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6 Pages

### Chap005

Course: FINA 6275, Spring 2012
School: GWU
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Word Count: 1587

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05 Chapter - Learning About Return and Risk from the Historical Record CHAPTER 5: LEARNING ABOUT RETURN AND RISK FROM THE HISTORICAL RECORD PROBLEM SETS 1. The Fisher equation predicts that the nominal rate will equal the equilibrium real rate plus the expected inflation rate. Hence, if the inflation rate increases from 3% to 5% while there is no change in the real rate, then the nominal rate will increase by 2%....

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GWU - FINA - 6275
Chapter 06 - Risk Aversion and Capital Allocation to Risky AssetsCHAPTER 6: RISK AVERSION AND CAPITAL ALLOCATION TO RISKY ASSETSPROBLEM SETS 1. 2. (e) (b) A higher borrowing is a consequence of the risk of the borrowers' default. In perfect markets with
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Chapter 07 - Optimal Risky PortfoliosCHAPTER 7: OPTIMAL RISKY PORTFOLIOSPROBLEM SETS 1. 2. (a) and (e). (a) and (c). After real estate is added to the portfolio, there are four asset classes in the portfolio: stocks, bonds, cash and real estate. Portfol
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Chapter 08 - Index ModelsCHAPTER 8: INDEX MODELSPROBLEM SETS 1. The advantage of the index model, compared to the Markowitz procedure, is the vastly reduced number of estimates required. In addition, the large number of estimates required for the Markow
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Chapter 09 - The Capital Asset Pricing ModelCHAPTER 9: THE CAPITAL ASSET PRICING MODELPROBLEM SETS 1. E(rP) = rf + P [E(rM ) rf ] 18 = 6 + P(14 6) P = 12/8 = 1.5 2. If the security's correlation coefficient with the market portfolio doubles (with all ot
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Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and ReturnCHAPTER 10: ARBITRAGE PRICING THEORY AND MULTIFACTOR MODELS OF RISK AND RETURNPROBLEM SETS 1. The revised estimate of the expected rate of return on the stock would be the ol
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Chapter 11 - The Efficient Market HypothesisCHAPTER 11: THE EFFICIENT MARKET HYPOTHESISPROBLEM SETS 1. The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period to pre
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Chapter 12 - Behavioral Finance and Technical AnalysisCHAPTER 12: BEHAVIORAL FINANCE AND TECHNICAL ANALYSISPROBLEM SETS 1. Technical analysis can generally be viewed as a search for trends or patterns in market prices. Technical analysts tend to view th
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Chapter 13 - Empirical Evidence on Security ReturnsCHAPTER 13: EMPIRICAL EVIDENCE ON SECURITY RETURNSPROBLEM SETS 1. Even if the single-factor CCAPM (with a consumption-tracking portfolio used as the index) performs better than the CAPM, it is still qui
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Chapter 14 - Bond Prices and YieldsCHAPTER 14: BOND PRICES AND YIELDSPROBLEM SETS 1. The bond callable at 105 should sell at a lower price because the call provision is more valuable to the firm. Therefore, its yield to maturity should be higher. Zero c
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Chapter 15 - The Term Structure of Interest RatesCHAPTER 15: THE TERM STRUCTURE OF INTEREST RATESPROBLEM SETS. 1. In general, the forward rate can be viewed as the sum of the market's expectation of the future short rate plus a potential risk (or `liqui
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Chapter 16 - Managing Bond PortfoliosCHAPTER 16: MANAGING BOND PORTFOLIOSPROBLEM SETS 1. While it is true that short-term rates are more volatile than long-term rates, the longer duration of the longer-term bonds makes their prices and their rates of re
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Chapter 17 - Macroeconomic and Industry AnalysisCHAPTER 17: MACROECONOMIC AND INDUSTRY ANALYSISPROBLEM SETS 1. Expansionary (looser) monetary policy to lower interest rates would stimulate both investment and expenditures on consumer durables. Expansion
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Chapter 18 - Equity Valuation ModelsCHAPTER 18: EQUITY VALUATION MODELSPROBLEM SETS 1. Theoretically, dividend discount models can be used to value the stock of rapidly growing companies that do not currently pay dividends; in this scenario, we would be
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Chapter 19 - Financial Statement AnalysisCHAPTER 19: FINANCIAL STATEMENT ANALYSISPROBLEM SETS 1. The major difference in approach of international financial reporting standards and U.S. GAAP accounting stems from the difference between principles and ru
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Chapter 20 - Options Markets: IntroductionCHAPTER 20: OPTIONS MARKETS: INTRODUCTIONPROBLEM SETS 1. Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk is invest
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Chapter 21 - Option ValuationCHAPTER 21: OPTION VALUATIONPROBLEM SETS 1. The value of a put option also increases with the volatility of the stock. We see this from the put-call parity theorem as follows: P = C S0 + PV(X) + PV(Dividends) Given a value f
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Chapter 22 - Futures MarketsCHAPTER 22: FUTURES MARKETSPROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support the futures market
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Chapter 23 - Futures, Swaps, and Risk ManagementCHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENTPROBLEM SETS 1. In formulating a hedge position, a stocks beta and a bonds duration are used similarly to determine the expected percentage gain or loss in th
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Chapter 24 - Portfolio Performance EvaluationCHAPTER 24: PORTFOLIO PERFORMANCE EVALUATIONPROBLEM SETS 1. As established in the following result from the text, the Sharpe ratio depends on both alpha for the portfolio ( P) and the correlation between the
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Chapter 25 - International DiversificationCHAPTER 25: INTERNATIONAL DIVERSIFICATIONPROBLEM SETS 1. International Investing Raises Questions was published in the Wall Street Journal in 1997. Some of the arguments presented in the article may no longer be
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Chapter 26 - Hedge FundsCHAPTER 26: HEDGE FUNDSPROBLEM SETS 1. No, a market-neutral hedge fund would not be a good candidate for an investors entire retirement portfolio because such a fund is not a diversified portfolio. The term marketneutral refers t
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Chapter 27 - The Theory of Active Portfolio ManagementCHAPTER 27: THE THEORY OF ACTIVE PORTFOLIO MANAGEMENTPROBLEM SETS 1. Views about the relative performance of bonds compared to stocks can have a significant impact on how security analysis is conduct
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Chapter 28 - Investment Policy and the Framework of the CFA InstituteCHAPTER 28: INVESTMENT POLICY AND THE FRAMEWORK OF THE CFA INSTITUTEPROBLEM SETS 1. You would advise them to exploit all available retirement tax shelters, such as 403b, 401k, Keogh pl
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IntroductionIntroductionChapter 1Options, Futures, and OtherDerivatives, 7th Edition, Copyright John C. Hull 20081Size of OTC and Exchange-Traded MarketsSize(Figure 1.1, Page 3)Source: Bank for International Settlements. Chart shows total princi
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Mechanics of Futures Markets MarketsChapter 2Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Futures ContractsAvailableon a wide range of assets Exchange traded Specifications need to be defined: What can be delive
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Hedging Strategies Using Futures FuturesChapter 3Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Long &amp; Short HedgesAlong futures hedge is appropriate when you know you will purchase an asset in the future and want
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Interest Rates InterestChapter 4Options, Futures, and Other Derivatives 7th Edition, Copyright John C. Hull 20081Types of RatesTreasuryrates LIBOR rates Repo ratesOptions, Futures, and Other Derivatives 7th Edition, Copyright John C. Hull 20082Me
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Determination of Forward and Futures Prices FuturesChapter 5Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Consumption vs Investment Consumption Assets AssetsInvestmentassets are assets held by significant numbers
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Interest Rate Futures InterestChapter 6Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Day Count Conventions in the U.S. (Page 129) (PageTreasury Bonds: Actual/Actual (in period) Corporate Bonds: 30/360 Money Market
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SwapsSwapsChapter 7Options, Futures, and OtherDerivatives, 7th Edition, Copyright John C. Hull 20081Nature of SwapsA swap is an agreement to exchangecash flows at specified future timesaccording to certain specified rulesOptions, Futures, and O
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Mechanics of Options Markets MarketsChapter 8Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Review of Option TypesAcall is an option to buy A put is an option to sell A European option can be exercised only at the
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Properties of Stock Options PropertiesChapter 9Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Notationc : European call option price p : European put option price S0 : Stock price today K : Strike price T : Life of
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Trading Strategies Involving Options OptionsChapter 10Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Types of StrategiesTakea position in the option and the underlying Take a position in 2 or more options of the sa
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Binomial Trees BinomialChapter 11Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081A Simple Binomial ModelAstock price is currently \$20 In 3 months it will be either \$22 or \$18Stock Price = \$22 Stock price = \$20 Stoc
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Wiener Processes and Its Lemma LemmaChapter 12Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Types of Stochastic ProcessesDiscretetime; discrete variable Discrete time; continuous variable Continuous time; discrete
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The Black-Scholes-Merton Model ModelChapter 13Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081The Stock Price AssumptionConsidera stock whose price is S In a short period of time of length t, the return on the stock
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Employee Stock Options EmployeeChapter 14Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Nature of Employee Stock Nature Options OptionsEmployeestock options are call options issued by a company on its own stock The
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Options on Stock Indices and Currencies CurrenciesChapter 15Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Index Options (page 325-335) (pageThemost popular underlying indices in the U.S. are The S&amp;P 100 Index (OEX
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Futures Options FuturesChapter 16Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Mechanics of Call Futures Mechanics Options OptionsWhen a call futures option is exercised the holder acquires 1. A long position in th
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The Greek Letters TheChapter 17Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081ExampleAbank has sold for \$300,000 a European call option on 100,000 shares of a nondividend paying stock S0 = 49, K = 50, r = 5%, = 20%
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Volatility Smiles VolatilityChapter18Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081What is a Volatility Smile? WhatItis the relationship between implied volatility and strike price for options with a certain matu
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Basic Numerical Procedures BasicChapter 19Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Approaches to Derivatives Approaches Valuation ValuationTrees MonteCarlo simulation Finite difference methodsJohn C. Hull 20
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Value at Risk ValueChapter 20Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081The Question Being Asked in The VaR VaRWhat loss level is such that we are X% confident it will not be exceeded in N business days?20082
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Estimating Volatilities and Correlations CorrelationsChapter 21Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Standard Approach to Estimating Standard Volatility (page 477) Volatility (page n as the volatility per d
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Credit Risk CreditChapter 22Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Credit RatingsInthe S&amp;P rating system, AAA is the best rating. After that comes AA, A, BBB, BB, B, CCC, CC, and C The corresponding Moodys
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Credit Derivatives CreditChapter 23Options, Futures, and Other Derivatives 7th Edition, Copyright John C. Hull 20081Credit Default Swaps CreditAhuge market with over \$40 trillion of notional principal Buyer of the instrument acquires protection from
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Exotic Options ExoticChapter 24Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Types of Exotics Package Nonstandard BinaryAmericanoptions Forward start options Compound options Chooser options Barrier optionsoptio
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Weather, Energy, and Insurance Derivatives InsuranceChapter 25Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Pricing Issues (page 581) (page PricingToa good approximation many underlying variables in insurance, wea
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More on Models and Numerical Procedures NumericalChapter 26Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Three Alternatives to Geometric Three Brownian Motion BrownianConstantelasticity of variance (CEV) Mixed Jum
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Martingales and Measures MartingalesChapter 27Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Derivatives Dependent on a Single Derivatives Underlying Variable UnderlyingConsider a variable (not necessarily the price
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Interest Rate Derivatives: The Standard Market Models StandardChapter 28Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081The Complications in Valuing The Interest Rate Derivatives (page 647) (page Weneed a whole term
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Quanto, Timing, and Convexity Adjustments ConvexityChapter 29Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Forward Yields and Forward Forward Prices Wedefine the forward yield on a bond as the yield calculated fro
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Interest Rate Derivatives: Model of the Short Rate ModelChapter 30Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Term Structure ModelsBlacksmodel is concerned with describing the probability distribution of a singl
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Interest Rate Derivatives: HJM and LMM HJMChapter 31Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081HJM Model: Notation HJMP(t,T ): price at time t of a discount bond with principal of \$1 maturing at T Wt : vector of
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Swaps Revisited SwapsChapter 32Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Valuation of SwapsThestandard approach is to assume that forward rates will be realized This works for plain vanilla interest rate and p
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Real Options RealChapter 33Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081An Alternative to the NPV Rule An for Capital Investments forDefinestochastic processes for the key underlying variables and use risk-neutra
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Derivatives Mishaps and What We Can Learn From Them WeChapter 34Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 20081Big Losses by Financial Big Institutions Institutions AlliedIrish Bank (\$700 million) Amaranth (\$6 bill
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OVERVIEW OF CONTENTSChapter 1 introduces the text. Chapters 2-5 set forth the basic analytical framework necessary to understand the pricing of bonds and their investment characteristics. Chapter 6 describes the treasury market. Chapters 7-9 explain the
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CHAPTER 2 PRICING OF BONDSCHAPTER SUMMARYThis chapter will focus on the time value of money and how to calculate the price of a bond. When pricing a bond it is necessary to estimate the expected cash flows and determine the appropriate yield at which to
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CHAPTER 3 MEASURING YIELDCHAPTER SUMMARYIn Chapter 2 we showed how to determine the price of a bond, and we described the relationship between price and yield. In this chapter we discuss various yield measures and their meaning for evaluating the relati
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CHAPTER 4 BOND PRICE VOLATILITYCHAPTER SUMMARYTo use effective bond portfolio strategies, it is necessary to understand the price volatility of bonds resulting from changes in interest rates. The purpose of this chapter is to explain the price volatilit