Question 1
You are advising a client to construct a portfolio worth £20 million. You’re considering constructing combining a risk-free asset with a portfolio of risky assets. Consider the data given and answer the subsequent questions:
American Express
(Amex) Coca-Cola
(Coca) The Gillet Company
(Gillet) T-Bills
Expected Return 16% 16.1% 17.6% 5%
Standard Deviation 29% 24.7% 27.3% 0%
Weights 32% 51% 17%
Correlations
Amex & Coca 0.61
Amex & Gillet 0.317
Coca & Gillet 0.548
Calculate the portfolio returns and standard deviation, if no investment is made in T-Bills. 05 Marks
Calculate the risk premium demanded by investors for buying one unit of risk.
05 Marks
If the target risk (standard deviation) is 15%; then what should be the weightage distribution between T-Bills and the portfolio. Also calculate the expected return of the combined portfolio for these weights.
05 Marks
Given your client’s target return is 25%; then what should be the weightage distribution between T-Bills and the portfolio. Do they need to borrow any money and if yes then how much they need to borrow? 05 Marks
Explain how Capital Allocation Line differs from and Capital Market Line.
05 Marks
(Total 25 Marks)
Question 2
Capital Asset Pricing Model (CAPM) is noted as a simple and popular approach for portfolio creation,
Explain CAPM for risk analysis and investment management. 10 Marks
Comment on the validity of assumption underlying the CAPM model and their implications for CAPM empirical strengths. 15 marks
(Total 25 Marks)
Question 3
Gamma airlines is currently considering a) to fix the price for their future jet fuel purchases; and, b) fix the exchange rate for their future international receipts. As a financial advisor of the firm you have advised them:
for the first (a) to buy a future on crude oil (cross-hedging)
For the latter (b) you suggest a currency future.
Assuming Delta Airline is a USA based firm and it receives and pay in $. Explain to the board of directors using the above scenarios as an example that:
What are the costs of making a futures contract in terms of settlement, delivery for both events if price fell below the agreed price and rise above the and who guarantees the fulfilment of contracts?
10 Marks
How cross hedging will enable the firm to fix the price for jet fuel.
05 Marks
Explain the uses of futures for speculating and arbitraging activities. Given the efficient market hypothesis why the chances of making arbitrage profits are said to be rare.
10 Marks
(Total 25 marks)
Question 4
Two clients of Barclays bank are offered the following fixed and floating rates for their borrowing per annum on a nominal denomination of £100 Million.
Fixed Rate (for 5 years) Floating rate
Client A 7% LIBOR Plus 0.5%
Client B 11% Libor Plus 0.9%
You are required to:
Design a swap agreement that will enable client A to pay a floating rate and client B to pay a fixed rate and is beneficial for both parties. The bank fee for arranging this deal is 10 basis point and assume the agreement is designed simultaneously. 10 Marks
How does a forward contract for currency exchange differs from swap agreement of currency exchange? 05 Marks
Swap agreements are said to be motivated by comparative advantages enjoyed by parties to an agreement. Discuss the key factors which cause these comparative advantages. 05 Marks
Explain the risk of swap deals (interest rate and currency swaps) to an intermediary and how can they hedge against it. 05 Marks
(Total 25 Marks)
Question 5
Using examples from the credit crisis of 2008;
Evaluate the role of securitisation in the financial crisis of 2007. 15 Marks
Evaluate the factors that lead to liquidity crisis in financial markets, use examples from 2007 financial crisis. 10 Marks
(Total 25 Marks)
Question 6
Explain Value at Risk (VaR) Var, Expected Short-fall and theoretical advantages of expected shortfall over VaR. In your answer also explain why VaR is integral for risk management at financial organisations. 15 Marks
Explain stressed VaR, its estimation and its implication for capital requirement estimation. 10 Marks
(Total 25 Marks)
