Finance

Topic 1: Financial Markets • You are among the OTC market makers in the stock of Bio-Engineering, Inc. and quote a bid of $102.25 and an ask of $102.50. Suppose that you have a zero inventory. • On Day 1 you receive market buy orders for 10,000 shares and market sell orders for 4,000 shares. How much do you earn on the 4,000 shares that you bought and sold? What is the value of your inventory at the end of the day? (Hints: It is possible to have negative inventory. Further, there is more than one correct way to value an inventory, but please state what assumption your valuation is based on.) • Before trading begins on Day 2 the company announces trial testing of a cure for acne in mice. The quoted bid and ask jump to $110.25 and $110.50, respectively. During Day 2 you receive market sell orders for 8,000 shares and buy orders for 2,000 shares. What is your total profit or loss over the two-day period? What is the value of your inventory at the end of Day 2? • What is a market maker’s objective? Is there anything you could have done during Day 1, consistent with a market maker’s objective, that would have improved your performance over the two-day period? Topic 2: Performance Measures • Suppose a 5-year zero-coupon Treasury bond with face value $1000 has a 5% yield (annually compounded). • What price does this bond sell for? • Suppose another zero-coupon Treasury bond also has a 5% yield, but sells for $325.57. What is the maturity of this bond? • Which of the following investments do you prefer? • Purchase a zero-coupon bond, which pays $1000 in ten years, for a price of $550. • Invest $550 for ten years in Chase at a guaranteed annual interest rate of 5.5%. • Suppose you get for free one of following two securities: (a) an annuity that pays $10,000 at the end of each of the next 6 years; or (b) a perpetuity that pays $10,000 forever, but payments do not begin until 10 years from now (the first cash payment from this security is 11 years from today). Which security would you choose if the annual interest rate is 5%? Does your answer change if the interest rate is 10%? Explain why or why not. • Suppose a hedge fund manager earns 1% per trading day. There are 250 trading days per year. Answer the following questions: • What will be your annual return on $100 invested in her fund if she allows you to reinvest in her fund the 1% you earn each day? • What will be your annual return assuming she puts all of your daily earnings into a zero-interest- bearing checking account and pays you everything earned at the end of the year? • Can you summarize when it is proper to ”annualize” using APR