midterm1_solution - Economics 136. Financial Economics...

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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 : x = 0 : 125 and y = & 0 : 1 . Hence by the LOOP, the price of AD1 must
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This note was uploaded on 10/17/2008 for the course ECON 136 taught by Professor Szeidl during the Fall '08 term at University of California, Berkeley.

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midterm1_solution - Economics 136. Financial Economics...

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