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principles of finance
Questions and Answers of
Principles Of Finance
The following table gives annual, end of year prices of a bond and of the consumer prices index Year Bond valueCPI value 2011 36.9 108.0 2012 39.8 110.3 2013 42.4 113.6 2014 38.1 116.1 2015 36.4
What are the key features of asset return time-series?
Present and explain a problem that can be approached using a time-series regression, another one using cross-sectional regression, and another using panel data.
Explain the differences between the following pairs of terms(a) Continuous and discrete data(b) Ordinal and nominal data(c) Time-series and panel data(d) Noisy and clean data(e) Simple and
The covariance between two variables is 0.99. Are they strongly related? Explain your answer.
Which is a more useful measure of central tendency for stock returns − the arithmetic mean or the geometric mean? Explain your answer.
Explain the differences between the mean, mode and median.Which is the most useful measure of an average and why?
What is the central limit theorem and why is it important in statistics?
(a) Explain the difference between a pdf and a cdf(b) What shapes are the pdf and cdf for a normally distributed random variable?
Expand the parentheses as far as possible for the following expressions(a) E(ax + by) for x,y variables and a,b scalars(b) E(axy) for x,y independent variables and a a scalar(c) E(axy) for x,y
Let us use for illustration a series of average UK house prices, measured annually for 2006 – 18 and given in column 2 of Table 2.3.Some figures for the general level of prices as measured by the
Given the data in the following table, calculate the returns for each year on a single share in a company that is purchased on 31 December 2012 for a price of 100 pence and then held for four years.
It is very straightforward to calculate internal rates of return using recent versions of Microsoft Excel. One way to do this would be to set out the cashflows in a spreadsheet, calculate their
To illustrate a finance application, suppose we have a bond that pays a£5 coupon annually with the next coupon due immediately, the bond has exactly five years left to maturity when it will be
What is the present value of £100 to be received in five years’ time if the discount rate is 2%?This would be P0 = £100/(1 + 0.02)5 = £90.57. This shows that £100 in five years’ time is worth
What is the effective rate when the nominal rate, r, is 2% and interest is compounded monthly (n = 12)?It would be: effective (to two decimal places).
Calculate the mean of the following numbers: 2, 4, −6, 7, 1, 0, 20.The series has N = 7 items. The mean,(to two decimal places).
Calculate asset price returns
Use standard formulae to value stocks and bonds
Calculate present values and future values
Compound and discount cashflows
Distinguish between different types of data
Deflate series to allow for inflation
Compare nominal and real series
Manipulate expressions using the expectations, variance and covariance operators
Compute summary statistics for a data series
Construct minimum variance and mean-variance efficient portfolios
10 Which item(s) in the balance-of-payments account, Table 5.1, would be most affected by an expected appreciation of the US dollar, and how would the item(s) and the current spot value of the dollar
9 If the overall level of interest rates in all countries went up, how would this affect the balance of payments of the United States as a net debtor nation?
8 If the balance of payments of Alaska were prepared, what do you think it would look like?How about the balance of payments of New York City? What do you think the net investment position of these
7 What is the difference between the immediate and the long-run effect of direct investment by foreigners when the direct investment is in a heavily export-oriented activity such as oil exploration
6 What is the difference between the immediate and the long-run effect of the sale of bonds to foreign investors?
5 How do we know that an exogenous increase in exports will cause a currency to appreciate even though the balance of payments is always zero? How does your answer relate to the law of supply and
4 Even if inflation did increase the value of exports, would the balance of trade and the exchange rate necessarily improve from inflation that is higher than in other countries?
3 Under what conditions would inflation increase the value of exports?
2 Can all countries collectively enjoy a surplus, or must all surpluses and deficits cancel against each other? What does gold mining mean for the world’s balance?
1 Since gold is a part of official reserves, how would the balance-of-payments statistics show the sale of domestically mined gold to the country’s central bank? What happens if the mining company
18 If a country is living beyond its means, does it have persistent trade surpluses or deficits?
17 What is the chief characteristic of the absorption approach to the balance of payments?
16 What did the ‘‘Merchantilists’’ think?
15 What does the net international-investment-position account show?
14 What is the identity linking the current account, capital account, change in official reserves, and statistical discrepancy?
13 What is a ‘‘capital account deficit?’’
12 What is a ‘‘current account surplus?’’
11 What is ‘‘direct investment?’’
10 What are ‘‘official reserve assets?’’
9 What is a ‘‘unilateral transfer?’’
8 What is a ‘‘balance of trade deficit?’’
7 How are interest earnings from foreign investments included in the balance of payments?
6 What are ‘‘debt service exports?’’
5 What are ‘‘invisibles’’ in the balance of payments?
4 What are a country’s ‘‘terms of trade?’’
3 What economic variables might affect the value of a country’s merchandise (goods)exports?
2 Are transactions giving rise to the demand for a country’s currency recorded as debits or credits in the balance of payments?
1 Does the balance-of-payments account record stocks or flows?
Determine a sensible structure for the dissertation
Find appropriate sources of literature and data
Choose a suitable topic for an empirical research project in finance
(a) Explain the principle behind the method of moments estimator.(b) What is the difference between the method of moments and the generalised method of moments (GMM)?(c) Explain what overidentifying
(a) Why is a member of the extreme value family of distributions usually more appropriate for capturing tail behaviour than assuming normality for financial time-series?(b) Explain the differences
(a) Explain the steps in the Fama–MacBeth method for testing the CAPM.(b) What is the time-series of cross-sections?
(a) What is an event study? Present and explain one potential use of an event study.(b) Explain the difference between the cumulative abnormal return and buy-and-hold abnormal return methods of
Implement the generalised method of moments for parameter estimation
Work with extreme value distributions
Employ the Fama–MacBeth and Fama–French approaches to testing asset pricing models and explaining the variation in asset returns
Set up and conduct a valid event study
A barrier option is a path-dependent option whose payoff depends on whether the underlying asset price traverses a barrier. A knock-out call is a call option that ceases to exist when the underlying
(a) Consider the following AR(1) model Design a simulation experiment to determine the effect of increasing the value of ϕ from 0 to 1 on the distribution of the t-ratios.(b) Consider again the
A researcher tells you that she thinks the properties of the Ljung–Box test (i.e., the size and power) will be adversely affected by ARCH in the data. Design a simulations experiment to test this
(a) Present two examples in finance and two in econometrics(ideally other than those listed in this chapter!) of situations where a simulation approach would be desirable. Explain in each case why
Describe the various techniques available for reducing Monte Carlo sampling variability
Explain the difference between pure simulation and bootstrapping
Design simulation frameworks to solve a variety of problems in finance
(a) Explain the difference between a censored variable and a truncated variable as the terms are used in econometrics.(b) Give examples from finance (other than those already described in this book)
(a) Describe the intuition behind the maximum likelihood estimation technique used for limited dependent variable models.(b) Why do we need to exercise caution when interpreting the coefficients of a
Compare and contrast the probit and logit specifications for binary choice variables.
Explain why the linear probability model is inadequate as a specification for limited dependent variable estimation.
Deal appropriately with censored and truncated dependent variables
Distinguish between the binomial and multinomial cases
Interpret and evaluate logit and probit models
Compare between different types of limited dependent variables and select the appropriate model
(a) What are the advantages and disadvantages of conducting unit root tests within a panel framework rather than series by series?(b) Explain the differences between panel unit root tests based on a
Find a further example of where panel regression models have been used in the academic finance literature and do the following:• Explain why the panel approach was used.• Was a fixed effects or
(a) Explain how fixed effects models are equivalent to an ordinary least squares regression with dummy variables.(b) How does the random effects model capture cross-sectional heterogeneity in the
(a) What are the advantages of constructing a panel of data, if one is available, rather than using pooled data?(b) What is meant by the term ‘seemingly unrelated regression’?Give examples from
Estimate and interpret the results from panel unit root and cointegration tests
Contrast the fixed effect and random effect approaches to panel model specification, determining which is the more appropriate in particular cases
Explain the intuition behind seemingly unrelated regressions and propose examples of where they may be usefully employed
Describe the key features of panel data and outline the advantages and disadvantages of working with panels rather than other structures
(a) Explain the link between state space models and the Kalman filter(b) What is the difference between the Kalman filter and the Kalman smoother?(c) In the context of a state space model, how can we
A researcher suggests that the volatility dynamics of a set of daily equity returns are different• on Mondays relative to other days of the week• if the previous day’s return volatility was
(a) What is a switching model? Describe briefly and distinguish between threshold autoregressive models and Markov switching models. How would you decide which of the two model classes is more
A researcher is attempting to form an econometric model to explain daily movements of stock returns. A colleague suggests that she might want to see whether her data are influenced by daily
Returning to the example of day-of-the-week effects in Southeast Asian stock markets, although significant coefficients in equation (10.4) will support the hypothesis of seasonality in returns, it is
Brooks and Persand (2001a) examine the evidence for a day-of-theweek effect in five Southeast Asian stock markets: South Korea, Malaysia, the Philippines, Taiwan and Thailand. The data, obtained from
Explain how the Kalman filter is used to estimate state space models
Set up and interpret simple state space models
Describe the intuition behind the estimation of regime switching models
Compare and contrast Markov switching and threshold autoregressive models
Specify and explain the logic behind Markov switching models
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