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THE ECONOMICS OF FINANCIAL MARKETS
R. E. BAILEY
Exercises for Chapter 1
Asset markets and asset prices
1. Consider the following foreign exchange rates:
£1 =
e
2
£1 = $1.5
$1 =
e
1
Examine the opportunity for arbitrage proﬁts if such prices were observed. What would you
predict would happen in such circumstances? What factors determine whether opportunities
for arbitrage proﬁts appear to remain in observed foreign exchange rates?
2. Suppose that
$80
invested today will result in a total payoff of
$320
in 20 years time.
How would you respond to the claim that the investment represents a 300% return, that is
15% per year over 20 years? In your answer calculate the investment’s annual rate of re
turn with (a) annual compounding, (b) sixmonthly compounding, (c) quarterly compounding,
(d) weekly compounding, (e) daily compounding (365 days per year), (f) continuous com
pounding (i.e. the force of interest).
3. Suppose that an asset has three possible payoffs (measured in units of account) with probabil
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This note was uploaded on 03/21/2011 for the course ECON 6120 taught by Professor Crabbe during the Spring '11 term at University of Ottawa.
 Spring '11
 CRABBE

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