QUESTION ONE

1. Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (i.e. bundling and unbundling financial assets) might be better spent on creating wealth ( i.e. creating real assets)

Evaluate this criticism. (15 Marks)

2. You are given the following data about available investments:

State of the Economy	Probability	Return (A)	Return (B)
Strong Boom	0.15	-0.60	0.75
Weak Boom	0.20	-0.30	0.50
Average	0.05	-0.10	0.15
Weak Recession	0.40	0.20	-0.10
Strong Recession	0.20	0.80	-0.35

Compute and fully interpret the following for these investments:

1. Mean rate of return for each investment (5 Marks)
2. Standard deviation for each investment. (5 Marks)
3. Coefficient of variation for each investment. (3 Marks)
4. Covariance among the rates of return. (4 Marks)
5. Correlation coefficient of the rates of return. (3 Marks)
6. Briefly explain the difference in assumptions underlying Portfolio Theory and the Capital Asset Pricing Model (CAPM) (5 Marks) [TOTAL: 40 MARKS]