• (4p) Assume the interest rate of a three-year maturity zero-coupon bond is 7.5% and a five-year bond is 9.5%. What is the expected interest rate between year three and five if you are considering:

  1. The liquidity preference theory?
  2. The expectations theory?

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  The answers should clearly indicate that you understand the theories and can put them in context. Just presenting the calculation and an answer will result in fewer points if any.

  
  

  1. (9p) A (zero-coupon) bond gives you a 5% return the first year and 7% return the second and the third year.
  2. (5p) What is the yield to maturity?
  3. (4p) Show (calculate and explain) how changed credit risk and changed (expected) inflation influences the value of the three-year bond.

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  Explain and motivate your answers. Use a selected rate of your own choice to re-calculate the valuations in of the (ii)-question if necessary.

  
  (12p) You have two bonds (A and B) with a (modified) duration of 4.3. Bond A is a coupon bond with a semi-annual coupon of SEK 75 and Bond B is a zero coupon bond.

  
  

  1. (4p) How much does the value of each bonds change if the interest rate changes by 0.1%-unit.
  2. (2p) What is the time to maturity for the zero coupon bond?
  3. (2p) Which bond has the longest time to maturity?
  4. (4p) Calculate the accrued interest of the coupon bond if you buy the bond 1 September year 2 and the coupons are paid out 1 January and 1 July.

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  Explain and motivate your answers.

  
  

  Question 2 (12 points)
  Assume you have two investors, S and T. They wish to invest in one of three possible portfolios. The portfolios characteristics are described in the table below.

  
  

  Portfolio	E(r)	σ (std)
  A	10%	0.07
  B	12%	0.18
  C	13%	0.29

  
  

  1. (10p) Which portfolio should Investor S and investor T respectively chose if their risk aversions are 2.5 (S) and 3.5 (T) respectively?
  2. (2p) Which investor will end up with the highest expected return? (support the answer)

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  Question 3 - (24 points)

  
  

  Consider the following probability distribution for stocks A and B:

  State	Probability	Returns on Stock A	Returns on Stock B
  1	0.1	10%	8%
  2	0.2	13%	7%
  3	0.2	12%	6%
  4	0.3	14%	11%
  5	0.2	15%	8%

  
  

  1. Calculate the expected rate of return of stocks A and B. (4 points)
  2. Calculate the standard deviations of stocks A and B. (4 points)
  3. Calculate the coefficient of correlation between A and B. (4 points)
  4. If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and standard deviation? (4 points)
  5. Calculate the weights of A and B in the global minimum variance portfolio. (4 points)
  6. Calculate the expected rate of return and standard deviation of the global minimum variance portfolio. (4 points)

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  Question 4 – (16 points)

  a. Discuss the similarities and the differences between the CAPM and the APT with regard to the following factors: capital market equilibrium, assumptions about risk aversion, risk-return dominance, and the number of investors required to restore equilibrium. (8 points)

  
  

  b. Describe the protective put. What are the advantages of such a strategy? (8 points)

  
  

  
  

  Question 5 – (10 points)

  Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios:

  
  

  Portfolio	Beta on F1	Beta on F2	Expected Return
  A	1	2	19%
  B	2	0	12%

  
  

  1. Assuming no arbitrage opportunities exist, what is the risk premium on the factor F1 portfolio. (5 points)
  2. Assuming no arbitrage opportunities exist, what is the risk premium on the factor F2 portfolio. (5 points)

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  Question 6 (15 points)

  Consider the regression outcome below between S&P500 (GSPPC) and Microsoft (MSFT). The regression is based on the monthly return (compounded) data over five years.

  
  

  1. (5p) Explain the outcome of the regression based on a suitable theoretical context.
  2. (5p) Should an investor use Microsoft to increase or decrease the risk of a portfolio?
  3. (5p) Do you identify any concerns with the regression?

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