Finance 1

Question 1

Define intertemporal budget constraints.

Answer 1

Pv of consumption = PV of income
C1 + (C2/1+R) = Y1 + (Y2/1+R)
1+R = slope of lines on graph

Question 2

Present value of a capital project

Answer 2

NPV= -I + (CF/1+R)

Question 3

What is the covariance equation, in the two risky assets section, between the portfolio and the asset

Answer 3

Q(AM)=W(A)Q(A)^2 + W(B)Q(AB)

Question 4

Covariance(c) in Naive diversification

Answer 4

Q^2= c + {(v-c)/N}

Question 5

Correlation coefficient

Answer 5

p= (c/v)^0.5

Question 6

Payoff of option made up of delta and bonds(debt)

Answer 6

C=delta*spotrate - Bond

Question 7

Black scholes formula and

When is it used

Answer 7

Replicating portfolio which is long in the stock and borrowing an amount
Option price = spotrate*N(d1) - PV(exercise price)N(d2)

Question 8

D1 and D2 formulas for black scholes

Answer 8

D1=((ln(spotrate/PV(exercise price))/volatility(squareroot of time to expiry) )+(0.5(squareroot of time to expiry)
D2 =d1 - (volatility*(square root of time to expiry))

Question 9

What does N(d2) represent in black scholes formula

Answer 9

Risk neutral probability the option will be exercised

Question 10

Lower bounds of call and put options

Answer 10

Lower bound of call price = spotrate - PV(exercise price)
Lower bound of put price = PV(exercise price) - spotrate

Question 11

Put call parity equation

Answer 11

Call price + PV(exercise price) = spot price + put price

Question 12

Variance when dealing with Pratt arrow

Answer 12

Var= (probability of outcome A)(return for outcome A - expected return) + (probability of outcome B)( return for outcome B - expected return)

Question 13

Formula for call option

Answer 13

C = (delta)(spotrate) - B

Question 14

Discount factor for bonds

Answer 14

Discount factor for year t = 1/(1+zero coupon yield for year t)

Question 15

Properties of utility function

Answer 15

1. Positive marginal utility
2. Diminishing marginal utility

Question 16

Max sharpe ratio

Answer 16

((Expected return of portfolio) -risk free return)/standard deviation of portfolio

Question 17

3 hypotheses of bonds

Answer 17

Expectations hypothesis
Liquidity premium
Inflation expectations

Question 18

Liquidity premium definition

Answer 18

Forward rates are higher than expected future forward rates due to holders requiring compensation for holding the bond for that long

Question 19

Inflation expectation definition

Answer 19

Increased inflation expectations cause a rise in long term interest rates due to the fisher equation

Question 20

Risk neutral valuation of binomial options

Answer 20

(e^(Return*Time)- down state of binomial option/(upstate - down state of binomial option)

(e^(RT)-d)/(u-d)

Question 21

Delta triangle thingy

Answer 21

Delta= (Cu-Cd)/S(u-d)

Question 22

Bond

Answer 22

Bond=(dCu - uCd)/(u-d)e^(RT)

Question 23

1Contract to sell forward
2contract to buy forward

Answer 23

1Long forward
2Short forward

Question 24

Risk neutral valuation of call option

Answer 24

Question 25

Abnormal returns

Answer 25

AR= R - E(R|Rm) E(R|Rm)= R + B*Rm - reps SML