a) In which financial markets can investors deal with financial instruments? What are their advantages and disadvantages?

b) Construct some simple examples to illustrate your answers to the following:

i. If interest rates rise, do bond prices rise or fall?

ii. If the bond yield is greater than the coupon, is the price of the bond greater or less than 100?

iii. Do high-coupon bonds sell at higher or lower prices than low-coupon bonds?

c) What is the relationship between forward rates and the market's expectation of future short rates? Explain in the context of the expectations theory of the term structure of interest rates.

d) Explain two factors that affect the duration of a bond and how these factors could affect the duration.

e) You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03. Show all your workings clearly.

i. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.08?

ii. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.08?

iii. What is the slope of the Capital Allocation Line formed with the risky asset and the risk-free asset? Graphically illustrate your answer.

Answer rating: 100% (QA)

Answer a Investors can deal with financial instruments in various markets such as stocks bonds forex derivatives commodities and real estate Advantages include potential for profit portfolio diversifi... View the full answer