Q1:

(a) Differentiate between systematic and non-systematic risk and elaborate on their
relation with β. What do you understand about the risk of an asset that has β = 0
and β < 0?

(b) You are offered a 8% coupon bond with a face value of Rs. 1000. The bond has
three years to maturity, the coupons are paid semiannually, and the yield to
maturity is 10%. What price are you willing to pay for this bond?

(c) Write a short note on the price yield curve.

Q2:
(a) Indicate on a mean-standard deviation diagram and explain the feasible set of 3
risky not perfectly correlated assets with different means when shorting of
assets is not allowed.

(b) You have a choice between receiving your salary of Rs. 120,000 in equal
monthly instalments of Rs. 10,000 or in a single lump sum at the end of each
year. If your required return is 12% p.a. compounding monthly, what year-end
salary would you demand?

(c) Using the capital market line elaborate on the price of risk.

Q3:
(a) In an economy there are 2 risky assets X and Y and a risk-free asset Z. The two
risky assets are in equal proportion in the market i.e. M=1/2 (X+Y). It is also
known that rz=0.1, σx= 0.02, σy = 0.04, σxy = 0.01 and rm= 0.18 (rz and rm are the
risk free and the market return)
i) Find the values for σm2, βx, βy
ii) Find rx and ry using the CAPM model

(b) What is immunization of a portfolio? What problems does it solve and what are
its shortcomings?

(c) Define the Capital Market Line and Security Market Line and state the
differences between them.

Q4:
(a) Given n basic risky assets with define the feasible set or region. Assuming risk
averse and nonsatiated investors with no shorting indicate on a mean – standard
deviation diagram the feasible set, the minimum variance set, the minimum
variance point and the efficient frontier.

(b) You have the option of investing in a coal mining firm. The price of a share of
the firm is Rs. 875. The share price is expected to be Rs. 1000 after a year but
due to uncertainty about how much coal will actually be mined the standard
 deviation of this return is σ = 40%. The current risk-free interest rate is 10%, the
expected return on the market portfolio is 17% and standard deviation of the
market return is 12%. Using the capital market line as a deciding factor, should
you invest in the coal mining firm?

(c) Shorting an asset converts a negative rate of return into a profit. True or False?
Explain with an example if true else give the reasoning if false.

Q5:
(a) Write a short note on the Markowitz Model.

(b) How does the inclusion of a risk-free asset impact the feasible region? Explain
and illustrate. Assume both borrowing and lending of the risk-free asset is
allowed.

(b) You have a Rs.1000 par value bond with 7 years to maturity. Find the current
price of the bond if:
i) 5% coupons are paid semiannually and the annual yield of the bond is
6%?
ii) The bond is a zero-coupon bond with annual yield 8%

Q6:
(a) Give the price sensitivity formula for a fixed income security and show its use
in approximating the change in price of a bond due to a small change in yield.
Use this formula to calculate the change in price and the new price of a 30-year
at par zero coupon bond with par value=100 and semi-annual coupon payment,
whose yield increases from 10% to 11%.

(b) Derive and explain the asset pricing form of CAPM?

(c) Derive an expression for the mean and variance of the rate of return of a
portfolio that has n assets with E(ri)=r i , variance of return of asset i = σi2 and
covariance of the return of asset j with asset i = σij. The weight of each asset in
the portfolio is wi.

Q7:
(a) Derive an expression for modified duration for a fixed income instrument where
payments are made m times per year and the yield based on those same periods
is λ. What is the relationship between duration and price sensitivity?
(b) Consider a portfolio with the following specifications:
Asset No. of Price of Expected
shares share return on
asset

A 200 30 3%
 B 1000 5 5%

C 50 400 2%

What is the mean return of this portfolio?

(c) Discuss the investment implications of CAPM emphasizing on the one fund
theorem and a CAPM purist.

Q8:
(a) Derive the certainty equivalent form of the CAPM pricing formula and discuss
its linearity property.

(b) There are 3 uncorrelated assets with variance of each =1 and r 1=1, r 2 =2 and
r 3 =3. Set up the Markowitz problem to get the optimal weights of the three
assets in the portfolio for a desired mean return of 2.

(c) Describe the qualitative properties of the price yield curve.

Q9:
(a) An investor is choosing between two mutual funds. The risk-free rate is 5% and
the average market return is 13%. The following information is available about
two funds in the market:

Fund A Fund B

β .8 1.2

σ 20% 32%

If borrowing and lending at risk free rate of interest is allowed, which of the two
funds do you prefer in your portfolio along with the risk-free asset to get the
market rate of return and why?

(b) “If returns on risky assets are uncorrelated, it is possible through diversification
to reduce the portfolio variance to zero.” Prove the statement in case of n assets
that have zero correlation with each other, have the same mean expected return
m and variance σ2. What happens if the assets are correlated?

(c) “When everyone follows the mean-variance methodology with the same
estimates of parameters, the efficient fund of risky assets will be the market
portfolio”. Give the equilibrium argument to prove the above statement.

Q10:
(a) You want to buy a new car. The price is Rs. 58,000. Dealer A provides
financing over 5 years at 5.5% p.a. compounding monthly with repayments to
be made monthly. Dealer B gives a Rs. 4000 discount and provides financing
over 5 years at 6% p.a. compounding monthly with repayments to be made
monthly. Which one will you choose?

(b) In a r - σ diagram defined by non-negative mix of two assets 1 and 2, prove that
the triangular region defined by the two original assets, has a height on vertical
axis A= (r 1σ2 + r 2 σ1)/ σ1+ σ2.

(c) “An asset on the capital market line has only systematic risk. Assets with
nonsystematic risk lie to the right of the line”. Explain and illustrate.

Q11:
(a) What can you say about the expected return of:
i) An asset with high σ and β = 0
ii) An asset with high σ and β < 0

(b) Variance of a portfolio is the weighted sum of variances of individual assets.

True or False? Explain.

(c) Calculate the duration and modified duration of a perpetual annuity that that
pays Rs. 100 at the beginning of each year with the first payment starting one
year from now and has a constant interest rate of 8% compounded annually.

Q12:
(a) The following information is known about 3 assets:

Asset r σ Correlation with market

Real Estate 8% 15% .5
Stocks 12% 22.5% 1
Gold 15% 15% .25
i) What is the return on a portfolio that includes all 3 assets in equal
weights?
ii) If the market standard deviation is 15%, what is the β of each asset?
iii) If real estate and stock is correctly priced according to CAPM, find the
market expected return and the risk-free rate.

(b) Define the duration of a fixed income instrument and give and explain its
general formula. When does the general duration formula become Macaulay
duration? Write the formula for Macaulay duration.

(c) Define the total return and rate of return on a single period investment. How are
the two notions related? What happens to the return and rate of return formula
when you short an asset?