ECOM050 Investment Management 2021
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January Examination Period 2021
ECOM050 Investment Management
Answer ALL Questions
Question 1
Consider the Capital Asset Pricing Model (CAPM hereafter):
a). Explain the main conclusions of the CAPM. Describe the equation of the Security Market Line (SML hereafter). Why, under the CAPM, must fairly priced assets plot exactly on the SML? [15 marks]
b). Describe how the early tests (Lintner, 1965; Miller and Scholes, 1972) of the CAPM were performed. Also, explain their main conclusions. [10 marks]
c). Apart from simplifying Diversification, what are the advantages of the Single Index Model compared with the Markowitz model for portfolio optimization? What are its disadvantages? [10 marks]
Question 2
a). Define the three forms of Market Efficiency. [6 marks]
b). “Under the modern theory of Market Efficiency, in an efficient market, returns are predictable to some degree” . Explain this view by comparing and contrasting it with the conventional theory of Market Efficiency. [15 marks]
c). The Efficient Market Theory states that "if prices are right, there are no easy profit opportunities". Whilst, Behavioural Finance argues that "the absence of profit opportunities does not necessarily imply that prices are right". Discuss the arguments underlying these statements. [14 marks]
Question 3
Suppose that the Index Model for stocks A and B is estimated from excess returns with the following results:
RA =2% +0.6RM+eA
RB =-2% + 1.1RM+eB
σM=20% R2A =0.20; R2B =0.12
a). What is the standard deviation of each stock? [4 marks]
b). Break-down the variance of each stock into the systematic and firm-specific components. [ 10 marks]
c). What are the covariance and correlation coefficient between the two stocks? [5 marks]
d). What is the covariance between each stock and the market index? [5 marks]
e). Why do we call alpha a “nonmarket” return premium? Why are high-alpha stocks desirable
investments for active portfolio managers? With all other parameters held fixed, what would happen to a portfolio’s Sharpe ratio as the alpha of its component securities increased? [6 marks]
2022-08-03