Past Paper 2010-11 Term 2

Past Paper 2010-11 Term 2 - ECO 3420B Financial Economics...

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ECO 3420B Financial Economics Final Examination (2010-11 Term 2) (Closed-Book) Always explain your answer clearly and completely. Credits are given to concise and well-presented answers. Provide diagrams wherever appropriate. Time allowed = 90 minutes. Answer all eight questions. Sub-questions carry the same marks unless otherwise stated. 1. a. Suppose you have two investment options in a world of certainty. One is to put your money in a bank and earn an interest rate of 3%. The other is to put it in an investment project which produces an income stream yielding a positive NPV at 3%. Which option would you choose? b. Suppose the bank increases the interest rate, show using the NPV formula that if the increase is large, you may decide to put your money in the bank instead. c. Deduce why the Quantitative Easing policy of the Federal Reserve has an expansionary effect on the economy. d. Why is that consumption smoothing need not be considered in the above analyses? Diagram necessary. 2. a. Consider four normally distributed assets with the following ROR and standard deviation: A = (10%, 0.01), B= (11%, 0.04), C=(13%, 0.08), D=(20%, 0.05). Locate these assets in a suitable diagram with clearly labeled axes. b. Try to rank, using indifference curves, the following pairs for a risk-averse investor: C and D, A and B. c. If we allow the risk-averse investor to form portfolios by mixing the four assets, which two assets are most likely to be demanded as part of the optimal portfolio? Show your answer in a diagram. 3. The Hong Kong Stock Exchange has no listed company in the private hospital industry at present. Now a private hospital is planning a major expansion which requires substantial capital injection and is choosing between two options. Option 1 is borrowing from banks. Option 2 is going for an IPO. The investment banker suggests option 2. What is the major reason? (Hint: use CAPM). 4. Consider the following common observations made on stock markets. First, the volatility test fails. Second, stock prices and stock indexes show mean reversion movements. Third, trading is dominated by institutional investors who invest through fund managers. Fourth, contrarian strategies work but are seldom adopted. a.
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This note was uploaded on 03/03/2012 for the course ECON 3420 taught by Professor Kwong during the Spring '11 term at CUHK.

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Past Paper 2010-11 Term 2 - ECO 3420B Financial Economics...

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