INDEX MODELS AND THE ARBITRAGE PRICING THEORY
l. a. To optimize this portfolio one would need:
estimates of means
estimates of variances
estimates of covariances
n2 + 3n
b. In a single-ind
1. Put values also must increase as the volatility of the underlying stock increases.
We see this from the parity relation as follows:
P = C + PV(X) S0 + PV(dividends).
Given a value of S and a risk-free interest rate, if C inc
FUTURES, FORWARDS, AND SWAP MARKETS
1. There is little hedging or speculative demand for cement futures, since cement
prices are fairly stable and predictable. The trading activity necessary to support
the futures market would not materialize.
TRADING ON SECURITIES MARKETS
Individual solutionanswers to this problem will vary.
In principle, potential losses are unbounded, growing directly with increases in
the price of Alcan.
If the stop-buy order can be filled at $78, the
FINANCIAL MARKETS AND INSTRUMENTS
Money market securities are called cash equivalents because of their great
liquidity. The prices of money market securities are very stable, and they can be
converted to cash (i.e., sold) on very short not
OPTIONS AND OTHER DERIVATIVES MARKETS:
1. We assume in all cases that the option position is established by buying at the ask
a. Option price = $3.95; payoff = 14 11 = 3; profit = 3 3.95 = 0.95
b. Option price = $0.52; payo
THE TERM STRUCTURE OF INTEREST RATES
1. In general, the forward rate can be viewed as the sum of the markets expectation
of the future short rate plus a potential risk or liquidity premium. According to
the expectations theory of the term struc
CAPITAL ALLOCATION TO RISKY ASSETS
1. a. The expected cash flow is (.5 $70,000) + (.5 200,000) = $135,000.
With a risk premium of 8 percent over the risk-free rate of 6 percent, the
required rate of return is 14 percent. Therefore, the present v
OPTIMAL RISKY PORTFOLIOS
1. (a) for sure.
(b) and (d) are firm-specific.
(c) and (e) can be either firm-specific or due to marketwide factors.
2. (a) and (c) enter into the portfolio variance and thus affect portfolio risk.
3. (a) is true by def
THE CAPITAL ASSET PRICING MODEL
1. E(rP) = rf + P[E(rM) rf]
18 = 6 + (14 6)
P = 12/8 = 1.5
2. If the covariance of the security doubles, then so will its beta and its risk premium.
The current risk premium is 14 6 = 8 percent, so the new risk pr
RETURN AND RISK: ANALYZING THE HISTORICAL RECORD
1. Your holding period return for the next year on the money market fund depends
on what 30-day interest rates will be each month when it is time to roll over
maturing securities. The one-year sav