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N1553

BSc EXAMINATION

Theory of Investments

MOCK Exam 2022/2023

SECTION A

There are five questions in this section.

Attempt ALL questions.

This section is worth 40 marks.

All questions are equally weighted.

Refer to specific discussions in class rather than providing a general answer.

Your answer should be concise and should not be much more than 150 words per question.

1.  Explain the main differences between buying a call option and selling a futures contract on the same underlying with the same maturity.  Can either of these be used for locking in a trading profit? (Why or why not?)

2. What is the difference between Sharpe’s measure and Treynor’s measure?  Under which cir- cumstances would you recommend Sharpe’s measure, and under which circumstances would you recommend Treynor’s measure for performance evaluation?

3.  Explain the main differences of how the DJIA (Dow Jones Industrial Average) and the S&P

500 index are constructed.   Explain in detail what the index construction implies for the weight of a large capitalization stock?

4.  Discuss, providing some empirical evidence, examples of trading strategies for which the main predictions of the CAPM (capital asset pricing model) do not hold.

5. Suppose you have found a UK stock with a beta of 3.  Discuss whether the following state- ments are correct, incorrect or partially correct:

(i) The stock has a particularly low risk.

(ii) The stock is not attractive to investors because it has a low expected return. (iii) The stock is negatively correlated with most stocks in the UK stock market.

SECTION B

There are four questions in this section.

Attempt THREE of the FOUR questions.

This section is worth 60 marks.

All questions are equally weighted.

Provide details on how you calculated the numerical answers to the questions.

6. The last ten observations of the holding period returns (HPR) of stock XYZ are given in the following table:

Period    XYZ

1            -3%

2             2%

3             6%

4            -5%

5           -10%

6            10%

7             3%

8             7%

9             0%

10          -3%

(a)  Estimate the expected return and the standard deviation of the stock.  Explain in your own words what the standard deviation measures and why it is a measure of risk. [ 8 marks ]

(b) What is the likely frequency of the data (daily, monthly, yearly)? Compare to historical historical data discussed in class to justify your answer. [ 5 marks ]

(b)  Calculate the covariance between the excess returns of portfolio A and B. Briefly discuss your results. [ 10 marks ]

(c)  "In an index model, the standard deviation of a well diversified portfolio is equal to its beta. " Discuss whether the statement is correct, incorrect or partially correct. [ 6 marks ]

9.  European put and call options with a strike price of £100 and maturity in 12 months are traded on XYZ cooperation stock. The current stock price is £102.

(a) Which of the two options is in-the-money? Which is out-of-the-money? [ 4 marks ]

(b) Assume that the call price is £15.05. What is the put price according to put-call parity? Assume that the risk-free rate is zero. [ 6 marks ]

(c)  Describe an option strategy (using the put or call above) that allows you to "hedge the downside risk", i.e.  a strategy that limits the possible losses from investing into the stock.  Provide a P&L diagram and numerical examples to show the advantages and disadvantages of the strategy. [ 10 marks ]