10 Marks]

You are provided with the following information. Use this information to answer the
questions below.
• SA interest rate is 10% per annum
• Brazil interest rate is 14% per annum
• The spot exchange rate is R0.29/Brazilian Real
• The forward exchange rate for 1 year is R0.26/Brazilian Real
• Assume the arbitrager can borrow R5m or an equivalent amount in Brazilian Real
at the current spot exchange rate.

3.1) Determine if the Interest Rate Parity holds.

[3]
3.2) What would the arbitrageur’s CIA (Covered interest arbitrage) profit or loss be?
Explain the steps in the transactions and show cash flows and workings.
[5]
3.3) The Monetary Policy Committee in South Africa needs to control for the increase
in inflation. What measures will it take in terms of future interest rates, and how
may this affect the rand?
[2]

END OF QUESTION PAPER

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 FTX3045S Finance IIB-Formula Sheet 1

 T 
  PV (CFt ) x t 
D   t 1 
PO

(1  y )
D perpetuity 
y

1 y T
Dannuity  
y (1  y ) T  1

1  y (1  y )  T (c  y )
D 
y 
c (1  y ) T  1  y 
1 y  1 
D parbond  1
y  (1  y) T 


[(1 + 𝑟) − 1]
𝐹𝑉𝐼𝐹𝐴 =
𝑟

[(1 + 𝑟) − 1] × (1 + 𝑟)
𝐹𝑉𝐼𝐹𝐴 =
𝑟

1
1−
(1 + 𝑟)
𝑃𝑉𝐼𝐹𝐴 =
𝑟

1
1−
(1 + 𝑟)
𝑃𝑉𝐼𝐹𝐴 = × (1 + 𝑟)
𝑟

(𝑃𝑉 ) + (𝑃𝑉 ) − 2 × (𝑃𝑉 )

𝐶𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 =
(∆𝑦𝑖𝑒𝑙𝑑) × 𝑃𝑉
(PV ) − (PV )
𝐷∗ =
2 × (∆Yield) × (PV )

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