Birla Institute of Technology & Science, Pilani.

Hyderabad Campus
Semester-I 2019-20
Maximum Marks- 25
Comprehensive Examination- Part A
Course Name: FOFA Course Code: ECON F212
Date: 08/12/2019 Time: 9a.m.-12p.m.

 Sharing of calculator is not allowed.

 Writing with pencil is not allowed. You may use pencil for drawing graphs.
 Answer scripts without Name and ID will not be evaluated.

1. Using graphs explain what will happen to 10-year Government bond yield and price
based on following events (Neatly label the axes). Assume that the policy rates and all
other risk factors remain unchanged.
1.1 Following the corporate tax cut the government is likely to borrow additional 2.68
trillion rupees through issuing bonds in the market by end of this fiscal year to meet its
revenue targets. [2]
1.2 Moody’s changed outlook for Indian economy from stable to negative during
November, 2019 owning to lower GDP growth rates, higher fiscal deficit and shadow
banking crisis. [2]

2. Briefly explain whether the following statements are true or false:

Clearly mention assumptions, if any or the underlying theory that you are using for the
answer. Also, provide graphs/ equation wherever necessary.
2.1 When investing in bonds, we should invest in bonds with higher yield to maturity
because they give higher expected returns. [2]
2.2 A flat term structure always indicates that investors do not expect interest rates to
change in the future. [2]
2.3 Bonds with higher coupon rate will have higher interest rate risk. [2]

3. Suppose the government decides to raise Rs.6000crore in the primary market by issuing
181-day Treasury (T) Bills with a face value of Rs.100 using uniform pricing method.
Consider the following bids:
Bidder 1 2 3 4
Bid Amount (in 1000 2000 3000 4000
Rs. crore)
Bid Price (in 96 94.75 95 93
Rs.)
3.1 Find out the discount yield, bond equivalent yield and effective annual yield for this
issue. [2]
3.2 Purely based on effective annual rate comment whether you will prefer to invest in the
T-Bill mentioned above or one of the following:
Option 1: Commercial Paper trading at Rs.97815 with a face value of Rs.100000
maturing in 71 days.
Option 2: A 91-day T-bill (face value of Rs.100) with a discount yield of 5.78%. [2]

Page 1 of 4
4. You are the CFO of Yep Bank, a private Indian bank, and you are evaluating following
two options to raise capital worth Rs.50 million Rupees:
Option1: Issue 1-year Commercial Paper at par (CP) in rupees worth Rs.50 million with
a FV of Rs.100000 having yield of 7.5%.
Option 2: Issue 1-year CPs at par in UK with a yield of 5% worth Rs.50 million. Current
spot rate is 92INR/Pound and you expect exchange rate at the end of the year will be
between 90INR/ Pound – 95INR/ Pound.
4.1 Compare the cost of raising capital in India and the cost of raising capital in UK in
worst and best case scenario when the currency risk is unhedged. What is the relation
between net exposure in foreign currency and exchange rate fluctuation? [2]
4.2 Suppose now as the CFO you decide to enter the foreign exchange market to hedge
currency risk and the 1 year forward rate is 93.5INR/Pound. What is the cost of raising
money in UK now? Which of the above two options (raining money purely in India or
raising money in UK and hedging the currency risk) seems more beneficial for the
bank? If spot rate after 1-year turns out to be 90INR/Pound what is the notional loss/
profit in percentage point terms between hedged and unhedged position. [2]
4.3 Suppose the 1-year interest rate in India is 5.1% and that in UK is 1.75%. What should
be the exchange rate after 1 year if no arbitrage condition holds. The spot rate is
92INR/Pound. [1]
4.4 Suppose the domestic interest rate suddenly falls by 100 basis point what will be effect
if this on short run exchange rate? Show graphically. [1]

5. Consider a 3-year Government security with a FV of Rs.1000 issued at par having a

coupon rate of 5% (Annual coupon payment). The issue has been stripped and the yield
in the market on the first day of trading is given below:
Time period 1 2 3
Yield 6% 6.12% 6.25%
5.1 Find the current price of all the non-interest bearing securities trading in the market (i.e.
prices of four zero coupon bonds). [2]
5.2 What must be the price of the unstripped coupon paying Government bond in the
market with FV of Rs.1000, coupon rate of 5% having 3-year maturity? Find the price
of a corresponding 3-year Corporate bond with a FV of Rs.1000 and annual coupon
rate of 5% with a YTM of 6.5%. Can we say that the corporate bond is riskier? Explain.
Clearly mention the possible sources of risks. [2]
5.3 Using the unbiased expectations theory find the expected 1-year spot rate in the market
at the end of year 1 and year 2. [1]

Page 2 of 4
 Birla Institute of Technology & Science, Pilani, Hyderabad Campus
Semester-I 2019-20
Maximum Marks - 5
Comprehensive Examination- Part B
Course Name: FOFA Course Code: ECON F212
Date: 08/12/2019 Time: 9a.m.-12p.m.
Name: ID No:
 Writing with pencil is not allowed.
 Answer scripts without Name and ID will not be evaluated.

1. Suppose increase in money supply is related to a rise in stock prices. Does this mean
that when you see that the money supply increased sharply in the past week you should
buy the stock? Justify your answer and explain the underlying theory clearly. [2]
____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
2. Consider the following excerpt from Mint article dated 1st December, 2019:

India’s economic slowdown intensified in the second quarter of 2019-20, with gross
domestic product (GDP) growing at 4.5%, half a percentage point slower than in the
previous three months and 2.5 percentage points lower than in the same quarter a year
ago. Manufacturing, led by the automobile industry, has contracted, and mining
stopped growing in the second quarter. Another three months of declines will officially
qualify as a manufacturing recession. Financial services and real estate, facing a credit
squeeze, also posted weaker numbers. Agriculture suffered from unseasonal rain and
its growth during the quarter also more than halved from the same period of 2018-19.

This picture becomes more worrisome with the government having notched up the full
year’s budgeted fiscal deficit by October. There is no fiscal wiggle room left: spending
is already over budget and the year’s tax revenue projections appear grossly

Page 3 of 4
 overstated. Recently announced tax giveaways are yet to work their way into the
economy, it seems.

Using the notion of Efficient Market Hypothesis (EMH) and the given information can
you justify Sensex and NIFTY trading at very high levels of over 40000 and 12000
respectively? Clearly mention the assumptions and the underlying form of EMH. [2]

_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

3. As per Bloomberg report the global stock of negative-yielding debt was in excess of
$17 trillion by end of August, 2019. Explain one plausible reason behind this observed
phenomenon in the backdrop of recent global economic events and geopolitical
outlook. [1]
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

Page 4 of 4