Financial markets Assignment
Instructions: Attempt the following three exercises.
Exercise 1
Answer the following questions. Justify your answers.
a) Which of the investments in the following table would be most attractive to each one of the following wealth owners?
i. A risk averse investor? Define the term risk averse investor
ii. . A risk neutral investor? Define the term risk neutral investor
|
Investment
|
Expected value of returns
|
Standard Deviation
|
|
A
|
40
|
5
|
|
B
|
80
|
5
|
|
C
|
80
|
7
|
|
D
|
85
|
20
|
b) Banks pay substantial amounts to monitor the risks they take. One of the primary concerns of a responsible bank managers is the value at risk (VaR). Why is VaR so important for any financial institutions especially banks.
c) What are the two kinds of risk associated with any financial instrument?
Give an example of how to deal with each one of them.
Exercise 2
Answer the following questions. Justify your answers.
a) Consider two possible investments whose future payoffs are completely independent of each other. Both investments have the same expected value of returns and the same standard deviation. If you have $1000 to invest, would you benefit from dividing your funds between these investments?
b) Suppose as in a), you considered only investments that had the same expected value of future returns and the same standard deviation and whose payoffs were independent of each other. Is it better to invest an equal amount in ten of them or concentrate your investment in only one or two of them?
c) You are considering three assets A, B, and C with risky future returns with the same expected value of future returns and the same standard deviation. The investments are sold only in units of $50 and you own $100 that you wish to invest. Suppose that the returns from A and B are independent of each other and the returns from B and C are perfectly negatively correlated with each other.
If you are a risk averse, which investment portfolio (allocation among the three assets) of your $100 would you prefer
Exercise 3
a) Explain why you would be more or less willing to buy long term Air Canada bonds under the following circumstances
i. Trading in these markets increases substantially
ii. You expect a bear market in stocks (stock prices to fall across the board)
iii. Brokerage commissions on stocks fall substantially
iv. You expect interest rates to rise in the future
b) What would happen to the demand curve for Rembrandt paintings if the stock market underwent a boom?
c) Predict what would happen to interest rates if prices in the bond market become more volatile
d) If the next governor of the Bank of Canada has a reputation for advocating a slower growth or money supply what will happen to interest rates today?
e) The M1 money supply growth rate in the US was about 16% in 2008, 7% in 2009, and 9% in 2010. How can you explain this fall in yields in terms of the income, price level, and expected inflation effects?