1. Consider the following bond: annual coupon 5%, maturity 5 years, annual compounding frequency.
i. What is its relative price change if its required yield increases from 10% to 11%?
ii. What is its relative price change if its required yield increases from 5% to 6%?
iii. What conclusion can you draw from these examples? Explain why.
2. The Pamodzi Dairy Company has just come up with a new lactose-free dessert productfor people who can't eat or drink ordinary dairy products.
Managementexpects the new product to fuel sales growth at 30% for about two years. Afterthat competitors will copy the idea and produce similar products, and growth willreturn to about 3%, which is normal for the dairy industry in the area. Pamodzi recently paid an annual dividend of K2.60, which will grow with the company.The return on stocks similar to Pamodzi's is typically around 10%. What is the mostyou would pay for a share of Pamodzi?
3. What are the implications of random walks and efficient markets for technicalanalysis? For fundamental analysis? Do random walks and efficient marketsmean that technical analysis and fundamental analysis are useless? Explain.
4. With aid of payoff diagrams explain carefully the difference between selling a call option and buyinga put option.
5. Suppose a stock currently trades at a price of K150. The stock price can go up 33 percentor down 15 percent. The risk-free rate is 4.5 percent.
i. Use a one-period binomial model to calculate the price of a put option with exerciseprice of K150.
ii. Suppose the put price is currently K14. Show how to execute an arbitrage transaction that will earn more than the risk-free rate. Use 10,000 put options.
iii. Suppose the put price is currently K11. Show how to execute an arbitrage transaction that will earn more than the risk-free rate. Use 10,000 put options.
6. With particular reference to the local market, identify and explain six constraints to portfolio revision process.
7. Use the Black-Scholes-Merton model to calculate the prices of European call andput options on an asset priced at K68.5. The exercise price is K65, the continuouslycompounded risk-free rate is 4 percent, the options expire in 110 days, and thevolatility is 0.38. There are no cash flows on the underlying.