Sample Examinations, 2023 FINM2416 Asset Pricing
Page 2 of 5
Question 1 (15 Marks)
Two stocks (A and B) have a covariance of 23. When combined in equal proportions into
portfolio Y, the variance of the portfolio is 30.25. Stock A has a variance twice that of
Stock B. Another portfolio (X) has an expected return of 17% and a variance of 50.
Additional Information
The expected return on the market is 15% and the risk free rate is 7%
Covariance (A,Market) = 22 and Covariance (B,Market) = 15.5
Variance of the Market is 15
Required:
a) Variance of Stock A and the variance of Stock B.
b) The correlation of Stock A with Stock B
c) Is portfolio Y efficient? Explain.
d) What is the expected return of portfolio Y?
e) Without doing any calculations, is portfolio X efficient? Explain.
f) What are the characteristics of an efficient portfolio? List at least 3 or 4.
Question 2 (10 Marks)
a) Your portfolio contains 60% of Bond I and 40% of Bond II. Details of the two bonds
are given below:
I. 10-year zero coupon government bond, par value $1000, current price = $613.91
II. 10-year zero coupon corporate bond, par value $1000, default premium= 2%
Find the price of Bond II.
Find the convexity of Bond I.
(4 marks)
b) Compare and contrast between hedging and speculation.
(3 marks)
c) January 520 and January 500 calls for ZOOM are traded at 10.50 and 18.50,
respectively. Which one is more likely to end up in the money? Why?
(3 marks)
Sample Examinations, 2023 FINM2416 Asset Pricing
Page 3 of 5
Question 3 (10 marks)
BHP Billiton has some debt outstanding and must make payments to customers of $7
million in 1 year and $2 million in 4 years. The yield curve is flat at 5%.
Required:
a) If BHP wants to fully fund its obligation to this customer with a zero-coupon bond,
what maturity bond must it purchase? What alternative does BHP have other than one
zero-coupon bond? Explain in detail and show all workings.
(4 marks)
b) What must be the total face value and total market value of the zero-coupon bond in
part a)? How does this relate to your alternative in part a)?
(3 marks)
c) What is convexity and its relation to duration?
(3 marks)
Question 4 (8 Marks)
Two firms are each offering investors the opportunity to invest in their corporate bonds.
The bonds have 3 years to maturity and are available at par value. The face value of each
bond is $1,000 and they pay annual coupon payments. Details are below.
Description Coupon
Per annum
Callable Call Price
Firm A 6.00% Non-callable NA
Firm B 6.20% Callable
(Immediately)
$1020
Required:
a) Suppose that market interest rates decline by 80 basis points (0.8%). Contrast the
effect of this decline on the price of each bond. Explain in detail. State all
assumptions.
(3 marks)
b) Should you prefer Firm A or Firm B bonds when rates are expected to rise or to fall?
Explain your choice. State all assumptions.
(2 marks)
c) What are five key rules of duration for the assessment of a bond’s sensitivity to
changes in interest rates?
(3 marks)
Sample Examinations, 2023 FINM2416 Asset Pricing
Page 4 of 5
Question 5 (7 Marks)
You have just secured a portfolio analyst job with a major equity fund. You have found it
difficult to focus on more than 30 stocks which have been drawn from several industries.
A client has come to you and said to forget about the 30 stocks and concentrate solely on
5 stocks. You need to respond to the client. In your response you must only respond
within the context of modern portfolio theory.
Required:
a) Contrast the concepts of systematic risk and firm-specific risk and give examples of
each type of risk.
(4 marks)
b) Critique the client suggestion. Discuss what factors are most important in selecting
stocks for a portfolio.
(3 marks)
END OF EXAMINATION
Sample Examinations, 2023 FINM2416 Asset Pricing
Page 5 of 5
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