(1) (a) (b) (c) (ii) (a) State the equation of the security market line and, assuming...
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(1) (a) (b) (c) (ii) (a) State the equation of the security market line and, assuming that the market portfolio offers a return in excess of the risk-free rate, use it to derive the betas of the market portfolio and the risk-free asset. Draw a diagram of the security market line relationship. What does the security market line indicate about the relationship between risk and return? [9] Derive the capital market line relationship and comment briefly upon its applicability. (b) Briefly interpret each of the terms in the relationship. [6] [Total 15] A bond trader assumes that f(t.7), the instantaneous forward rate of interest at time T implied by the market prices of bonds at the current time 1, can be modelled by: f(1,7)=0.04-02 +0.06(1-2)+0.1(1-02-0.2 where r=T-1. (i) (ii) Sketch a graph of f(1.7) as a function of 7. This model is a time-homogeneous, Markov model. Explain what this means. [2] (iii) Calculate the following quantities using this model: (a) (b) (c) the current 10-year spot rate the instantaneous forward rate of interest in two years' time the current price of a 10 year zero-coupon bond m [3] You should express your answers to (a) and (c) as annualised continuously- compounded rates. [6] [Total 11] (1) (a) (b) (c) (ii) (a) State the equation of the security market line and, assuming that the market portfolio offers a return in excess of the risk-free rate, use it to derive the betas of the market portfolio and the risk-free asset. Draw a diagram of the security market line relationship. What does the security market line indicate about the relationship between risk and return? [9] Derive the capital market line relationship and comment briefly upon its applicability. (b) Briefly interpret each of the terms in the relationship. [6] [Total 15] A bond trader assumes that f(t.7), the instantaneous forward rate of interest at time T implied by the market prices of bonds at the current time 1, can be modelled by: f(1,7)=0.04-02 +0.06(1-2)+0.1(1-02-0.2 where r=T-1. (i) (ii) Sketch a graph of f(1.7) as a function of 7. This model is a time-homogeneous, Markov model. Explain what this means. [2] (iii) Calculate the following quantities using this model: (a) (b) (c) the current 10-year spot rate the instantaneous forward rate of interest in two years' time the current price of a 10 year zero-coupon bond m [3] You should express your answers to (a) and (c) as annualised continuously- compounded rates. [6] [Total 11]
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Here are the solutions to the questions with workings 1 a The equation of the security market line is Ri Rf iRm Rf Where Ri is the expected return on ... View the full answer
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
Posted Date:
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