# Questions - QuestionsforChapt.1 .E. 1.:1=e21=\$1.5\$1= .

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Questions for Chapt.1   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 = e2 £1 = \$1.5 \$1 = e1 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 return with (a) annual compounding, (b) six-monthly compounding, (c) quarterly  compounding, (d) weekly compounding, (e) daily compounding (365 days per year), (f) continuous compounding (i.e.  the force of interest). 3. Suppose that an asset has three possible payoffs (measured in units of account) with  probabilities given below: Payoff: Probability: 1 0.3 4 0.5 5 0.2 (a) Calculate the expected payoff on a unit of the asset.

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