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Sample midterm 1b

Sample midterm 1b - Economics 136 Financial Economics...

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Economics 136. Financial Economics Sample midterm 1B, Fall 2009 Read through the entire exam carefully, and then do all questions. You will be graded on the quality of your explanations as well as the numerical accuracy of your answers. Write your name, your GSI’s name and your section time on your blue book. You may use a calculator and one two-sided sheet of handwritten notes. 1. True or false (18 points, 6 each) Are the following statements true or false? Explain your answer in no more than two sentences. You will be graded on the quality of your explanation. (i) When yields are positive, the price of a zero-coupon bond is always below face value. (ii) The Dow Jones Industrial Average is a price weighted portfolio. Suppose that you are an index fund manager, and your job is to replicate the Dow; then you have to rebalance your portfolio when prices change, because the price weights change. (iii) Consider a European put and a European call option on ABC stock with the same strike price X and expiration date T . Suppose that due to a change in market conditions, the put price increases, but the price of ABC stock and the riskfree rate R f are unchanged. Then the call price must decrease. 2. Mortgage backed securities (28 points, 7 each) An investment bank just purchased a pool of subprime mortgages, which is exposed to risk of foreclosure if the economy hits a recession next year. You have the following economic data about the prices and payo ff
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