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Unformatted text preview: UNIVERSITY OF TORONTO AT SCARBOROUGH DEPARTMENT OF MANAGEMENT ECMC49: FINANCIAL ECONOMICS Winter 2010 A. Mazaheri Test2(Solutions) Instructions : This is a closed book examination. You are permitted to bring a nonprogrammable calculator and a handwritten one side of one 8 11 page with notes and/or formulae. Show all your work otherwise you will not get full credit . Make sure you allocate time appropriately . You have 2 hours. Good Luck! NAME: _____________________________________________ ID#: _____________________________________________ Problem1 _______________ (15 points) Problem2 _______________ (20 points) Problem3 _______________ (25 points) Problem4 _______________ (15 points) Total _____________ (72 points) 2 Problem1 [15 Points]: Answer the following short questions. a) [4 Points] The indifference curves from a meanvariance utility function intersects the vertical axis at the risk free rate. False/True show why? Solution: False because: CE A r E U = = 2 5 . ) ( Therefore the indifference curves intersects the vertical axis at E(r)=CE f r b) [4 Points] A stock with an expected rate of return less than the risk free rate is never included in the market portfolio because one is always better off choosing the risk free asset. False/True, Explain why? Answer : False, in equilibrium negative Beta assets on average earn less than the risk free rate because they contribute negative risk in the market portfolio, see formula. The correlation between the negative Beta asset and the market portfolio is negative, the asset cancels risk so is used as insurance. 3 b) [7 Points] The following information about Asset A & Asset B is given: Security Expected Return Standard Deviation A 0.04 0.15 B 0.08 0.25 The risk free is 7% and the coefficient of correlation is AB = 1.00. On the graph below, carefully plot the feasible set of portfolios of securities 1 and 2. (Use nonnegative weights for the securities.) Identify the portfolio weights that would give you the minimum standard deviation portfolio and plot the CAL....
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 Spring '11
 mazaheri
 Management

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