STRATHMORE UNIVERSITY BUSINESS SCHOOL

BACHELOR OF COMMERCE
END OF SEMESTER EXAMINATION
BCF 3202: FINANCIAL INSTITUTIONS AND MARKETS

DATE: Time: 2 Hours

INSTRUCTIONS

1) Answer question one and any other two questions

2) Question one is compulsory and carries 30 marks
3) All other questions carry 20 marks each
 

QUESTION ONE

a) Describe a financial system distinguishing it from a financial market (2 marks)

b) A financial system exists because of important roles it plays to meet the gaps in the
economy. Discuss five roles (5 marks)

c) Define a derivative (2 marks)

d) Differentiate between

(i) The long and Short (2 marks)

(ii) forward contracts, futures contracts (2 marks)

(iii) Swaps and options (2 marks)

e) Discuss six advantages of derivatives (6 marks)

f) Company AA ltd issues a 10 years bond AA that has a par value of Ksh 2000. The
coupon rate is 13.5% and currently the bond is selling at Ksh 2200. Calculate

(i) Current yield of bind AA (2 marks)

(ii) The yield to maturity of the bond (4 marks)
g) The government of Kenya is issuing a one-year treasury bill that has a par value of Kes
100,000 at an issue price of Kes 91,500. If investors require a 12 % annualized return.
Calculate the price that they are willing to pay and advice the investor (3 marks)

Page 1 of 4 
 
 (TOTAL 30 MARKS)

Question Two

a) Equities are some of the instruments that trade in the capital markets. Explain three
reasons why equities have the most risk of all the financial securities (3 marks)

b) Define information asymmetry (2 marks)

c) Differentiate between adverse selection and moral hazard (3 marks)
d) State two major problems that adverse selection causes the financial system
(2 marks)
e) Choose any two financial institutions and explain how they deal with information
asymmetry problem (4 marks)

f) The central bank of Kenya is involved in controlling the financial system in Kenya and
ensuring stability as well. Discuss six tools that the CBK uses to ensure stability
(6 marks)

(TOTAL 20 MARKS)
Question Three

a) Define financial intermediation (2 marks)

b) Commercial banks involve in maturity intermediation. Discus the serious risk/problem they
face as they engage in maturity intermediation. (3 marks)

c) Discuss any three types of financial intermediation (6 marks)

d) Explain the difference between a conversion ratio of a bond and conversion premium
of a bond (2marks)
e) Define (i) Bond conversion parity (2 marks)
(ii) Bond conversion price (2 marks)
g) A company current share price is kes 45, and the conversion ratio for a bond with a par
value of ksh 1000, issued ten years ago is 35:1, calculate the conversion value of the
bond? (2 marks)
h) In reference to the bond in part e above, if the bond has a par value of Ksh 2000, and
has a current market price of ksh 2100. Would you convert it if today was conversion
date as per the bond agreement? Give a reason for your answer (1 marks)
(TOTAL 20 MARKS)

Question four

a) Differentiate between capital markets and money markets (2 marks)

b) Explain three characteristics of money markets (3 marks)
c) Discuss four factors that influence the issue price of a bond (4 marks)

Page 2 of 4 
 
 d) Explain the relationship between bond prices, yields and market interest rates taking
into consideration the price and reinvestment risk (4 marks)

e) The principal amount of a bond is kes 5,000, the maturity is 7 years, the coupon rate is
12%, and interest payments are made annually. The market interest rate used to discount
the bonds’ expected cash flows until maturity is assumed to be constant at 12%. The
bonds are issued and redeemed at par. For the partially amortized bond, the balloon
payment is kes 1500 at maturity.
f) Calculate the cash flows if:
i. the bond is a bullet bond (2 marks)
ii. the bond is fully amortized bond (3 marks)

iii. the bond is partially amortized bond (2 marks)

(TOTAL 20 MARKS)
Question Five

a) If a company issues a callable bond that has a par value of 1,000 at an issue price of
Ksh 950. The bond has a maturity period of 10 years and coupon rate is 12%. The call
is supposed happen at the end of year 5. Explain the circumstances that will motivate
the company to exercise the call at the end of year five (2 marks)

b) If you buy a puttable share from Company BB ltd and an issue price of Ksh 20 per
share. The put is supposed to happen five years from now with a put price of sh 30 per
share. The share price keeps ricing and falling depending on the performance of the
company. Explain the reasons that will motivate you to exercise the put. (3 marks)

c) The following information relates to futures on equity whose current market price is
Ksh 43. It has a futures price of kes 50 at day 7.
It has a margin account of kes 12 and a maintenance margin is 50% of the margin
amount. The following are the prices of the underlying from day zero to day 7.
Day 1 2 3 4 5 6 7
Price 46 56 62 55 48 37 49

Required
i. Show the mark to market process for the above agreement (4 marks)
ii. On which specific day/days is a margin call made (2 marks)

(c). Sessy goes long on a put option on a share with Ethan The put option has a premium of kes
27. The strike price is Kes 70 after 5 days. Currently the share has a market price of kes 80.
The price of the share on the 5th day can either be Kes 60 or 85
Required:

(i) Calculate the pay-offs for Long on both prices (3 marks)

Page 3 of 4 
 
 (ii) Calculate the pay-offs for Short on both prices (3 marks)
(iii) Show the profits for Long when the prices of the share is Kes 93 (3 marks)

(TOTAL 20 MARKS)
 

Page 4 of 4