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FN2190 - Asset Pricing and Financial Markets

The document is the preliminary exam for the FN2190 module on Asset Pricing & Financial Markets at the Singapore Institute of Management, University of London, dated March 3, 2020. It consists of four questions covering topics such as bond pricing, portfolio theory, the Capital Asset Pricing Model (CAPM), and options pricing. Candidates are instructed to answer any three questions within a three-hour timeframe, with specific marks allocated to each part of the questions.

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57 views5 pages

FN2190 - Asset Pricing and Financial Markets

The document is the preliminary exam for the FN2190 module on Asset Pricing & Financial Markets at the Singapore Institute of Management, University of London, dated March 3, 2020. It consists of four questions covering topics such as bond pricing, portfolio theory, the Capital Asset Pricing Model (CAPM), and options pricing. Candidates are instructed to answer any three questions within a three-hour timeframe, with specific marks allocated to each part of the questions.

Uploaded by

Nguyễn Nhật Thành
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

SINGAPORE INSTITUTE OF MANAGEMENT

UNIVERSITY OF LONDON
PRELIMINARY EXAM 2020

MODULE CODE : FN2190

MODULE TITLE : Asset Pricing & Financial Markets

DATE OF EXAM : 3/3/2020

DURATION : 3 Hours

TOTAL NUMBER : 5 pages


OF PAGES
(INCLUDING
THIS PAGE)
-------------------------------------------------------------------------------------------------------

INSTRUCTIONS TO CANDIDATES :-

Answer any three of the four questions.


All questions carry equal marks.
You have three hours to complete the exam.
Candidates are strongly advised to divide their time accordingly.
There are 99 marks available on this paper.
A handheld calculator may be used when answering questions on this paper and it
must comply in all respects with the specification given with your Admission Notice.
The make and type of machine must be clearly stated on the front cover of the
answer book.
[Calculator]
DO NOT TURN OVER THIS QUESTION PAPER UNTIL YOU ARE TOLD TO
DO SO.

Question 1

FN2190 Asset Pricing & Financial Markets Page 1 of 5


You observe the following information on U.K. default-free government bonds. All
bonds pay annual coupons and have a par value of £100.

Price Maturity Coupon Rate


Bond A £96.266 2 years 2%
Bond B £103.885 2 years 6%
Bond C 2 years 10%

(a) Using Bond A and Bond B what is the current term structure of interest rates?
[8 marks]

(b) Explain the current term structure of interest rates from part (a) using term
structure theories? [6 marks]

(c) How many units of Bond A and Bond B do you need to buy/short to replicate the
cash flows of Bond C? What is the price of this replicating portfolio? [8 marks]

(d) Without doing any calculations explain which bond will have the highest
Macaulay duration and which bond will have the lowest Macaulay duration?
[3 marks]

(e) If Bond C is actually currently trading at £110 is there an arbitrage opportunity?


If so clearly detail the arbitrage strategy and show all resultant cash flows.
[8 marks]

Question 2

FN2190 Asset Pricing & Financial Markets Page 2 of 5


(a) Prove that for an annual coupon bond that if the coupon rate equals the yield to
maturity then the bond trades at par? [6 marks]

(b) A bond's duration can be used to infer how the bond's price will react to a change
in yield to maturity. Give a brief overview of how the duration measure is
derived and thus why it is informative about the relationship between prices and
yields. What are its shortcomings as a measure of the sensitivity of prices to
yields? [8 marks]

(c) You are going to enter into a contract to receive cash flows of £10 every year
forever with the first cash flow starting at t=2. What is the present value of these
cash flows now i.e. t=0 if the relevant semi annual APR is 12%? [6 marks]

(d) Company A currently plows back 30% of its earnings and earns a return of 25%
on this investment. The forward looking dividend yield on the stock is 5%.

(i) Company A continues to plow back 30% of earnings and earns a return of
25% on the investment, at what rate will earnings and dividends grow and
what is the expected return on Company A’s stock? [5 marks]

(ii) Suppose that management suddenly announces that there are no future
investment opportunities. Company A now intends to pay out all its
earnings. Calculate the percentage change in the stock price. [8 marks]

Question 3

FN2190 Asset Pricing & Financial Markets Page 3 of 5


(a) If an investor can construct a portfolio of stocks that has a long-run mean return
that is reliably above the mean return on the market, is this evidence that the
investor has some skill in picking stocks? Justify your answer. [6 marks]

(b) Discuss the assumptions of the CAPM. Is a stock with a negative alpha in relation
to the security market line (SML) underpriced or overpriced? Explain. [6 marks]

(c) You are an investor and you want to form a portfolio that consists of two stocks,
Stock A and Stock B, whose returns have the following characteristics:

Stock Expected Return Standard Deviation Correlation Between A and B

A 10% 20% 0.4

B 20% 30%

If you invest 50% of your wealth in Stock A and 50% of your wealth in Stock B
what is your portfolio's expected return and standard deviation? Without doing
any calculations do you think your portfolio is the minimum variance portfolio
(where the minimum variance portfolio is constructed using only Stock A and
Stock B)? Explain. [10 marks]

(d) Now consider a third asset, the risk-free asset to combine with Stock A and Stock
B. The risk-free rate has a return of 5%. If you invest 50% in the risk-free asset,
25% in Stock A and 25% in Stock B what is your portfolio's expected return and
standard deviation? Explain using your answer why a risk-averse investor would
never want to hold Stock A on its own (i.e. a portfolio that has 100% invested in
Stock A). [8 marks]

(e) Discuss the momentum anomaly from an efficient markets perspective. [3 marks]

Question 4

FN2190 Asset Pricing & Financial Markets Page 4 of 5


(a) Stock ABC has a current price of £80 and in each of the next 3 month periods will
either increase by 50% or fall by 10%. Stock ABC will not pay any dividends
over the next year and the risk-free rate is 2% for each 3 month period.

(i) Use the risk-neutral method to calculate the no arbitrage price of a


European call option on Stock ABC with 6 months to maturity that has an
exercise price of £85. [6 marks]

(ii) What is the replicating portfolio of the European call option at the initial
node i.e. today? [6 marks]

(iii) How does the price of the call option change if it’s an American option?
[3 marks]

(b) Using the parameters of the Black-Scholes options pricing model explain how
increases in each parameter, holding all other parameters constant, affects the
price of a European call option on a non-dividend paying stock? [10 marks]

(c) You are a researcher for an investment bank and are trying to determine how
stock prices react to dividend announcements. Describe in detail how you would
conduct an event study to investigate whether the market reacts to announcements
of dividend changes in a timely and accurate fashion. [8 marks]

FN2190 Asset Pricing & Financial Markets Page 5 of 5

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