Question 1

1. Discuss this statement: financial intermediaries would not exist if there are no information costs and transaction costs.

2. Risk sharing benefits both financial intermediaries and individual investors. Discuss this statement.

3. Distinguish between mortgage and mortgage backed security. Provide examples of each.

Question 2

1. If you expect a decrease in interest rate in coming weeks, would you rather hold a ten-year bond or a two-year bond today, with the same coupon rate, yield to maturity and face value? Which bond has a greater interest rate risk?
2. The return on zero coupon bond is equal to the rate of capital gain. Discuss this statement.
3. If market is efficient, foreign exchange rates should follow random walk theory, like stock prices. Do you agree with this statement? Explain your answer.

Question 5

1. Do net present value and internal rate of return methods always lead to the same investment decision for independent projects and mutually exclusive projects? Explain your answer.
2. Consider the cash flows from projects A and B:

Project	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
A	240000	140000	80000	60000	20000	20000
B	240000	20000	40000	60000	100000	180000

If the required rate of return is 11 per cent, determine the net present value and internal rate of return of both projects. Which project should be chosen? Explain your answer.

Question 6

The standard deviations of returns on assets A and B are 20 per cent and 10 per cent respectively. A portfolio is constructed consisting of 40 per cent in asset A and the remainder in asset B. Calculate the portfolio standard deviation if the correlation of returns between the two assets is:

(a) +1.0

(b) +0.5

(c) 0

(d) -0.5

(e) -1.0