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Continuous Evaluation 2
[1] Reading the Financial Markets: French elections (20% of the grade)
After the first round of voting on Friday, 21 April 2017, independent candidate Emmanuel Macron (who is pro-Europe and wants France in the euro) beat populist candidate Marine Le Pen (who is anti-Europe and wants France out of the euro) by 24% to 21%. This how financial markets reacted:
Friday, April 21 (before the election)
. French sovereign 10-year bond yield: 1.05%
. German sovereign 10-year bond yield: 0.24%
. Credit Default Swap on French bond: 114 basis points
. USD/EUR: 1.0728
. CAC-40 French Stock market index: 5059.20
Monday, April 24 (after the election)
. French sovereign 10-year bond yield: 0.79%
. German sovereign 10-year bond yield: 0.41%
. Credit Default Swap on French bond: 71 basis points
. USD/EUR: 1.0926
. CAC-40 French Stock market index: 5268.85
Explain the reaction of investors in financial markets.
[2] Risk and diversification (20% of the grade)
The standard deviation of the average stock is greater than the standard deviation of the market portfolio made up of all stocks. What is the best explanation for this?
a) the Sharpe ratio
b) diversification
c) the dividend discount model
d) the price-to-earnings ratio
e) your stock has higher risk
[3] Risk and diversification (20% of the grade)
TRUE OR FALSE? “The benefits of diversification increase with increased correlation.
[4] Financial markets in general (10% of the grade)
If you have €300,000, where can you invest your money? List all possible investments.
[5] Define financial risk in 1 sentence (10% of the grade)
[6] Case Study: Lufthansa Corporation and Transaction Exposure (20% of the grade)
In January 1985, the German airline company, Lufthansa, signed a contract with the
U.S. Corporation, Boeing, to purchase 20 Boeing 737 airplanes. Boeing agreed to deliver the airplanes to Lufthansa in one year later, in January 1986. Lufthansa agreed to make a single payment, of $500 million, when the planes were delivered. The spot exchange rate at the time the contract was signed was DM3.2/$, which corresponded to a deutschmark liability of 1.6 billion.
Background
Since 1982, the U.S. dollar had been steadily appreciating against the German mark. In January 1982, the dollar was trading around 2.3 marks, and by January 1985, it had risen to 3.2. This represented an appreciation of the dollar of just under 40%.
Although many analysts had concluded that the U.S. dollar was overvalued during this period, it continued to show strength. Government intervention to weaken the dollar was not being discussed at this time. See chart which follows.
Issue
While many forecasters were predicting an eventual weakening in the U.S. dollar, for Lufthansa, the size of the contract, which was denominated in U.S. dollars, was seen as a too large of an uncovered transaction exposure.
Recommendation
What would you have recommended that Lufthansa do, and why?