investment

   

EC7092   All  Candidates  

     

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Summer  Term  Examinations  2016      

DO  NOT  OPEN  THE  QUESTION  PAPER  UNTIL  INSTRUCTED  TO  DO  SO  BY  THE   CHIEF  INVIGILATOR  

 

Department   Economics  

Module  Code   EC7092  

Module  Title   Investment  Management  

Exam  Duration   (in  words)  

Two  Hours  

 

CHECK  YOU  HAVE  THE  CORRECT  QUESTION  PAPER    

Number  of  Pages   Three  

Number  of  Questions   Six  

Instructions  to   Candidates  

  This  paper  is  in  two  sections.  Students  should  attempt  ALL  the  questions  in   Section  A  and  ONE  question  in  Section  B.       The  maximum  mark  awarded  for  Section  A  is  60  marks.  The  maximum  mark   awarded  for  Section  B  is  40  marks.  The  maximum  mark  for  the  entire  paper  is   100  marks.            

 

For  this  exam  you  are  allowed  to  use  the  following  

Calculators   Casio  FX83GTPLUS  or  Casio  FX85GTPLUS    

Books/Statutes   NOT  PERMITTED  

Additional  Stationery   No  

   

EC7092   All  Candidates  

     

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SECTION A

Answer ALL questions. Each question carries a weight of 20 marks.

1. There are three assets. Their expected returns, and variances of returns, are described in the table below. The returns on the assets are uncorrelated.

Expected Return: E(R) Variance of Returns: σ 2 Asset 1 0.2 0.24 Asset 2 0.24 0.6 Asset 3 0.04 0

a. Plot the assets in the expected return/variance space. (20%) b. Find the optimal risky portfolio, and calculate its expected return and the variance

of its returns. (50%) c. Then suppose that an investor’s preferences are given by the mean-variance

utility function:

U = 3 E(R) – 5σ 2

Find the optimal portfolio for this investor. (30%)

2. The Bank of England conducted an auction for selling its latest issue of government gilts. The table below gives the selling prices of the gilts for different maturities. All of them are zero coupon gilts and they are expected to pay £1,000 on maturity.

Guilt Duration 1 Year 2 Year 3 Year 5 Year 10 Year Auction Price £ 961.54 £ 898.63 £ 847.77 £ 799.10 £ 760.32

a. Derive and plot the bond yield curve implied by the above prices, assuming that if no bond expires at a specific year then the yield remains the same. (60%)

b. What information could an analyst obtain from the above yield curve? (40%) 3. Suppose that the returns of the assets in the table below are derived by the two-factor

model Ri = ai +b1iI1 +b2iI2 +εi

   

EC7092   All  Candidates  

     

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Suppose that the first factor has an expected rate of return of I1=5% and a standard deviation σ1=3%. The second factor has an expected rate of return of I2=12% and a standard deviation σ2=5%. The returns between the two factors and the returns between the idiosyncratic component of each asset and each factor are uncorrelated. The risk-free rate of return is RF = 2%.

αi b1i b2i σεi

Asset 1 0.4% 0.3 0.5 22% Asset 2 1.4% 0.2 0.1 9% Asset 3 -3.0% 2.2 -0.3 4% Asset 4 3.4% -1.2 0.5 10% Asset 5 3.0% 2.1 0.4 29%

a. Rank the above assets according to the Sharpe ratio from the most to the least desirable (50%)

b. Do you spot any arbitrage opportunity? If so, how would you exploit it? (50%)

SECTION B

Answer ONE of the following questions. Each question carries a weight of 40 marks. If you answer more than one question, only the worst answer will be credited to you.

4. Explain the main differences between CAPM, Markowitz’s theory of portfolio selection and the Single-Index model.

5. If you were a hedge-fund manager, what arguments would you use to convince your prospective clients to invest in your company rather than pursue a passive investment strategy?

6. What are the main valuation approaches for equities and under what conditions are they valid?

 

END  OF  PAPER