{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

midterm1_solution

# midterm1_solution - Economics 136 Financial Economics...

This preview shows pages 1–2. Sign up to view the full content.

Economics 136. Financial Economics Midterm 1, Fall 2008, Suggested solutions 1. True or false. (20 points, 5 each) (i) True. The price of a zero-coupon bond is P = F= (1 + R ) T and when R > 0 , this is les than F . (ii) False. A price weighted portfolio means that you hold an equal number of shares of each company in your portfolio, and hence requires no rebalancing when prices change. (iii) False. By put-call parity, C 0 = S 0 + P 0 ° X= (1 + R f ) . Since S 0 , X and R f are unchanged, an increase in the put price P 0 must result in an increase in the call price C 0 . 2. Mortgage-backed securities (28 points, 7 each) Stock index Treasury Mortg pool Tranch A Tranch B State 1: good times 16 10 20 10 10 State 2: recession 8 10 8 0 8 Price today 10 9 (a) To construct AD1, consider a portfolio of x shares of the stock index and y shares of the bond.For this to be a replicating portfolio, we need 16 x + 10 y = 1 8 x + 10 y = 0 : Solving these, we °nd x = 0 : 125 and y = ° 0 : 1 . Hence by the LOOP, the price of AD1 must be 10 ± (0 : 125) + 9 ± ( ° 0 : 1) = \$0 : 35 . To price AD2, note that the price of a portfolio of AD1

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 3

midterm1_solution - Economics 136 Financial Economics...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online