Question One

1. Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (i.e. bundling and unbundling financial assets) might be better spent on creating wealth (i.e. creating real assets.) Evaluate this criticism.
2. You are given the following data about available investments:

State of the Economy	Probability (Y)	Return (A)	Return (B)
Strong Boom	0.15	-0.60	0.75
Weak Boom	0.20	-0.30	0.50
Average	0.05	-0.10	0.15
Weak Recession	0.40	0.20	-0.10
Strong Recession	0.20	0.80	-0.35

Compute and fully interpret the following for these investments:

1. Mean rate of return for each investment.
2. Standard deviation for each investment.
3. Coefficient of variation for each investment.
4. Covariance among the rates of return.
5. Correlation coefficient of the rates of return.
6. Briefly explain the difference in assumptions underlying portfolio theory and the CAPM.

Question Two

Mutale and Luyando are vice presidents of Copperbelt Money Management (CMM) and co-directors of the companys pension fund management division. A major new client, the Nkana League of Cities, has requested that CMM present an investment seminar to the mayors of the represented cities. Mutale and Luyando, who will make the presentation, have asked you to help them by answering the following questions.

(a)What are a bonds key features?

(b) How is the value of any asset whose value is based on expected future cash flows determined?

(c) What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon, paid semi-annually, if its required return is 10%?

(d) (1) What is the value of a 13% coupon bond that is otherwise identical to the bond described in Part c above? Would we now have a discount or a premium bond?

(2) What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond?

(3) What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return increased to 13%?

(e) (1) What is the yield to maturity on a 10-year, 4% semi-annual coupon, $1,000 par value bond that sells for $887.00 and another that sells for $1,134.20? What does the fact that it sells at a discount or at a premium tell you about the relationship between r_d and the coupon rate?

(2) What are the total return, the current yield, and the capital gains yield for the premium bond in part e (1)? Assume that it is held to maturity and the company does not default on it.

Question Three

In the context of the Efficient Market Hypothesis;

1. Describe the weak form, the semi-strong form and the strong form of capital market efficiency. (9 marks)
2. Which form, if any, do you favour and why? (3 marks)
3. In your opinion, in what form is the Zambian capital market and why? (4 marks)
4. What should be done, if any, to bring it to the form you favour? (4 marks)