5. A consumer's MRS of y for x equals 2. Y is on the vertical axis and X is on the horizontal axis.

Which of the following statements is TRUE?

I. He will be strictly better off if he purchases an additional unit of x if the price ratio is less than 2.

II. He should purchase an additional unit of x as long as the price ratio is greater than 2.

III. He is willing to give up 2 x for one additional y.

a. I only

b. II only

c. III only

d. II and III only

e. I and III only

6. Uma and Valerie live in the same town where they both face the same prices. Uma has

preferences that can be represented by the utility function U(X,Y)=X+Y Valerie has preferences

that can be represented by the utility function V(X,Y)=3X+3Y. Which of the following statement

is true?

a. Valerie gets greater satisfaction from her consumption than Uma

b. The quantity of X purchased by Uma PLUS the quantity of X purchased by Valerie will

equal the total quantity of Y they purchase.

c. Valerie and Uma will always purchase the same quantity of X with the same income

d. A tax on X would have a greater welfare effect on Valerie than on Uma

e. None of the above is true

7. After graduating from high school, Steve had three choices, listed in order of preference: (1)

matriculate at our campus, (2) work in a printed circuit board factory, or (3) attend a rival

college. His opportunity cost of going to college here includes which of the following?

a. the cost of books and supplies at the rival college

b. the income he could have earned at the factory plus the direct cost of attending

college here (tuition, textbooks, etc.)

c. the benefits he could have received from going to the rival college

d. only the tuition and fees paid taking classes here

e. cannot be determined from the given information

8. The income effect is

a. in the opposite direction from the substitution effect.

b. always in the same direction as the substitution effect.

c. always greater than the substitution effect.

d. Always less than the substitution effect.

e. could be in the same or in the opposite direction from the substitution effect.

The bond market of a country consists of the following Government issued bonds, with their corresponding market prices per 100 nominal: Term Coupon Price Redemption Discount Yield % p.a. factor 1 year 5 99 876 5.130 0.95120 2 year 5.25 99.970 5.266 0.90239 3 year 6 101.882 5.305 0.85623 4 year 4.75 98.072 5.297 5 year 4.5 96.880 5.225 In each case, coupons are paid annually and the next one is due to be paid in a year's time. Redemption yields are annually compounded. The short-term (one-year) risk free rate is 5% per annum, continuously compounded. (i) Calculate the annual discount factors applicable to this yield curve in years four and five. (A discount factor for year n is the present value of one unit of cash payable at the end of year n. The right-hand column above gives the values for years one to three.) [2] (ii) (a) Using the values from (i), calculate the fixed coupon of a 5-year par value fixed to floating interest rate swap. (b) Explain why this might not be the true market price. [4] (iii) (a) Demonstrate that the market expects short-term interest rates to rise up to the end of year two, then fall thereafter. (b) Explain the implication of this fact to investors in the 2- and 5-year bonds who are expecting to receive the redemption yield. [4] (iv) Estimate using the Black model the price of a one-year European Call option on the 5-year Government bond. The price volatility of this bond is 6% per annum, and you may assume that the option is exerciseable immediately after the bond pays its coupon. [4] (v) Explain why the Black model might not be entirely appropriate for the valuation(9 points) SEV Life is reviewing the investment strategy for the assets supporting its life insurance liability. (a) (2 points) Calculate the risk aversion value that would make SEV indifferent between the two portfolios in terms of risk-adjusted expected return. Show all work. Portfolio Expected Return Standard Deviation of Return A 10% 18% B 8% 12% (b) (/ point) Due to the long duration of the liabilities, SEV has invested primarily in fixed income assets. Over the next quarter, equities are forecasted to significantly outperform fixed income investments and the CEO has asked the investment team to adjust their portfolio allocations. Recommend how the investment team should respond to the CEO. (c) (2 points) SEV is anticipating a spike in mortality as a result of a pandemic impacting the regions where their policyholders are located. Evaluate how this would impact the investment team's strategy and propose appropriate actions. (d) (4 points) Critique the following statements: A. The fixed income portfolio manager should focus on maximizing returns in order to increase product competitiveness. B. To achieve immunization, the entire portfolio does not have to be turned over to rebalance. Furthermore, rebalancing need not be done on a daily basis. C. Use both effective duration and key rate duration to capture non-parallel shifts in the yield curve. D. SEV investing in coupon-paying bonds to support the liability of its life insurance product is appropriate