Question :

(a) Describe how cash flows are exchanged in an "interest rate swap".

(b) A government issues a 90-day Treasury Bill at a simple rate of discount of 5% per annum. Calculate the rate of return per annum convertible half yearly received by an investor who purchases the Bill and holds it to maturity.

(c) An asset has a current price of £1.20. Given a risk free rate of interest of 5% per annum effective and assuming no arbitrage, calculate the forward price to be paid in 91 days.

(d) State the main differences between a preference share and an ordinary share.

(e) An insurance company calculates the single premium for a contract paying £10,000 in ten years' time as the present value of the benefit payable, at the expected rate of interest it will earn on its funds. The annual effective rate of interest over the whole of the next ten years will be 7%, 8% or 10% with probabilities 0.3, 0.5 and 0.2 respectively.

(i) Determine the single premium.

(ii) Determine the expected profit at the end of the term of the contract.

(f) An ordinary share pays annual dividends. The next dividend is expected to be 10p per share and is due in exactly 9 months time. It is expected that subsequent dividends will grow at a rate of 5% per annum compound and that inflation will be 3% per annum. The price of the share is 250p and dividends are expected to continue in perpetuity.

Calculate the expected effective real rate of return per annum for an investor who purchases the share.