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Q1.
The 8%, 5-year bonds issued by ABC Corporation that pay semi-annually are selling to yield 6 percent.
Calculate the Macaulay duration, Modified duration and convexity of the bond.
Q2.
A five-year corporate bond that pays 12 percent per year via semi-annual coupons, with a 8 percent
market rate and a $1,000 maturity is worth $1,162.21. The bond has a duration of four years. Based
on the duration formulation:
a. Find the price of the bond if the interest rate increases 2 percent.
b. Find the price of the bond if the interest rate decreases 2 percent.
Q3.
Stock L has a standard deviation of 5 and stock M has a standard deviation of 15. The coefficient of
correlation of the returns of stock L and M is +.40. Can a portfolio of these two stocks be produced
that has a smaller standard deviation of return than either security taken alone? Why or why not?
Q4.
Following are data for several stocks. The data result from correlating returns on these stocks versus
returns on a market index:
Stock Alpha (A) Beta (B) Unsystematic Risk (e2)
___________________________________________________
MNO -.05 +1.6 .04
PQR +.08 -0.3 .00
LUV .00 +1.1 .10
____________________________________________________
a. Which single stock would you prefer to own from a risk-return viewpoint if the market index
were expected to have a return of +.10 and a variance of return of .10?
b. What does the e2 value for PQR imply? The A value for LUV?
Q5.
The following questions relate to the Sharpe and Markowitz methodology. Suppose we had the
following data on four stocks
Stock Markowitz Alpha Variance Correlation Matrix
Expected (%) Systematic Unsystematic A B C D Market
Return (%)2 (%)2
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a. “Markowitz would argue that a portfolio consisting of equal investments in stocks A, B, C
and D should provide an expected return of 11.5% and an expected risk (standard deviation
of return) of 2.52%”. Do you agree or disagree? Why?
b. Suppose the market is expected to have a return over a forward period of 12% with a return
variance of 6% squared. Calculate the expected return and risk for a portfolio consisting of
equal proportions of stocks A and C.
Q6.
Securities A and B and the market portfolio have the following expected returns, variance and
covariances of return
EXPECTED RETURN
_______________________________
A 0.06
B 0.12
Market Portfolio (M) 0.08
________________________________
VARIANCE- COVARIANCE MATRIX
________________________________________________________________
A B M
________________________________________________________________
A 0.05 0.02 0.06
B 0.02 0.09 0.105
M 0.06 0.105 0.075
_________________________________________________________________
a. Find the expected return, standard deviation of return, and beta for a portfolio having
proportions XA = 0.40, and XB = 0.60
b. State the investment objective(s) that may be met by the above investment strategy in (a).
Give reasons.
c. What should be the proportions of investment in securities A and B if it were to be an index
linked portfolio?
d. Given the economic scenario of controlled growth, is it advisable to hold the portfolio as in
(a) or as in (c)? Why?
Q7.
You are given the following forecasts for the states of economy and the conditional returns of
shares X, Y and the market
State of the Economy Conditional Returns (%)
Probability X Y Market
__________________________________________________________________________
Recession, high interest 0.20 -13 -4 -9
Recession, low interest 0.15 16 -2 8
Boom, high interest 0.40 32 21 16
Boom, low interest 0.25 12 20 20
a. Calculate the ex-ante betas for stocks X and Y
b. If the risk-free rate is 4%, calculate the ex-ante alphas for stocks X and Y
c. Are these stocks under or over-priced? Explain.
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Q8.
Three bonds are being examined by an investor planning to send his daughter to college in ten years.
Each bond is highest in quality.
Suppose you are the manager of an investment fund in a two-parameter economy. Given the following
a. Would you recommend investment in security J with E (RJ) = 0.12 and Cov (RJ, RM) = 0.01? Why
or why not?
b. What are the important factors that influence the decision to include or exclude a security in a
portfolio?
c. Suppose that in the next period, security RJ has earned only 5% over the preceding period. How
would you explain this ex-post return?
Q10.
(a) Given the following spot rates for various periods of time from today, calculate forward
rates from years 1 to 2, 2 to 3, and 3 to 4.
1 5.0%
2 5.5%
3 6.5%
4 7.0%
(b) Assume that the CAPM holds and the returns are generated by a two-factor model. You are
given the following information:
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