Principles of Finance

Principles of Finance

Principles of Finance
Assignment II

Q1. You have been asked by the prospective directors of a shortly to be established business what is meant by ordinary shares, preference shares and debt capital. Further, you have been asked to provide a brief explanation of their relative advantages and disadvantages as sources of funds to expand the business. Write an essay to assist these managers. (300 words max)

Q2. Adam, a speculator, is convinced that the stock market will fall significantly in the forthcoming months. The current market index (14 August) level is 4954 (FTSE 100). He is investigating a strategy to exploit this market fall: sell five FTSE 100 Index futures on NYSE Liffe with a December expiry, current price 5086.

Assume: no transaction costs.
Required: For the derivative
(a) What would the profit (loss) be if the index rose to 5450 in December under the strategy?
(b) What would the profit (loss) be if the index fell to 4550 in December under the strategy?

Q3. A buyer of a futures contract in Imaginationum with an underlying value of £400,000 on 1 August is required to deliver an initial margin of 7.5 per cent to the clearing house. This margin must be maintained as each day the counterparties in the futures are marked to market.
Required:
(a) Display a table showing the variation margin required to be paid by this buyer and the accumulated profit/loss balance on her margin account in the eight days following the purchase of the future.
(Assume that the maintenance margin is the same as the initial margin.)

(b) Explain what is meant by ‘gearing returns’ with reference to this example. (Hint: gearing has the same meaning as leverage, note how the returns in the Imaginationum are amplified in the futures contract and comment on it.) (75 words max)
(c) Compare forwards and futures markets and explain the coexistence of these two.

(The complete document will all questions have been attached as a download file)

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 Principles of Finance

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