Bahir Dar University

College of Business and Economics

Department of Accounting and Finance
Postgraduate Program

Financial Institutions and Capital Markets Assignment (20%)

Question No.1
Consider a bond with term to maturity of 5 years, a par value of Br. 1000, annual interest payment
and a coupon interest of 12% annually and the spot rates are as follows:

Term Spot Rate

1 year 9%

2 year 9%

3 year 9%

4 year 9%

5 year 9%

Required:

1. Determine the price of the bond

2. If we assume the above spot rates were yearly rates, will your answer differ in (1)?
Why?
3. Assume the above example except that the investor expects to sell the bond at Birr
1,100 at the end of the 2nd year and expects to incur Birr 80 brokerage cost on the sale of
the bond too in addition to the brokerage cost of Birr 50 at the time of purchase.
Calculate the price of the bond?
Question No.2
A corporation wants to issue a bond on a competitive bidding basis. The corporation has indicated
that it will issue Br. 150 million of an issue. The following yield bids and the corresponding
amounts were submitted:
Bidder Amount (in million) Bid
A Br. 40 7.4%
B 30 8.1
C 40 7.8
D 20 7.9
E 30 8.0
F 25 8.0
G 40 7.6
H 30 7.5
In addition to the above bidders assume there are two additional bidders- X and Y- who have
submitted Br. 40 million and 60 million, respectively, at the stop yield.
Instruction:
1. Who are the winning bidders
2. What is the stop yield?
3. How much will be awarded (allocated) to each of bidder X and Y?

Question No. 3
Assume that there is a put option on asset XYZ that expires in one month and a strike price of
Br.1,200. Assume the put option is selling for Br. 40. The current price of asset XYZ is Br.1,000.
Assume the option can be exercised only at the expiration date. Assume the price of the asset at the
expiration date is Br 1,300.
Required:
A. Should the buyer of the option exercise or do not exercise the option? Please justify your
answer
B. What is the net profit or loss for the seller of the option if the buyer of the option exercises
the option?

Question No. 4
Assume the following data relates to Dashen Bank operating in Ethiopia.
Assets Book Value Credit Risk Weight
Cash in the vault Br. 400,000 ?
Treasury securities 500,000 ?
Deposits with foreign banks 500,000 20%
Investments 1,000,000 50%
Loans and advances 1,600,000 100%
Total assets Br.4,000,000
Assume further that the share capital of the bank is Br. 70,000 and Retained earnings and legal
reserves amounted Br. 60,000 and Br. 40,000 respectively.

Required:
1. Determine the total risk weighted asset
2. Determine the total minimum capital requirement
3. Determine the total actual capital of the bank
4. Determine the capital adequacy ratio
5. Does Dashen Bank fulfill its capital requirement? Justify your answer

Question No.5

Assume an issuer has a six year financing horizon and needs to borrow Br. 100,000 today. The
issuer has two alternatives.
Alternative 1: Sell a six year instrument that pays interest of 12% per annum compounded
monthly.
Alternative 2: Sell a four year instrument that pays interest of 8% per annum compounded
quarterly and when it matures issue a two year instrument that pays interest semiannually.
Alternative 3: Sell a four year instrument that pays interest of 10% per annum compounded
quarterly and when it matures issue a two year instrument that pays interest semiannually.
Suppose further that the issuer’s expectation of the two year interest rate four years from now is
16% per annum on a bond equivalent basis.
Required:
1. Determine the implied forward rate on a bond yield equivalent basis between Alternative
One and Alternative Two
2. Determine the implied forward rate on a bond yield equivalent basis between Alternative
One and Alternative Three
3. Which alternative do you recommend to the issuer if the issuer is willing to take advantage
of differences between expectations and forward rates?

Question No.6
Fill in the blank space using “higher” or “lower” or “same”. Consider the visible differences only
and assume other things constant.
1. A less credit worthy corporation is expected to pay a (the) ___________rate of interest than
(as) a similar more credit worthy corporation.
2. A municipal bond is expected to pay a (the) ___________rate of return than (as) a similar
treasury bond.
3. A callable bond is expected to pay a (the) ___________ rate of return than (as) a similar
non-callable bond.
4. A bond backed by collateral is expected to pay a (the) ___________rate of return than (as)
a bond that is not.
5. A financial asset with a thick market provides a (the) ___________rate of return than (as) a
similar financial asset with a thin market.
Question No.7
Consider a bond with term to maturity of 5 years, a par value of Br. 1000, annual interest payment
and a coupon interest of 10% annually and the yearly rates are as follows:
Year Yearly rate
1st year 10%
nd
2 year 10%
rd
3 year 10%
th
4 year 11%
th
5 year 11%
Required:
1. Determine the price of the bond
2. If an investor incurs a brokerage cost of Birr 70 at the time of purchase only, what will
be the correct price of the bond given the above information?
3. Assume the above example except that the investor expects to sell the bond at Birr
1,100 at the end of the 3rd year and expects to incur Birr 80 brokerage cost on the sale of
the bond too in addition to the brokerage cost of Birr 70 at the time of purchase.
Calculate the price of the bond?

Question No.8
Assume that there is a put option on asset XYZ that expires in one month and a strike price of Br.10,000.
Assume the put option is selling for Br. 300. The current price of asset XYZ is Br.10,000.
Required:
A. Should the buyer of the option exercise or do not exercise the option assuming the price of the
asset at the expiration date is:
i. Br. 9,000
ii. Br. 12,000
B. what is the net profit or loss for the investor in each case if the investor makes the right decision?

Question No.9
Suppose you have planned to carry out the following activities:
A. You have imported goods from Great Britain for £100,000 to be paid three months from
now.
B. To raise funds by selling bonds six months from now
C. You have exported goods to U.S.A. for $100,000 to be received six months from now.
D. To raise funds by selling common stock two months from now
Required:
For each of the above activities, what is the risk you face? (Make your answers very
specific-Answers that are general will not be given any value).
Question No.10
Fill in the blank space using “higher” or “lower” or “same”. Consider the visible differences only
and assume other things constant.
A. A more liquid financial asset is expected to pay a (the) ___________rate of interest than
(as) a similar less liquid financial asset.
B. A treasury bond is expected to pay a (the) ___________rate of return than (as) corporate
bond of the same maturity.
C. A commercial paper is expected to pay a (the) ___________ rate of return than (as) a
treasury bill.
D. An issuer of putable bond is expected to pay a (the) ___________rate of return than (as) on
its issue of a similar non-putable bond.
E. An issuer of common stock is expected to pay a (the) ___________rate of interest than (as)
on its issue of e bonds.
Question No.11
A corporation wants to issue a bond on a competitive bidding basis. The corporation has indicated
that it will issue Br. 150 million of an issue. The following yield bids and the corresponding
amounts were submitted:

Bidder Amount (in million) Bid

A Br. 40 7.4%

B 18 8.1

C 28 7.9

D 20 7.8

E 20 8.0

F 25 7.9

G 10 7.7

H 40 7.8

I 40 7.6

J 50 7.5

K 30 7.6

L 10 7.7

M 20 7.5
Instruction:

a. Who are the winning bidders?

b. How much of the security will be allocated to each winning bidder?
c. If this auction is a multiple –price auction, at what yield will each winning bidder be
awarded the security?
d. If this auction is a single –price auction, at what yield will each winning bidder be awarded
the security?
Question No.12
Assume an investor has a four year investment horizon and needs to invest Br. 500,000 today. The
investor has two alternatives.
Alternative 1: Buy a four year instrument that pays interest of 12% per annum compounded
quarterly.
Alternative 2: Buy a one year instrument that pays interest of 8% per annum compounded
quarterly and when it matures reinvests the proceed in another three year instrument that pays
interest semiannually.
Suppose further that the investor’s expectation of the three year interest rate one year from now is
16% per annum on a bond equivalent basis.
Required:
1. Calculate the implied forward rate.
2. Which alternative do you recommend to the investor if the investor is willing to take
advantage of differences between expectations and forward rates?
Question No.13
Consider a bond with term to maturity of 5 years, a par value of Br. 1000, annual interest payment
and a coupon interest of 12% annually and the spot rates are as follows:
Term Spot Rate
1 year 9%

2 year 9%

3 year 10%

4 year 11%

5 year 11%

Required:

1. Determine the price of the bond

 2. If an investor incurs a brokerage cost of Birr 60 at the time of purchase only, what will
be the correct price of the bond given the above information?
3. Assume the above example except that the investor expects to sell the bond at Birr
1,100 at the end of the 2nd year and expects to incur Birr 80 brokerage cost on the sale
of the bond too in addition to the brokerage cost of Birr 50 at the time of purchase.
Calculate the price of the bond?
Question No.14
Assume that there is a call option on asset XYZ that expires in one month and a strike price of
Br.1,100. Assume the put option is selling for Br. 30. The current price of asset XYZ is Br.1,000.
Assume the option can be exercised only at the expiration date. Assume the price of the asset at the
expiration date is:

Case 1: Br 1,200
Case 2: Br 900

Required:
A. what is the net profit or loss for the buyer of the option in each of the above cases if the
buyer exercises the option?
B. Should the buyer of the option exercise or do not exercise the option in each of the above
cases?

Question No. 15
Suppose, a savings and loan association is ‘borrowing short and lending long’’. You and your
friend are discussing the advantages and disadvantages of such strategy for such financial
institutions. If short term interest rates decline, this financial institution gets killed because its
spread income will decline or may even get negative, says your friend.
Required:
a) What is meant by ‘’borrowing short and lending long’’?
b) Do you agree with your friend explanation? Why?

Question No.16
Fill in the blank space using “higher” or “lower” or “same”. Consider the visible differences only
and assume other things constant.
A. A more reversible financial asset is expected to pay a (the) ___________rate of interest
than (as) a similar less reversible financial asset.
B. A bond that has more desirable feature to the issuer is expected to pay a (the)
___________rate of return than (as) a similar bond that has not..
C. A financial asset whose return is more predictable is expected to pay a (the) ___________
rate of return than (as) that which has less return predictability.
D. An issuer of convertible bond is expected to pay a (the) ___________rate of return than
(as) on its issue of a similar non-convertible bond.
E. An issuer of government bonds is expected to pay a (the) ___________rate of interest than
(as) an issuer of corporate bonds.
Question No.17
Discuss the basic activity and the various economic functions of a financial intermediary.
Question No.18
Mention each of the four tools of monetary policy and describe how the National Bank of Ethiopia
along with the commercial banks can increase or decrease the money supply to achieve certain
goals using those tools.
Question No. 19
Consider a given bond that has five years maturity, Br.1000 face value and a 10 percent coupon rate.
Suppose a broker’s commission of Br.50 is imposed by brokers to buy a bond but there is no broker’s
commission on the sale. Assume further, that the discount rate (minimum required rate of return) is 12
percent and the bond pays interest annually.

Required:

a) What is the price of the bond?

b) By relating to the example given, discuss how the reversibility of a financial asset affects its
value

Question No.20
Suppose that the NBE purchased Br. 100 million treasury bills from a dealer. Assume that the
public including the dealer holds 80% in checkable (demand) deposit, and the remaining in cash or
currency. The reserve requirement of banks is 12 percent of any deposit and banks want to hold
1% of any deposit in excess reserves for precautionary purposes.
Required:
1. Determine the total demand deposit that can be created from injection of reserves by NBE
2. Determine the demand deposit multiplier
3. Determine the total pocket money that can be created from injection of reserves by NBE
4. If the money supply (M1) has already reached Br. 400 billion just before injection of
reserves, what is the new level of money supply (M1)?
Question No.21

Social psychology factors can cause a financial crisis. Mention at least four of these factors and
describe how each factor causes a financial crisis.

Question No.22
Consider a bond with term to maturity of three years, coupon rate of 10% per annum, par value of
Birr 1000, yield of 9% per annum and annual interest payment.
Required:
1. If yield changes by 1%, what will be the duration?
2. Interpret the result in (1)
3. If yield increases by 2%, what will happen to price? ( Indicate direction and magnitude of
change)