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Investment Analysis and Portfolio Management Christmas Worksheet 2007 - 2008

This document contains an investment analysis and portfolio management worksheet with 5 questions. Question 1 asks about bond yields, pricing bonds, and the term structure. Question 2 examines efficient portfolios with two risky stocks and introduces borrowing/lending, calculating the market portfolio. Question 3 provides a single-factor market model for 3 stocks and asks about portfolio standard deviation and expected returns. Question 4 discusses adjusting historical betas and using betas in portfolio construction. Question 5 defines call and put options, describes a risk-free portfolio, explains the binomial option pricing model, and prices a European put option.

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56 views

Investment Analysis and Portfolio Management Christmas Worksheet 2007 - 2008

This document contains an investment analysis and portfolio management worksheet with 5 questions. Question 1 asks about bond yields, pricing bonds, and the term structure. Question 2 examines efficient portfolios with two risky stocks and introduces borrowing/lending, calculating the market portfolio. Question 3 provides a single-factor market model for 3 stocks and asks about portfolio standard deviation and expected returns. Question 4 discusses adjusting historical betas and using betas in portfolio construction. Question 5 defines call and put options, describes a risk-free portfolio, explains the binomial option pricing model, and prices a European put option.

Uploaded by

farrukhazeem
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Investment Analysis and Portfolio Management

Christmas Worksheet 2007 2008


Question 1.
(i) Define the yield of a bond.
(ii) Four pure discount bonds, all with face values of $1000, and maturities of 1, 2, 3
and 4 years are priced at $970, $965, $950 and $940 respectively. Calculate their
yields.
(iii) Using the answer to (ii), price a bond that pays a coupon of $50, has a face value
of $1000 and matures in 4 years.
(iv) Using the answer to (ii), plot the term structure. Comment upon its form.
(v) Does liquidity preference explain the term structure?
Question 2.
(i) Assume there are two risky stocks available. Stock A has an expected return of
10% and a standard deviation of 5%. Stock B has an expected return of 8% and a
standard deviation of 3%.
a. Assuming the returns on the two stocks are uncorrelated plot the set of efficient
portfolios and mark on the minimum variance portfolio.
b. If all investors are risk averse, will short sales of either stock be observed?
(ii) Now introduce borrowing and lending at a risk-free rate of interest of 5%.
a. Plot the new efficient frontier.
b. Determine the structure of the market portfolio.
How will an increase in the rate of interest affect the percentage of stock A in the
market portfolio?
Question 3.
Assume that returns are generated by a model where the market is the single factor.
The details of the model for three stocks are:

Stock

Beta

ei

Portfolio weight

A
B
C

1.1
0.8
1.0

7
2.3
1

0.2
0.5
0.3

The expected return on the market is 12% with a standard deviation of 18%. The risk
free rate is 5%.
(i) What is the standard deviation of the return on the portfolio?
(ii) Explain why it is not possible to compute the expected return on the portfolio
using this data. What assumption can you make that will allow you to compute the
expected returns? What are the expected returns under this assumption?
(iii) Discuss the limitations of the market model as a guide to portfolio choice.

Question 4.
(i) Why would a security analyst consider adjusting historical betas?
(ii) Given the betas of a set of stocks, how can they be employed in portfolio
construction?
(iii) Assume there are two stocks, A and B, with A 0.7 and B 1.3 , and
idiosyncratic variations eA 2, eB 3 . If the variance of the return on the market is
2
M
25 , calculate the variance of a portfolio consisting of 110% of stock A.
(iv) What is the variance of the portfolio in (iii) if it is 20% financed by borrowing?

Question 5.
(i) Describe call and put options, making sure that you distinguish between American
and European. Show how a risk-free portfolio can be constructed using these options.
(ii) Describe how the binomial model can be used to price a call option.
(iii) Compute the equilibrium price of a European put option with 6 months until the
exercise date when the exercise price is 3.00, the current stock price 2.95, and the
stock price at the exercise date may be 3.10 or 3.05. Assume that the annual risk
free rate of return is 6%.

This work will be graded but will not be assessed.


Work to be submitted during lecture 1 next term.

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