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Financial Economics - Exercises with answers

Economía Financiera (Universidad Carlos III de Madrid)

Studocu no está patrocinado ni avalado por ningún colegio o universidad.

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Topic 1 - Exercises

1. Short selling is:

a. To borrow a financial asset in order to sell it; the objective is to repurchase
it later (to give it back to the original owner/lender) at a lower price
(hopefully).
b. To borrow a financial asset in order to buy it; the objective is to resell it later
(to recuperate it back from the original owner/lender) at a lower price
(hopefully).
c. To borrow a financial asset in order to sell it; the objective is to repurchase it
later (to give it back to the original owner/lender) at a higher price
(hopefully).
d. None of the above.

2. What is an arbitrageur:
a. An individual who deals with investment banks or investment funds and sets
the level of return.
b. An individual who sells forward contracts and usually works for investment
banks or investment funds.
c. An individual who works for the government and watch the activity of
investment banks.
d. An individual who looks for arbitrage opportunities and usually works for
investment banks or investment funds.

3. Select the correct answer

a. The basic function of primary markets is to provide liquidity.
b. The basic function of secondary markets is to allow firms raise funds.
c. An arbitrage operation implies obtaining a positive profit at zero risk, and
without any cost.
d. d. A financial analysis is an agent that evaluates shares that are either
undervalued or overvalued using as a unique tool historical prices of those
shares (and specially focusing on graphs that are formed with those historical
prices)

4. Mark the correct answer.

a. Minor investors only trade in primary markets. Institutional investors only
trade in secondary markets.
b. Primary markets are not regulated. Contrarily, secondary markets are
regulated.
c. Firms are financed in primary markets. Secondary markets provide
liquidity to stocks.
d. Investors trade the stocks in primary markets. Firms are financed in the
secondary markets.

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5. Generally speaking, financial assets can be classified in three groups,

a. Equity, debt and derivatives.

b. Equity, interest rates and Exchange rates.
c. Commodities, debt and derivatives.
d. Stocks, preferred stocks and debt.

6. If you short sell a stock, you are expecting that its price,
a. It will decrease.
b. It will keep constant.
c. It will increase.
d. The price is indifferent, because we have to return the borrowed asset.

7. The market value of a share is:

a. It is the price of the share in the primary market. It is the value investors attach
to the firm.
b. It is the price of the share in the secondary market. It is the value investors
attach to the firm.
c. It is the price of the share in the primary market. It is the value owners give to
the firm.
d. None of the above.

8. Arbitrage opportunities arise when:

a. An investor can obtain a benefit buying an asset at a cheap price and selling
it expensive.
b. An investor can obtain a riskless benefit buying an asset at a cheap price and
selling it expensive.
c. An investor can obtain a risk bearing benefit.
d. An investor can obtain a riskless benefit without the requirement of an
initial investment.

9. Mark the correct answer.

a. Short selling is a suitable trading strategy when we believe that a stock price
is going to increase in the future.
b. An arbitrage opportunity allows investors to obtain risky profits with positive
initial cost.
c. Financial assets are issued in the primary markets.
d. According to the level of regulation, the financial markets can be sovereign
(or corporate) debt markets, stock markets and derivative markets.

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10. Mark the correct answer.

a. An OTC market is an organized market.
b. In the OTC markets the financial contracts are standardized, liquidity is high
and the level of regulation is high.
c. An OTC market is an unregulated market where each operation is unique
(no standardized).
d. OTC institutions are not markets.

11. The stock of Santander, S.A. is priced at EUR 11.15 in the Spanish stock market. At
the same time, this stock is quoted at EUR 11.07 in the German market. Assuming
that there are no transaction costs and you want to arbitrage this difference, mark
the suitable strategy.
a. Sell Santander’s stock in Spain, and buy it in Germany. The total gain will be
EUR 0.03 per stock.
b. Buy Santander’s stock in Germany, and sell it in Spain. The total gain per
stock is EUR 0.08.
c. It is not possible to implement an arbitrage strategy with this data.
d. Buy Santander’s stock in Spain, and sell it in Germany. The total gain will be
EUR 0.08 per stock.

12. According to these following trades, mark the correct expected return. Assume that
there is no uncertainty in the future prices.
a. Today, you buy a stock with price EUR 25.00. You will sell it tomorrow in EUR
30.00. The expected return is 25.00%.
b. Today, you short-sell a stock with price EUR 25.00. This stock is repurchased
tomorrow at EUR 30.00. The expected return is
-20.00%.
c. Today, your short-sell a stock with price EUR 25.00. This stock is repurchased
tomorrow at EUR 30.00. The expected return is -16.67%.
d. None of the above.

13. When pursuing the strategy of short selling:

a. An investor sells a stock that she does not own, so that she has to buy back
the share at the new traded market price when the position is closed.
b. Allows the investor to benefit from a drop in the stock price.
c. Allows the investor to benefit from an increase in the stock price.
d. A and b are correct

14. Indicate the correct anwer.

a. Short selling is recommended when we think that the value of a given asset
will increase in the future
b. An arbitrage opportunity allows to the investor to obtain riskless benefit
with no initial investment

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c. Financial assets are issued in the secondary market.

d. The degree of regulation determines whether a market is a derivatives
market, a fixed income market or an equity market

15. Telefonica, is trading in the Spanish stock market at a price equal to €11.06. It is
simultaneously trading in the German market with a price equal to €11.15. Assuming
that there are no transaction costs, what would be the appropriate arbitrage
strategy,
a. Short sell the Telefonica share in Spain and buy it in Germany gaining a
profit of 0.07 Euros.
b. Buy the Telefónica in Spain and short sell in Germany, gaining €0.03 Euros.
c. It is not posible gain arbitrage profits given the above data.
d. Buy a Telefonica share in Spain and sell it in Germany, gaining €0,09.

16. The price of Microsoft’s stocks at NASDAQ is $34.6 and, simultaneously, its price is
$34.5 at NYSE. It would exist an arbitrage opportunity if,
a. The total transaction fee does not exceed $0.1.
b. When short-selling at NASDAQ and buying at NYSE.
c. A and B are both true.
d. A and B are both false.

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UC3M

Topic 2 - Exercises

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Interest rates:

1.- Compute the equivalent annual interest rate of a

quarterly interest rate of 4%. Use the formula of the
compound interest rate: *

a. 10.37%.
b. 4.00%.
c. 8.16%.
d. 16.98%.

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Interest rates:

2.- How long will it take an investment of 300€ to

double its value at annual 14.8% compound
interest?*

a. 4 years.
b. 7 years.
c. 6 years.
d. 5 years.

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Interest rates:

4.- Determine the final value in 25 years and 6

months, of an amount equal to 10,000€ paid today
(t0). Assume compounded capitalization, and the
compound interest rate is 6.00%.*

a. 46181.77 euros
b. 2165.35 euros
c. 44187.51 euros
d. None of the previous answers is correct.

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Interest rates:

5.- Compute the equivalent annual interest rate of a

semiannual interest rate of 4%. Use the formula of
the compound interest rate:*

a. 9.34%.
b. 7.46%.
c. 8.52%.
d. 8.16%.

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Interest rates:

7.- The quarterly compound interest rate equivalent

to the 5% annual is rate:*

a. 1.23%
b. 1.39%
c. 0.94%
d. None of the above.

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Interest rates:

8.- The Orange Bank Account of ING Direct pays you

a 2.60% annual interest rate the next 4 months.
Assuming you deposit EUR 100,000 in this fund
during 4 months, compute the final value of your
investment. Consider a compound interest rate and
the absence of taxes. (Note: if your answer differ in
any decimal mark the closest number) *

a. EUR 859.26.
b. EUR 579.38.
c. EUR 1002.35.
d. EUR 947.32.

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Present and future value:

1.- You have created your firm, and you need to

finance your projects. These are the different sources
of financing that are available to you. Which one is
less interesting for you? Consider an (annual)
interest rate of 8.5%. *

a. A unique payment of EUR 12,000 in one year.

b. 12 monthly payments of EUR 1,000 each one.
The first payment is due the next month.
c. EUR 6,000 in one year, and EUR 6,000 in two
years.
d. 4 quarterly payments of EUR 3,000 each one.
The first payment is due the next quarter.

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Present and future value:

4.- Today, you invest EUR 10,000 in a bank account

with maturity 2 years. At maturity, the final payoff is
EUR 11,236. Determine the interest rate of your bank
account (assume a compound interest rate).*

a. 6.000% annual.
b. 0.487% monthly.
c. Both A and B are correct.
d. None of the above.

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Present and future value:

5.- Imagine you inherit 50,000 euros. Assuming that

the annual cost of capital is 3%, what would you
prefer?*

a. A payment of 50,000 euros today.

b. 10 annualities of 5,000 euros, starting the
payments in one year.
c. A unique payment of 55,000 euros in 3 years.
d. 30 semi-annual payments of 1,200 euros. The
first payment is in the next six months.

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Annuities:

1.- Félix Pérez has been working during his whole

life, and he is now planning to retire (there are 7
years left). He is planning to do an investment plan
that would allow him to live comfortably from then
on. When he retires he would like to have a total
capital of 100.000 euros, in order to travel. If the
annual interest rate is 5%, what should be the
amount to be deposited on a monthly basis, in order
to reach that capital, and assuming that deposits are
made at the end of each month.*

a. Between 3600 and 3900 euros

b. Between 970 and 1050 euros
c. Between 500 and 700 euros
d. None of the previous answers is correct.
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Annuities:

2.- Assume that César holds a 10 year mortgage (with

quarterly payments), and an initial debt of 400,000 €
with BBVA. This bank charges an annual interest rate
equal to the EURIBOR plus a differential of 1.00%. If
the EURIBOR is 3.5%, determine the constant
amount that should be paid by César. *

a. Between 12,420 and 12,439 euros

b. Between 12,100 and 12,355 euros
c. Between 10,700 and 10,800 euros.
d. None of the previous answers is correct.

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Annuities:

3.- A ten year old child will receive from 18 years

onward, an annual rent, that will be paid at the
beginning of year, with an initial value of 4,000 euros
until he is 25 years old, and that will increase at a 5%
annual rate. What is the present value if the annual
interest rate is 8%?*

a. Between 10,000 and 12,000 euros.

b. Between 12,000 and 14,000 euros.
c. Between 14,000 and 16,000 euros.
d. None of the above.

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Annuities:

3.- n=∞

1−[ 1+f n 1+i −n ]

 V17 = Cn · ;
i−f
C
n=∞ => V17 = 1
i−f
1 C1 1
 V10 = 𝑉17 · =
1+𝑖 7 i−f 1+𝑖 7
4.000 1
 V10 = · = 77.798´719
0´08−0´05 1+0´08 7

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Annuities:

3.- Unitil he is 25 => n=8 (18, 19, 20, 21, 22, 23, 24, 25)

1−[ 1+f n 1+i −n ]

 V17 = Cn · ;
i−f
1 1−[ 1+f n 1+i −n ] 1
 V10 = 𝑉17 · =Cn · ·
1+𝑖 7 i−f 1+𝑖 7
1−[ 1+0,05 8 1+0,08 −8 ] 1
 V10 =4000 · · = 15697,97
0,08−0,05 1+0´08 7

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Annuities:

5.- An investor wants to contract a savings plan for

the tuition fees of his son, who is expected to get
enrolled at University in 17 years. To this end, this
investor is going to do monthly payments. The
tuition fees will be EUR 60,000 in year 17. Determine
the monthly payment of the savings plan, given that
the first payment will be due next month. The
compound (annual) interest rate is equal to 2%.*

a. Between EUR 2,120 and EUR 2,160.

b. Between EUR 2,800 and EUR 3,000.
c. Between EUR 240 and EUR 250.
d. None of the above.

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Annuities:

5.-
1−[ 1+i −n ]
 V0 = Cn · ;
i

𝑛 1−[ 1+i −n ] 𝑛
 Vf = 𝑉0 · 1 + 𝑖 =Cn · · 1 +𝑖
i
𝑚𝑜𝑛𝑡ℎ𝑠
n=17𝑦𝑒𝑎𝑟𝑠 ∗ 12 = 204
𝑦𝑒𝑎𝑟
1
i= 1 + 0´02 12 - 1 = 0´00165158

𝑉𝑓
 Cn = 1−[ 1+i −n ]
= 247,6
i
· 1+𝑖 𝑛

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Annuities:

12.- Cajamadrid, S.A. issued shares denominated

“preferentes” in 2009. This type of product offers a
constant payment in perpetuity. Given that each of
these shares provide a payment equal to €70
annually, calculate the present value of the cash-flow
given that the annual discount rate for this asset class
is 25%. *

a. €12
b. €280
c. €75
d. None of the above

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Annuities:

12.-
1−[ 1+i −n ]
 V0 = Cn ·
i
𝐶 70
 n= ∞ => V0 = 𝑛 = = 280
i 0,25

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Annuities:

13.- You have signed a mortgage contract with your

bank in order to finance your house. The mortgage
amounts to €200.000 euros that have to be repaid in
35 years; with constant monthly payments. For a
given 3% annual interest rate, determine the
monthly quantity that should be repaid. *

a. 701,43 Euros
b. 894,36 Euros
c. 765,19 Euros
d. 641,70 Euros

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Annuities:

13.-
1−[ 1+i −n ]
 V0 = Cn · ;
i

𝑚𝑜𝑛𝑡ℎ𝑠
n=35𝑦𝑒𝑎𝑟𝑠 ∗ 12 = 420
𝑦𝑒𝑎𝑟
1
i= 1´03 12 - 1 = 0´002466269

𝑉0
 Cn = 1−[ 1+i −n ]
= 765,2
i
·

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Annuities:

15.- Suppose that you are 65 years old and you are
retired. To complement your monthly pension, your
bank offers you an inverse mortgage. The bank
agrees to pay you EUR 1100 per month until you
pass away. Assuming that the price of your house is
EUR 200.000, and that the (annual) interest rate is 4%,
what must be your life expectancy to be interested in
this business? *

a. Between 23 and 24 years

b. Less than 10 years
c. Between 13 and 14 years
d. None of the above

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Annuities:

15.-
1−[ 1+i −n ]
 V0 = Cn · ;
i

n=?
1
i= 1 + 0´04 12 - 1 = 0´00327

1−[ 1+0,0327 −n ]
 200000 = 1100· ⇒ 276𝑚𝑒𝑠𝑒𝑠
0,0327
⇒ 23 𝑎ñ𝑜𝑠

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Annuities:

18.- Determine the pending amount after

reimbursing the second payment of a loan with
principal EUR 15,000, maturity 5 years, and constant
annuity amortization, given an annual interest rate of
8%.*

a. Between EUR 11,220 and EUR 11,240.

b. Between EUR 10,560 and EUR 10,580.
c. Between EUR 9,870 and EUR 9,890.
d. None of the above.

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Annuities:

18.-
1−[ 1+i −n ]
 V0 = Cn · ;
i
𝑉0 15000
 𝐶𝑛 = 1−[ 1+i −n ] = 1−[ 1+0,08 −5 ]
= 3.756,85
i 0,08

n=3 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑙𝑒𝑓𝑡

1−[ 1+i −n ] 1−[ 1+0,08 −3 ]

 V0 = Cn · = 3756,85 · =
i 0,08
9681,77
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Annuities:

19.- Today is January 1st, 2012, and you are 50 years

old. Every year, you decide to allocate EUR 4,000 at
the end of every year during 15 years in a bank
account with 2.5% annual (compound) interest rate.
The future value at your retirement will be employed
to receive an annual constant payment during the
following 20 years. What is the annuity you will
receive, considering that the annual interest rate is
still 2.5%?*

a. Between EUR 4,870 and EUR 4,890.

b. Between EUR 4,590 and EUR 4,610.
c. Between EUR 4,720 and EUR 4,740.
d. None of the above.
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Annuities:

19.- Contributions
1−[ 1+i −n ]
 V50 𝑦𝑒𝑎𝑟𝑠 = Cn · ;
i
1−[ 1+0,025 −15 ]
 V50 𝑦𝑒𝑎𝑟𝑠 = 4000 · = 49.525,51
0,025
Payments (received)
1−[ 1+i −n ] 1
 V50 𝑦𝑒𝑎𝑟𝑠 = An · ∗
i 1+𝑖 15
V50 𝑦𝑒𝑎𝑟𝑠
 𝐴𝑛 = 1−[ 1+i −n ]
= 4601,13
· i
∗
1
1+𝑖 15

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Topic 3 – NPV, Payback rule and IRR – EXERCISES

1. Using the Net Present Value method, compute which of the following projects is
better. The interest rate is 12%:

TIME (YEARS)
PROJECT 0 1 2 3
A -150 50 125 190
B -200 25 50 350
C -300 0 0 603,46

a. A and C are equal.

b. A and B are equal.
c. A is the best.
d. C is the best.

2. Compute, approximately, the IRR of the following three projects:

TIME (YEARS)
PROJECT 0 1 2 3
A -150 0 0 190
B -200 0 0 350
C -300 0 0 535

a. 0.136, 0.249, 0.291.

b. 0.136, 0.500, 0.291.
c. 0.136, 0.500, 0.582.
d. 0.272, 0.249, 0.582.

3. The Internal Rate of Return of a project (IRR) is:

a. The discount rate that makes the NPV equals to 0.
b. The discount rate that makes the NPV equals to the payback.
c. The discount rate that makes the NPV positive.
d. The discount rate that makes the NPV negative.

4. Assume an investment with an initial investment at time t=0, and positive cash-flows
from t=1 until maturity. Mark the false sentence.
a. We have to invest in the project if its NPV is bigger than zero.
b. We have to invest in the project if its cost of capital is lower than IRR.
c. If the NPV of this project is zero, then its return is zero.
d. If two firms develop this project, the firm whose cost of capital is lower will
obtain a higher NPV.

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5. According to the Payback criteria, what is the best project?

YEARS
PROYECT 0 1 2 3 4 5
1 -40 10 10 5 3 30
2 -25 5 5 10 15 15
3 -20 5 5 5 10 15
4 -15 7 8 2 2 2

a. Project 1.
b. Project 2.
c. Project 2 or 3, indistinctly.
d. Project 4.

6. The Paris Saint-Germain (PSG) football team wants to hire a new player, and they
have two options. Option A: an Argentinian player who costs EUR 50 million.
Additionally, PSG has to include the salary of the player (EUR 15 million per year from
year 1 to 3). Moreover, PSG expects to sell this player with price EUR 55 million at
year 3. Option B: a Brazilian player, whose numbers are: EUR 60 million for hiring;
annual salary of EUR 18 million (years from 1 to 4); selling at year 4 with price EUR
75 million. According to the NPV criteria, which one will you hire? The cost of capital
is 3.0%, and you can choose just one player.
a. The Brazilian player, because it cost EUR 17 million less than the
Argentinian one.
b. The Argentinian player, because increases the PSG’s economic value.
c. We are indifferent between the Argentinian and the Brazilian player.
d. None of the two, because they both reduce the PSG’s economic value.

7. Your investment has a 70% probability of being successful, which means a cash-flow
of EUR 500,000 the next year. Otherwise, the cash-flow will be 0. Given an
opportunity cost rate of 7%, choose from the following initial investments the one
that leads to a higher NPV value.

a. EUR 467,289.72
b. EUR 483,644.86
c. EUR 420,560.75
d. EUR 405,321.77

8. Positive NPV projects are more likely,

a. When investing in financial assets, because the barriers to entry are lower.
b. When investing in financial assets, contrary to real asset investments.
c. When investing in real assets, because the barriers to entry are lower.
d. When the barriers to entry are high, no matter the investment type.

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9. Using the Net Present Value method, compute which of the following projects is
better. The interest rate is 10%:

TIME (YEARS)
PROJECT 0 1 2 3
A -150 50 125 190
B -200 25 50 350
C -300 0 0 535

a. A and C are equal.

b. A and B are equal.
c. A is the best.
d. B is the best.

10. Compute, approximately, the IRR of the following three projects:

TIME (YEARS)
PROJECT 0 1 2 3
A -150 0 0 190
B -200 0 0 350
C -300 0 0 535

a. 0.082, 0.205, 0.213.

b. 0.345, 0.587, 0.799.
c. 1.768, 1.654, 1.654.
d. 2.324, 2.543, 0.987.

11. Select the Project that should be chosen according to the PayBack selection criteria:
T=0 T=1 T=2 T=3 T=4 T=5 T=6

A -100 20 74 100 100 100 100

B -250 125 30 100 200 200 200

C -1000 500 580 500 500 1000 0

a. Project A
b. Project B
c. Project C
d. None of the above.

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12. Compute the maximum amount you would invest today in the following project: if
the project is successful –which it will happen with probability 45%-, then the cash-
flow will be EUR 10.5 million in one year. Otherwise, the cash-flow will be EUR 5.0
million. The annual discount rate of the project is 14%.
a. EUR 7.43 million.
b. EUR 4.41 million.
c. EUR 6.56 million.
d. None of the above.

13. Compute the NPV of this project. The discount rate is 12%.

t=0 t=1 t=2 t =3

-100 -250 +200 +170

a. NPV between EUR 20.00 and EUR 22.00.

b. NPV between EUR 15.00 and EUR 17.00.
c. NPV between EUR -43€.00 and EUR -42.00.
d. None of the above.

14. In real asset markets,

a. There are few barriers to entry, and potentially few investments with positive
NPV.
b. The NPV of the real investment assets rapidly converges to zero.
c. There are many barriers to entry, and potentially, many investments with
positive NPV.
d. An investment with positive NPV has no interest for investors, who will not
compete for that investment.

15. Mark the incorrect answer.

a. The payback is the number of years needed to recover the initial investment.
b. The payback rule is attractive to managers that are assessed based on short
term results.
c. The payback is expressed in monetary terms (example: dolars).
d. The discounted payback considers the time value of money.

16. Determine the NPV of this project with the following cash-flows assuming that the
annual cost of capital is 12%.
t=0 Year 1 Year 2 Year 3
-500 +350 +200 +200
a. NPV between 120€ and 130€
b. NPV between -15 € and -5€
c. NPV between 110€ and 115€.
d. None of the above.

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17. Given the following cash-flows, under which range of discount rates would you
accept the project?

t=0 Year 1 Year 2

-200,00 +300,00 -82,08

a. Discount rates between 18,50% and 19,84%.

b. Discount rates between 12,50% and 13,50%.
c. Discount rates higher than 17,40%.
d. None of the above.

18. The payback criteria is a usual methodology to measure the quality of a postgraduate
course. Assuming that an MBA in an American University costs approximately
$120,000, if the payback reported in the advertising brochures is 2 years, what is the
expected salary per student after completion of the MBA?
a. $50,000
b. $61,000
c. $175,000
d. B and c are correct

19. A certain project will be successful with probability 59.25%, producing a cash-flow
of EUR 12.5 million at the end of next year. If the project fails, the cash-flow is
estimated to be EUR 5 million. Assuming an (annual) opportunity cost of 12%, what
is the maximum amount that you will be able to invest in the project?
a. 8.43 million, approximately
b. 5.41 million, approximately
c. 10.5 million, approximately
d. 3.45 million, approximately

20. Compute the project’s NPV assuming an annual discount rate of 8%. Cash-flows are,

t=0 Year 1 Year 2 Year 3

-500 +350 +200 +170

a. NPV between 20€ and 30€

b. NPV between 5 € and 15€
c. NPV between -15€ and -5€.
d. None of the above

21. Select the wrong answer:

a. NPV’s rule establishes that we have to reject those projects with negative
NPV.
b. There are a lot barriers to entry in the market for real assets
c. Potentially, there are a lot of investments with positive NPV in financial
markets, because barriers to entry are very low.
d. Capital rationing has to be applied when there is a limited availability of
cash/credit for facing the initial negative cash flows of a project.

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22. A firm is studying to construct a new building in Madrid. The cost of analyzing this
project is EUR 300,000. According to this report, the initial investment must be EUR
1 million (paid in t0), plus some operating costs of EUR 300,000 euros per year. The
building is expected to provide an annual income of EUR 450,000 euros. At year 10,
the project could be sold for EUR 500,000. The risk-free rate is 3.5%, and the cost of
capital for this kind of projects is 8%. Determine if the project should go on.
a. Yes. NPV is EUR +238,108.9.
b. No. NPV is EUR -61,891.
c. Yes. NPV is EUR +6,512.
d. None of the above.

23. According to the PayBack rule, select the best project:

T=0 T=1 T=2 T=3 T=4 T=5 T=6

A -100 20 40 100 100 100 100

B -250 125 130 100 200 200 200

C -500 10 20 300 600 900 2500

D -1000 500 480 500 500 1000 0

a. Project A
b. Project B
c. Project C
d. Project D

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T4. The model of Gordon. Return and risk: the basics.

1. Compute the stock price of a firm that pays a dividend of €1.5 per share; its expected
earnings are €1.5 mill. for year 1, and €2.5 mill. for year 2. Then, the firm expects to
increase its earnings at 4% annual rate. The payout-ratio is 60%, and it is constant
for the entire life of the firm. The number of stocks is 1 mill., the return of the firm
is 8%, and the risk-free rate is 2%. Hint: use the Gordon model.
a. Between €35.2 and €36.0.
b. Between €40.5 and €43.
c. Between €66.53 and €69.53.
d. None of the above.

D1 D2
0´9 1´5
1´5 · 0´6 2´5 · 0´6 1´5(1+q) 1´5(1+q)2

D = 1´5
q = 4% anual increment
Pay-out = 60%
r = 8%

q n D = Pay − out · B
D1 1−( ) 1 D1 D2 1
1+r
P0 = + D2 [ ] · (1+r)= (1+r) + (r−q) · (1+r) D1 = 0´6 · 1´5 = 0´9
(1+r) 1+r−q
D2 = 0´6 · 2´5 = 1´5

0´9 1´5 1
P0 = + · = 0´8333 + 37´5 · 0´9259 = 35´4928
(1+0´08) (0´08−0´04) (1+0´08)

2. The price of URALITAN stock is €11 in the secondary market. The dividend for next
year will be €0.5 euros, and it will growth at 10% annual up to infinite. Determine
the discount rate of the market.
a. Less than 5%.
b. Higher than 10% and lower than 13%.
c. Higher than 22%.
d. None of the above.

P0 = 11€
Dr = 0´5€
g = 0´1=10%
r=?

D
P0 =
(r−g)

0´5 0´5
11 = → r= + 1´1 - 1 → r = 0´145454→ 14´5454%
(1+r−1´1) 11

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3. In January 2012, the Spanish Government considered the possibility of privatizing

the National Lottery, Lotería Nacional. The project is expected to pay a cash-flow of
EUR 3.000 million at the end of 2012, and this cash-flow will grow at a constant and
perpetual rate of 3%. Assuming that i) the discount rate of this type of business is
15% and ii) the Spanish Governments planned to issue 10 million of shares, compute
the stock’s price of Lotería Nacional estimated by the analysts in January 2012. Note:
assume that the cash-flow paid is equal to the total amount of dividends.
a. EUR 20.000 (per share).
b. EUR 2.500 (per share).
c. EUR 34,75 (per share).
d. None of the above.

Dr = 3.000 millons
g = 3%
r = 15%

3.000
𝐷 10 3.00
P0 = = = = 2.500€/Share
𝑟−𝑔 0´15−0´03 0´12

4. An analyst estimates that today (t=0) the benefits per share of the firm CICISA will
be 40€ in the first year (t=1), and 50€ in the second year (t=2). He predicts that after
the second year benefits will grow at 2% in perpetuity. Historically, the pay-out of
this firm has been 55%, and it is not assumed to change in the future. What should
be the market price of these stocks? Assume that the cost of capital is 9% for this
type of firms.

a. The price will be 125.30 euros.

b. The price will be 350.84 euros.
c. The price will be 380.60 euros
d. None of the above.

D1 D2
22 27´5 g = 0´02
40 · 0´55 50 · 0´55 Pay-out = 55%
r = 9%

22 27´5 1
P0 = +[
(0´09−0´02)
· (1+0´09)] = 20´1834 + [392´8571 · 0´9174] = 380´60
(1+0´09)

D = Pay − out · B
D1 = 0´55 · 40 = 22
D2 = 0´55 · 50 = 27´5

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5. Cajamadrid, S.A. issued preferred stocks in 2009. A preferred stock is simply a

constant and perpetual annuity. Assuming that you got EUR 37 each year in terms of
dividend, compute the price of the preferred stock in the market. The rate of
discount of the preferred stocks is 22% annual.
a. EUR 12.
b. EUR 280.
c. EUR 75.
d. None of the above.

D = 37€
D 37
P0 = ? P0 = = = 168´1818€
r 0´22
r = 22%

6. Assume that a company´s share is trading at a price equal to €52.35. The dividend
growth rate is expected to be constant and equal to 8.25%. If the expected return
offered by similar firms in the sector is equal to 19.12%, how much would the next
payable dividend be?
a. Between €5.66 and €5.74
b. Between €4.30 and €5.32
c. Between €10.00 and €10.02
d. None of the above

P = 52´35€
g = 8´25%
r = 19´12%
D D
P0 =
(r−g)
; 52´35 = = 5´6904€/ Acción
0´1912−0´0825

7. The stocks of firm XYZ are quoted at EUR 5.00 in the secondary market. The firm has
announced that the next year dividend (t=1) will be EUR 0.10. This dividend is
expected to growth at 2% annual rate after then. Determine the discount rate of the
stock that the market is applying.
a. Less than 5%
b. Higher that 8%, and less than 10%
c. Higher than 5%
d. None of the above.

P = 5€
D = 0´10€
g = 2%
r=?
D 0´10 0´2
P0 = ; 5= ; 5 · (r - 0´02) = 0´10 ; 5r - 0´1 = 0´1 ; r = = 0´4 → 4%
(r−g) r−0´02 5

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8. Compute the price of XSL stocks by considering a dividend of EUR 3.0 the next year;
an annual dividend growth rate of 3.5%; and a firm’s cost of capital of 5.0%
a) EUR 85.7
b) EUR 200.00
c) EUR 100.00
d) EUR 142.90

D = 3€
g = 3´5%
r = 5%
3
P=? P0 =
(0´05−0´035)
= 200€

9. An oil company is willing to pay the following dividends: Year 1: €4; Year 2: €5; Year
3 and following years (4, 5, 6…infinite): €2. The required rate of return for firms in
this sector is 11%. Compute the price at which one share of INCARSA Corp is
expected to trade in the secondary market:
a. 22.42
b. 23.45
c. 20.35
d. None of the above

4€ 5€ 2€ ... r = 11%

Año: 0 1 2 3 4 5 6 ... ∞

4 5 2 1
P= + + ·( = 3´9564 + 4´8917 + 14´7568 = 22´42
1+0´011 (1+0´011)2 0´11 1+0´011)2

10. The payout ratio of a company is:

a. The money you invest minus the money you receive when you sell the stock.
b. The proportions of shares that an investor holds.
c. The result of the dividends per share divided by the earnings per share.
d. None of the above.

11. Suppose the expected return on the market is 18%, the risk free rate is 3% and the
standard deviation for the market is 4%. Find the expected return for a portfolio that
has a standard deviation of 2%:
a. 12.30%.
b. 11.30%.
c. 10.30%. (10,5%)
d. 14.30%.

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Risk premia 0´15

E(r) = · σ2 + rq ; E (r) = · 0´02 + 0´03 ; E(r) = 0´105 → 10´5%
σ1 0´04

E(r) (%) CAL (Capital Allocation Line)

E(R p ) = 18%
Risk premia=15% 15+3=18
3%

𝜎2 =2% 𝜎1 =4% 𝜎(%)

12. The following graph shows:

a. The feasible set varies depending on the value of the standard deviation of
the risk-free asset and the expected return of the portfolio.
b. The feasible set varies depending on the value of the correlation coefficient
between the returns of the two assets.
c. The volatility of the individual asset A changes when the correlation
coefficient varies.
d. The return of the individual asset B varies when the correlation coefficient
changes.

13. Here is the variance-covariance matrix of assets A, B and C. Compute the volatility
of an equally weighted portfolio composed by these three assets.

A B C
A 0,04 -0,002 0
B -0,002 0,0225 0,003
C 0 0,003 0,0625

a. Between 8% and 9%.

b. Between 11% and 12%.
c. Between 14% and 15%.

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d. Between 17% and 18%.

Equaly weighted wA = wB = wC = 1/3

They are duplicated

PESOS: A-A B-B C-C A-B A-C B-C

1 2 1 2 1 2 1 1 1 1 1 1
σ2P = ( ) · 0´04 + (3) · 0´0225 + (3) · 0´0625 + 2 · 3 · 3 (-0´002) + 2· 3·3 0 + 2 · 3 · 3
3
0´003=
0´0044 + 0´0025 + 0´00694 - 0´00044 + 0 + 0´00066

= 0´0141
Volatility → σ = √0´0141 = 0´11874 → 11´87%

Alternative
0,04 −0,02 0 1/3
𝑡
σP = 𝑤 Σ𝑤 = (1/3 1/3 1/3) ( −0,02 0,0225 0,03 ) (1/3)= 0,0141
0 0,03 0,0625 1/3

14. Consider a portfolio composed by a large number of stocks. In this portfolio,

a. The total risk of the portfolio is always equal to zero.
b. The idiosyncratic risk tends to infinity.
c. The systematic risk is zero.
d. The idiosyncratic risk tends to zero.

15. In which case is it possible to build a risk-free portfolio?

a. When the correlation coefficient is equal to 0.

b. When the correlation coefficient lies in the interval (-1, 1).
c. When the correlation coefficient is equal to 1 and short selling is not allowed.
d. None of the above.

16. Mark the correct answer.

a. Systematic risk can be reduced by including more assets in your portfolio.

b. The total risk of a portfolio increases when the total number of portfolio’s
assets increases.
c. The total risk of a portfolio diminishes when the total number of portfolio’s
assets increases.
d. None of the above.

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17. Your portfolio is composed by 65% in BBVA stocks, 25% in Banco Santander stocks,
and the rest in Treasury bills (risk-free asset). The expected return of BBVA stocks is
3.5%; the expected return of Banco Santander stocks is 5.5%, and that of Treasury
bills is 0.5%. Moreover, the volatility of BBVA stocks is 15%; the volatility of Banco
Santander stocks is 25%, and the covariance between BBVA and Banco Santander is
0.002. Determine the volatility of your portfolio.
a. I need more data. It’s not possible to compute it.
b. Between 11.5% and 12.5%
c. Between 10.20% and 11.20%
d. None of the above.

Weight Return Volatilty

0´152 0´002 0
BBVA W1 = 65% R1 = 3´5% σ1 = 15% (0`002 0´252 0)
Banco Santander W2 = 25% R 2 = 5´5% σ2 = 25% 0 0 0
Treasury bills W3 = 10% R 3 = 0´5% σ3 = 0%
Covariance BBVA y Santander 0´002 We supose bonds have
no risk/volatility

σ2R = w12 · σ12 + w22 · σ22 + 2w1 w2 σ1,2 (or) σR = √w12 σ12 + w22 σ22 + 2w1 w2 ρ1,2 σ1 σ2

σRp =√(0´65)2 · (0´15)2 + (0´25)2 · (0´25)2 + (0´10)2 · (0)2 + 2 · 0´65 · 0´25 · 0´002
ΣRp = √0´00950625 + 0´00390625 + 0´00065 = √0´0140625 = 0´118585 →
σRp = 11´8585%

18. Assume that you create a portfolio by investing in the IBEX35 index, and Treasury
bills (risk-free asset). If you want a total volatility of your portfolio equal to 9%,
compute the weight of IBEX35 in the portfolio. The expected return on IBEX35 is
2.5%, and its volatility is 13%.
a. 6.9%
b. More than 100%
c. 69.2%
d. None of the above

Expected return → ERP = w · Rm + (1 - w) Rf

Risk → σRP = w · σM (the risk free asset doesn’t add risk)
σRP 0´09
Risky asset weight → w = = = 0´6923 → 69´23% IBEX35
σM 0´13
Risk free asset weight → (1 - w) = 30´77% peso

Another posibility:
(0´09)2
σ = √w 2 · σ + (1 − w) · σ2 ; 0´09 = √w 2 · 0´132 → (0´09)2 = w · 0´13 ; (0´13)2
= w2
→ w = 69´23%

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19. Compute the return and volatility of the portfolio composed by assets A, B and C.
This portfolio is equally weighted.

Asset Expected return

A 2%
B 12%
C 20%

Variance-covariance matrix
A B C
A 0.0064 0 0
B 0 0.0169 -0.0050
C 0 -0.0050 0.0049

a. Return = 11.33%; volatility = 4.50%.

b. Return = 13.58%; volatility = 17.20%.
c. Return = -6.83%; volatility = 8.60%.
d. None of the above.

Return:
1 1 1
ERP = · 0´02 + 3 · 0´12 + 3 · 0´2 = 0´1133 → 11´33%
3

1 2 1 2 1 2 1 1 1 1 1 1
σ2RP : ( ) · 0´0064 + ( ) · 0´0169 + ( ) · 0´0049 + 2 · · 0 + 2 · · 0 + 2 · · (-0´005)
3 3 3 3 3 3 3 3 3
= 0´00071111 + 0´00187777 + 0´00054444 + 0 + 0 - 0´00111
= 0´002023

Risk → σ𝑅𝑃 = √0´002023 = 0´0449 → 4´49%

20. Mark the correct answer.

a. Systematic or market risk is diversifiable.
b. Idiosyncratic or specific risk increases when adding more risky assets to
our portfolio.
c. The total risk of the portfolio is reduced when increasing the number of
risky assets. Note: we assume that correlations among them are
different.
d. The Gordon model does not use the stock dividends for computing the
stock price.

21. When increasing the total number of assets in a portfolio,

a. Total risk can be eliminated.
b. Systematic risk can be reduced.
c. Systematic risk converts into diversifiable risk.
d. None of the above are true.

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22. Compute the volatility of a portfolio composed by Jazztel bonds, BME stocks and
Treasury bonds (risk-free). The correlation coefficient between Jazztel bonds and
BME stocks is 0.5. Here is some useful data:

Jazztel bonds BME stocks

Expected return 10% 15%

Volatility 15% 25%

a. Between 11.3% and 11.9%.

b. It is not possible to compute it: I need more data.
c. Between 1.3% and 1.5%.
d. Between 32% and 36%.

0´152 0´5 0
Covariance matrix ( 0´5 0´252 0)
0 0 0

Correl coef. Std.dev.

1 2 1 2 1 1
σ2RP = ( ) · (0´15)2 + ( ) · (0´25)2 + 2 · · 0´5 · 0´15 · 0´25 =
3 3 3 3
0´0025 + 0´00694 + 0´0041666 = 0´0136066 → 1´36%

Volatility → σ𝑅𝑃 = √0´0136066 = 0´116647 → 11´66%

23. You want to construct a risk-free portfolio by combining just to stocks (A y B).
Volatility of stock A (B) is 10%(18%). Their correlation coefficient is -1. Compute the
weight of stock A in the portfolio.
a. It is impossible to construct a risk-free portfolio.
b. Between 63% and 65%.
c. Between 32% and 38%.

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d. None of the above.

σ2R = wA2 · σ2A + wB2 · σ2B + 2wA w𝐵 σ𝐴,B = wA2 · σ2A + wB2 · σ2B + 2wA w𝐵 σA σB 𝜌A,B = 0

And 1 = 𝑤𝐴 + 𝑤𝐵

then
𝜎B2 −𝜎𝐴 𝜎𝐵 𝜌𝐴,𝐵
WA = 2 + 𝜎2 − 2 𝜎 𝜎 𝜌
𝜎A B 𝐴 𝐵 𝐴,𝐵
0´182 −(−1) · 0´10 · 0´18 0´0504
WA = = = 0`6428 → 64´28%
0´102 + 0´182 − 2(−1)0´10 · 0´18 0´0784

WB = 35´72%

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T5 – Markowitz's model

1. Compute the portfolio of minimum variance by combining two risky assets: asset 1,
expected return 6%, and standard deviation of 14%; asset 2, expected return 15%,
and standard deviation 25%. The correlation coefficent is 0.8.
a. W1=100%, because asset 1 exhibits lower risk.
b. W1=63.77% and W2= 36.23%.
c. W1=151.23% and W2= -51.23%.
d. None of the above.

σ2Rp = w12 · σ12 + w22 · σ22 + 2w1 w2 σ1,2

σ2Rp = w12 · σ12 +(1 − w1 )2 · σ22 + 2w1 (1 − w1 )2 · ρAB · σ1,2 · σ1,2

∂σ2Rp 𝜎22 − ρ12 · σ1 · σ2

= 0 => w1 =
𝜕𝑤1 𝜎12 + 𝜎22 − 2 · ρ12 · σ1 · σ2

0´252 − 0´8 · 0´14 · 0´25 0´0345

w1 = = = 1´321 → 132%
0´14 2 + 0´252 − 2 · 0´8 · 0´14 · 0´25 0´0261

w2 = 1 - 1´321 = - 0´321 → - 32%

2. Determine the weight of risk-free asset in a portfolio with standard deviation of 12%.
This portfolio is composed by the (mean-variance) optimal portfolio, with an
expected return of 15% and volatility of 22%, and the risk-free asset, with an
expected return of 5%.
a. 80%.
b. Between 60% and 70%.
c. 45.45%.
d. None of the above.

Erp = w · rm + (1 − w)rf
σrp 0´12
σrp = w · σm → w = = = 0´5454 → 54´54% weight in risky asset
σm 0´22

𝑟𝑝 (1 - w) = 45´46% weight in risk free asset

15%

𝑟𝑓
12% 22% 𝜎𝑝

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3. According to the Markowitz model, investors with the same risk-aversion coefficient
will choose,
a. The same final portfolio (composed by any risky portfolio and risk-free
asset).
b. The same (optimal) risky portfolio, if there is a risk-free asset in the
economy.
c. A different optimal portfolio, if there is a risk-free asset in the economy.
d. Answers A and B are correct.

4. Mark the correct answer.

a. Systematic or market risk is diversifiable.

b. Idiosyncratic or specific risk increases when adding more risky assets to
our portfolio.
c. The total risk of the portfolio is reduced when increasing the number of
risky assets. Note: we assume that correlations among them are
different.
d. The Gordon model does not use the stock dividends for computing the
stock price.

5. Assume that there is a market with n risky assets and one risk free asset. Under the
mean variance model:

a. All risk averse investors will always invest in a portfolio that has the risk
free asset.
b. Some risk averse investors will invest in a portfolio made just with the
optimal portfolio (tangency portfolio). <= Not correct!! (bad translated)
c. None of the risk averse investors will invest in a portfolio made with the
optimal portfolio.
d. All risk averse investors will invest in a portfolio made with the optimal
portfolio.

6. Here you have three different risky portfolios. If you can combine these risky
portfolios with treasury bonds (risk-free asset), determine the fund you will choose.
Risk-free asset has an expected return of 4% (annual).

Funds Expected return (annual) Volatility (annual)

101 12% 21%

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102 15% 26%

103 21% 30%

a. Fund 101
b. Fund 102
c. Fund 103
d. None is superior, it depends on the invertor's risk aversion coefficient.

The one with CAL (Capital Allocation Line) with the largest slope (Sharpe Ratio)
Erp −rf
Sh =
σrp
return 103
0´12−0´04
Sharpe Fund 101 = = 0´38 102
0´21
0´15−0´04
Sharpe Fund 102 = = 0´42 101
0´26
0´21−0´04
Sharpe Fund 103 = = 0´56
0´3
risk

7. Determine the minimum variance portfolio, given that the correlation coefficient
between GAGO and LUCO is equal to -1, and the volatility of GAGO and LUGO shares
is 18% and 25% respectively.

a. The weight invested in GAGO will be between 10% and 15%

b. The weight invested in GAGO will be between18% and 25%
c. The weight invested in GAGO will be between 57.5% y 59%.
d. Ninguna de las anteriores.

σ2LUCO − ρ · σGACO · σLUCO

wGACO =
σ2GACO + σ2LUCO − 2 · ρ · σGACO · σLUCO

0´252 − (−1) · 0´18 · 0´25 0´1075

wGACO = = = 0´581395→ 58´13%
0´182 +0´252 −2(−1) · 0´18 · 0´25 0´1849

0´182 − (−1) · 0´18 · 0´25 0´0774

wLUCO = = = 0´418604→ 41´86%
0´182 +0´252 −2(−1) · 0´18 · 0´25 0´1849

8. Consider an investment opportunity set just composed by risky assets. All the
correlations (ρ) among assets are comprised in between -1 < ρ < +1. Mark the correct
answer.
a. The minimum risk portfolio of the investment opportunity set has zero
volatility.

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b. If you are situated on the efficient frontier, you cannot obtain more
return without increasing your risk.
c. Dominated portfolios offer more return for the same level of risk.
d. All investors will choose the same optimal portfolio, no matter their risk
aversion level is.

9. Imagine a financial market with risk-free asset return of 1.00% annual. The equation
of the Capital Allocation Line (CAL) for a given portfolio with expected return of 10%
annual, and standard deviation of 15% annual is,
a. E(ri) = 0.01 + 0.67σi
b. E(ri) = 0.01 + 0.60σi
c. E(ri) = 0.02 + 0.67σi
d. E(ri) = 0.02 + 0.60σi

Ec −rf 0´10−0´01
Erp = rf + · σp → = 0´01 + · σp = 0´01 + 0´6σp
σc 0´15

10. An investment bank offers you to invest in one of these three funds. The return of
risk-free rate is 2% annual. Which fund will you choose?

Fund Expected return Volatility

A 12% 20%
B 22% 24%
C 25% 32%

a. Fund A.
b. Fund B.
c. Fund C.
d. There is not enough data for computing the answer.

Erp −rf
Slope of the CAL (Sharpe)
σc
0´12−0´02
A→ 𝑆ℎ𝐴 = 0´2 = 0´5
0´22−0´02
B→ 𝑆ℎ𝐵 = 0´24 = 0´8333 
0´25−0´02
C→ 𝑆ℎ𝐶 = = 0´718
0´32

11. Assume an economy without risk-free asset,

a. The optimal risky portfolio is the tangent portfolio.
b. All efficient portfolios are located in the efficient frontier. This line
maximizes the return for a given risk level (and viceversa).
c. A and b are correct.
d. None of the above.

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12. Given assets A and B, compute the minimum variance portfolio,

Asset Expected return (annual) volatility (annual)

A 6% 27%
B 9% 32%
Correlation = Corr(A,B) = 30%

a. WA = 58.35%.
b. WA = 38.05%.
c. WA = -38.05%.
d. None of the above.

From exercise 1 we already know that wA should be

𝜎22 − ρ12 · σ1 · σ2
w1 =
𝜎12 + 𝜎22 − 2 · ρ12 · σ1 · σ2

0´322 − 0´3 · 0´32 · 0´27 0´07648

wA = = = 0´619471→ 61´94%
0´272 + 0´322 −2 · 0´3 · 0´27 · 0´32 0´12346

WB= 1- WA= 38,06%

13. Determine the amount to be invested in the risk free asset if the annual expected
return of the optimal risky portfolio (in the Markowitz Model) is 15% annual and the
annual return from Treasury Bills is 5% annual. Moreover, the annual volatility of the
optimal risky portfolio 22% and the desired volatility of the given portfolio is 12%
annual.
a. Between 54% and 56%.
b. Between 65% and 67%.
c. Between 44% and 46%.
d. None of the above.

σ𝑝 = 𝑤𝑚 . σm
𝜎𝑝 12%
𝑤𝑚 = 𝜎 = = 0´5454→ 54´54%
𝑚 22%
𝑤𝑟𝑓 = 1 - 𝑤𝑚 = 45´45%
14. Within the Markowitz model framework, assume that the market portfolio has an
expected return of 12% and standard deviation 25%; the return of the risk-free asset
is 2%. Which weights would you assign to each asset type in order to reach a 20%
portfolio return?

a. 25% in the risky asset.

b. 50% in the risk-free asset.
c. 80% in the risk-free asset.

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d. 180% in the risky asset.

Erp = 𝑤𝑚 · EC + (1 − 𝑤𝑚 )Em
0´20 = w 0´12 + (1 - w) 0´02
0´2 = 0´12w + 0´02 - 0´02w ; w = 180% risky ; (1 - w) = -80% risk-free

15. Assume that investors can access to the same investment opportunity set, which
includes both risk and risk-free assets. According to the mean-variance (Markowitz)
model, mark the correct answer:

a. The optimal portfolio depends on the investor’s risk aversion level.

b. In absence of risk-free asset, there exists a set of efficient portfolios, but there
is no optimal portfolio.
c. Dominated portfolios are (mean-variance) efficient portfolios.
d. The minimum variance portfolio is the optimal portfolio, no matter the investor’s
risk aversion level.

16. Your portfolio is composed by 60% in stocks; 30% are commodities, and the rest are
Treasury bills (risk-free asset). The (annual) expected return of stocks is 15%,
commodities 11%, and Treasury bills 4%. The stock's volatility is 22% annual,
commodities is 31% annual, and covariance between stocks and commodities is
0.015. Determine the volatility of the portfolio.
a. Impossible to calculate. I need more data.
b. Between 17.60% and 17.80%.
c. Between 11.20% and 11.60%.
d. None of the above.

0´222 0´015 0
Covariance matrix =Σ= [0´015 0´312 0]
0 0 0
W=[0,6 0,3 0,1]

σ2 = 𝑤 𝑡 . Σ. w = 0´62 · 0´222 + 0´32 · 0´312 + 2 · 0´6 · 0´3 · 0´015 = 0´017424 + 0´008649

+ 0´0054 = 0´031473
σ = √0´031473 = 0´17740 → 17´74%

17. Asume that you invest in S&P500 index and Treasury bills. If you want to form a
portfolio with volatility 16%, determine the weight of S&P500 (with expected return
12%, 25% annual volatility).
a. 6.40%.
b. More than 100%.

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c. 64%.
d. None of the above.

0´16
σp = 𝑤𝑚 · σm ; 0´16 = 𝑤𝑚 · 0´25 ; 𝑤𝑚 = = 0´64 → 64%
0´25

18. Assume an economy without risk-free rate:

a. The optimal portfolio is the tangent portfolio, where the CAL is the
efficient frontier and it exists one optimal portfolio.
b. The optimal portfolio is in the efficient frontier, and it is common to all
investors.
c. Efficient portfolios are in the efficient frontier, and each investor will
choose an efficient portfolio depending on their preferences.
d. The optimal portfolio is the minimum variance portfolio.

19. An investment bank offers you to invest in one of these three funds. The return of
risk-free rate is 4% annual. Which fund will you choose?

Funds Expected return Volatility

101 12% 21%
102 15% 26%
103 21% 30%

a. Fund 101
b. Fund 102
c. Fund 103
d. None is superior; it depends on the risk aversion coefficient of the
investor.

20. Systematic risk,

a. It is possible to diversify by investing in different assets.
b. It cannot be eliminated by diversification.
c. It is the idiosyncratic (or individual) risk of any firm.
d. Answers B and C are correct.

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21. Suppose the expected return on the market is 15%, the risk free rate is 4% and the
standard deviation for the market is 3%. Find the expected return for a portfolio that
has a standard deviation of 2%:
a. 12.25%.
b. 13.25%.
c. 11.25%.
d. 11.33%.

rm −rf rm − 0´04
Erp = rf + · σm → 0´15 = 0´04 + · 0´03 ; rm = 11´33%
σp 0´02

22. A portfolio manager can invest in two shares (Telefónica and Repsol), whose
expected returns are -10% and 25%, respectively. Additionally, their standard
deviations are 40% and 27%, respectively. What are the weights that should be
invested in each of these assets if the aim is to obtain the minimum variance
portfolio?
a. WTEL = -2.08 and WREP = 3.07, if the correlation coefficient between Telefónica
and Repsol is 1, and short selling is allowed.
b. WTEL = 0.4 and WREP = 0.6, if the correlation coefficient between Telefónica
and Repsol is -1, and short selling is allowed.
c. WTEL = 2.08 and WREP = 3.07, if the correlation coefficient between Telefónica
and Repsol is 1, and short selling it is allowed.
d. A and b are correct.

𝜎22 − ρ12 · σ1 · σ2
w1 = 2
𝜎1 + 𝜎22 − 2 · ρ12 · σ1 · σ2

1=TELEFONICA
2
0´27 −1 · 0´4 · 0´27 −0´0351
ρ = 1{wTEL = 2 2
0´4 + 0´27 − 2 · 0´27 · 0´4 · 1
= 0´0169
= −2´0769 → −207´69%
wREP = 307%
2
0´27 +1 · 0´4 · 0´27 0´1809
wTEL = = 0´4489 = 0´4029 → 40´29%
ρ = -1{ 2 2
0´4 + 0´27 − 2 · 0´27 · 0´4 ·(−1)
wREP = 59´70%

23. Assume that the correlation coefficient between Telefónica and Repsol is equal to
0, given the data in the previous exercise, the expected return and volatility of an
equally weighted portfolio made of Telefónica and Repsol, are:
a. Return and volatility 5.00% and 15.00%, respectively.
b. Return and volatility 7.50% and 24.13%, respectively.
c. Return and volatility -1.15% and 30.47%, respectively.
d. Return and volatility 8.03% and 22.79%, respectively.

E = 50% R TEL + 50% R REP = 50% (-10%) + 50% 25% = 7´5%

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24. An investor wants to invest in the risk-free asset “rf” and a risky asset “i”. Assuming
the return of the risk-free asset is rf=5%, and given the following data,

Asset 1 2 3 4
E[Ri] 15% 20% 16% 13%
i 40% 50% 30% 15%

On the basis of the generated Capital Allocation line (CAL) for each of the risky
assets, determine the investor´s optimal choice. Invest in the:
a. Risk-free asset and the first risky asset, which generates the CAL E[Rp]= rf+0.38p
b. Risk-free asset and the second risky asset, which generates the CAL E[R p]=
rf+0.40p
c. Risk-free asset and the third risky asset, which generates the CAL E[Rp]=
rf+0.37p
d. Risk-free asset and the forth risky asset, which generates the CAL [ER p]=
rf+0.53p

rm −rf
ERP = rf + · σp
σm

0´15−0´05
Asset 1 → ERP = rf + · σp → ERP = rf + 0´25σp
0´4

0´2−0´05
Asset 2 → ERP = rf + · σp → ERP = rf + 0´3σp
0´5

0´16−0´05
Asset 3 → ERP = rf + · σp → ERP = rf + 0´36σp
0´3

0´13−0´05
Asset 4 → ERP = rf + · σp → ERP = rf + 0´53σp
0´15

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T6. The CAPM model

1. Compute the beta of a stock with variance 0.022, and its covariance with the market
portfolio (index S&P500) is 0.011.
a. 0.5
b. 22.72
c. Impossible to compute.
d. None of the above.

𝐶𝑜𝑣 (𝑟𝑖 ,𝑟𝑚 )

𝛽= 2
𝜎𝑚

2. Market risk premium is 8%, and stock risk premium is 3%, then
a. The stock has a negative beta.
b. The stock has a beta lower than one.
c. The stock has a negative correlation with the market.
d. The stock has a beta equal to 2.66.

E(𝑟𝑖 ) - 𝑟𝑓 = 𝛽 ( 𝑟𝑚 - 𝑟𝑓 )
𝐸(𝑟𝑖 ) – 𝑟𝑓 3%
𝑟𝑚 – 𝑟𝑓
= 𝛽 = 8% = 0,375

3. Suppose that an investment fund holds a portfolio with three risky assets, with the
following characteristics: Asset 1: β= 0.06, and portfolio weight 23%; Asset 2: β=
1.01, and portfolio weight 37%. The returns of asset 3 have a covariance with the
return of the market of 0.0405. Considering that the standard deviation of return of
the market portfolio is 15%, compute the β of this portfolio.
a. 0.5000.
b. 0.9565.
c. 0.4655.
d. 1.1075.

𝐶𝑜𝑣 (𝑟𝑖 ,𝑟𝑚 ) 0´0405

𝛽3 = 2 = = 1´8
𝜎𝑚 0´152
𝛽𝑝 = ∑ 𝛽𝑖 · 𝑤𝑖 = 0´06 · 0´23 + 1´01 · 0´37 + 𝛽3 · 0´4 = 0´3875 + 1´8 · 0´4 = 1´1075

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4. Which of the following statements is true:

a. Under the CAPM, agents hold non-diversified portfolios, hence they demand
a risk premium which depends on the systematic risk of each asset (and not
on specific risk).
b. Under the CAPM, agents hold diversified portfolios, hence they demand a
risk premium which depends on the specific risk of each asset (and not on
systematic risk).
c. The Beta shows the sensitivity of an asset’s excess return to changes in the
market return. How much the return increases when the risk increases one
unit.
d. The Beta shows the sensitivity of an asset’s excess return to changes in the
market return. How much the return decreases when the risk increases one
unit.

5. Under the CAPM model, assume that the market expects a 10% for the company
Fedex, its Beta is 0.9, the expected market return is 8% and the return of the risk
free asset is 0.30%:

a. The price of this asset should fall in order to be correctly priced.

b. This asset is correctly priced.

c. The price of this asset should rise in order to be correctly priced.

d. None of the above.

10%
𝑟𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 = 10% 7´23%
𝑟𝐶𝐴𝑃𝑀 = 𝑟𝑓 +𝛽 (𝑟𝑚 -𝑟𝑓 )= 0´30% + 0´9 (8% - 0´3%) = 7´23% 𝑟𝑓

6. Choose the correct answer:

a. According to the CAPM, two assets with the same idiosyncratic risk have the
same expected return.

b. According to the Markowitz model all assets have a value of Beta equal to 1.

c. The slope of the SML is determined by the value of Beta.

d. According to the CAPM, the expected return is determined by the systematic

risk, which is measured by the value of Beta.

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7. Compute the stock price of Amazon given that it pays a constant and perpetual
(annual) dividend of 1.5€. The first dividend will be payable in one year. The beta of
Amazon is equal to 1.7, the annual expected market risk premium is 12.00% and the
annual expected return on the market portfolio is 13.5%.
a. It is not possible to calculate. We need to know the discount rate of similar
firms.
b. Between 6.75€ and 6.95€.
c. Between €4.7€ and 4.99€.
d. None of the above.

𝑟𝑖 = 𝑟𝑓 + 𝛽(𝑟𝑚 - 𝑟𝑓 )

𝑟𝑖 = 1´5% + 1´7 · 12% = 21´9%

𝐷1 1´5
𝑝= = = 6´849
𝑟 0´219

8. Determine the stock price of a firm that pays 1€ in t=1, growing at 5% up to infinite.
The stock beta is 1.2, the market risk premium is 9% (annual), and the risk-free rate
is 4% (annual).
a. Between 10.1 and 10.3 euros.
b. Less than 10 euros.
c. Between 10.5 and 11 euros.
d. None of the above.

1€ ↑5%1´05€ 1´0525€ ....

0 1 ∞
E(𝑟𝑖 ) = 𝑟𝑓 + 𝛽(𝑟𝑚 - 𝑟𝑓 )
E(𝑟𝑖 ) = 0´04 + 1´2 · 0´09 = 0´148

𝐷𝑖𝑣 1
𝜌0 = → 𝜌0 = = 10´2040
𝐸(𝑟𝑖 ) − 𝑔 0´148− 0´05

9. Choose the correct answer.

a. A well-diversified portfolio has a beta equal to zero.
b. A well-diversified portfolio has a beta equal to one.
c. The systematic risk of a portfolio is reduced when increasing the number of
risky assets.
d. The idiosyncratic risk of a portfolio is reduced when increasing the
number of risky assets.

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10. Choose the correct answer:

a. According to the CAPM, the expected return of a risky asset depends on its
total risk.
b. According to the CAPM, individual volatility is the only source of risk.
c. The beta measures the sensitivity of asset returns to changes in market
portfolio returns.
d. Market portfolio's volatility is always equal to 1.

11. Suppose that an investment fund holds a portfolio with three risky assets, with the
following characteristics: Asset 1: β= 0.07, and portfolio weight 25%; Asset 2: β=
1.03, and portfolio weight 35%. The returns of asset 3 have a covariance with the
return of the market of 0.0305. Considering that the standard deviation of return of
the market portfolio is 17%, compute the β of this portfolio.
a. 0.978
b. 0.897
c. 0.798
d. 1.987

Explained

12. Determine what proportion needs to be invested in Google´s shares if an investor

wishes to make a portfolio with the shares of Google and Xerox and achieve a
portfolio beta equal to 0.95. Google´s shares have a correlation with the market
portfolio equal to 0.65. The beta of Xerox is 1.7. We also know that the volatility of
the market portfolio is equal to 19%, and that the volatility of Google shares is 25%.
a. 88.79%
b. 75.32%
c. -13.27%
d. None of the above.

𝐶𝑜𝑣(𝐺, 𝑀) 𝜌𝐺,𝑚 · 𝜎𝐺 · 𝜎𝑚 0´65 · 0´25 · 0´19

𝛽𝐺 = 2
= 2
= = 0´85526
𝜎𝑚 𝜎𝑚 0´192

𝛽𝑝 = 𝑤𝐺 · 𝛽𝐺 + 𝑤𝑥 · 𝛽x
0´95 = 𝑤𝐺 · 0´85526 + (1 - 𝑤𝐺 ) · 1´7 ; 0´95 = 0´85526𝑤𝐺 + 1´7 - 1´7𝑤𝐺 ;
− 0´75
- 0´75 = - 0´84474𝑤𝐺 ; 𝑤𝐺 = ; 𝑤𝐺 = 0´887847 → 88´784%
− 0´84474

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13. Assume that the stock market index S&P500 provides an expected return of 12%.
The risk free interest rate is 1% and Microsoft´s shares have a beta equal to 0.6. The
expected return for Microsoft according to quoted prices is 10%. Under the CAPM
model these data imply:

a. The share of Microsoft is overvalued. There are arbitrage opportunities.

b. The share of Microsoft is undervalued. There are arbitrage opportunities.
c. The share of Microsoft is correctly valued. There are no arbitrage
opportunities.
d. This question cannot be replied due to data.
Similar to exercise 5

14. Which of the following sentences regarding the SML (Securities Market Line) and the
CML (Capital Market Line) is correct?
a. The slope of the SML is the Beta and the slope of the CML is the Sharpe Ratio
of the Market Portfolio.
b. The CML with lowest slope generates the most efficient investment
opportunity set in the expected return volatility space.
c. The slope of the SML is the market risk premium and the slope of the CML
is the Sharpe Ratio of the Market Portfolio.
d. The SML is introduced in the Markowitz´s model.

15. The CAPM beta measures:

a. The systematic risk of an asset
b. The specific risk of a given asset
c. The total risk of an asset
d. None of the above.

16. Determine the beta of a portfolio made of 3 assets that invests 40% in Telefónica
Shares 25% in BBVA shares and the remaining in the risk free asset. The beta of
Telefonica shares is 1.2, and the beta BBVA shares is 1.6.
a. Between 1.1 and 1.2
b. Between 0.93 and 0.95
c. Between 0.85 and 0.91
d. None of the above

𝛽 = 0´40 · 1´2 + 0´25 · 1´6 + 0´35 · 0 = 0´88

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17. According to the CAPM, if the beta of the Apple stock is equal to 1, then
a. On average, the returns generated by Apple must replicate those generated
by the S&P500 index.
b. The Apple stock replicates the returns of the diversified portfolio, also named
market portfolio.
c. The idiosyncratic risk of the stock of Apple is high.
d. A and b are correct.

18. The S&P500 index gives an expected return of 12%. The risk-free asset is 1%, and the
stock of Apple has a beta coefficient equal to 1. However, the stock of Apple offers
an expected return of 10% in the market. Under the CAPM, this implies,
a. The stock of Apple is overvalued. There are arbitrage opportunities.
b. The stock of Apple is undervalued. There exist arbitrage opportunities.
c. The stock of Apple is correctly priced. There are not arbitrage opportunites.
d. Impossible to answer. We need more data.
Similar to 5

19. Determine the proportion to be invested in IBM shares if one wants to buy a
portfolio with a beta equal to 0.7, given that you can invest in shares of IBM and GE.
IBM has a correlation of 0.0034, with the market portfolio and the beta of GE shares
is 1.2. We also know that the volatility of the market portfolio and IBM are 15% and
20% respectively.
a. 75%
b. 25%
c. 13%
d. None of the above.
Similar done

20. Find under the CAPM the expected return of a portfolio of shares that has a
correlation with the market portfolio of 0.5 and a market variance of 0.44. If the
market risk premium is 10%, the risk free rate is 1% and the volatility of the shares
portfolio is 15%.
a. Between 0.5% and 1%
b. Between 2 and 2.6%
c. Between 3 and 3.9%
d. None of the above

E(𝑟𝑖 ) = 𝑟𝑓 + 𝛽(𝑟𝑚 - 𝑟𝑓 ) = 0´01 + 0´1130 · 0´1 = 0´0213 → 2´13%

𝐶𝑜𝑣𝐴,𝑚 0´04974
𝛽= 2 = = 0´1130
𝜎𝑚 0´44

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21. Which of the next statements relating to the SML (securities market line) and the
CML (capital markets line) is TRUE?
a. The slope of the SML is the beta and the slope of the CML is the Sharpe ratio
of the market portfolio.
b. Because it measures systematic risk, the SML only applies to portfolios and
not individual shares.
c. The CML can have negative slope while the SML cannot.
d. The slope of the SML is the market risk Premium and the slope of the CML
is the Sharpe ratio of the market portfolio (of the portfolio!!)

22. An investor holds a portfolio made of two assets, assets A and B. The beta of asset A
is 0.7 and the beta of asset B is 1.5. The investor wants to build a portfolio with a
beta equal to 0.3. What weight should be allocated to asset A to construct the
desired portfolio?
a. -0.5
b. 0.9
c. 1.5
d. -1.1

𝛽𝑝 = 𝛽𝐴 · 𝑤𝐴 + 𝛽𝐵 · 𝑤𝐵 = 𝛽𝐴 · 𝑤𝐴 + 𝛽𝐵 · (1 - 𝑤𝐴 )

− 1´2
0´3 = 0´7𝑤𝐴 + 1´5 (1 - 𝑤𝐴 ) ; 0´3 - 1´5 = 0´7𝑤𝐴 - 1´5𝑤𝐴 ; 𝑤𝐴 = ; 𝑤𝐴 = 1´5
− 0´8
→150%

23. Once the desired portfolio with beta 0.3 is constructed, the investor decides to invest
50% of her wealth in cash, and the remainder 50% in the portfolio. What is the final
beta of her investment?
a. 0.15
b. 1.30
c. 0.30
d. 0.45

𝛽𝑝 = 𝛽𝑀 · 𝑤𝑀 + 𝛽𝐶 · 𝑤𝐶 =0,3*0,5 = 0,15

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24. By definition, on the Capital Market Line (CML) are placed,

a. All investors' portfolios that combine risk-free asset and any risky portfolio.

b. All investors' portfolios that combine market portfolio and risk-free asset.

c. All stocks that are correctly priced according their beta.

d. None of the above.

25. A given portfolio has a beta equal to 0.6 and expected return 7%. The portfolio is
composed by two subportfolios, a fixed income portfolio with beta 0,2 and an
equity portfolio with beta 0,9. what percentage of the portfolio is invested in the
equity subportfolio?

a. 27,24%

b. 32,58%

c. 57,14%

d. 62,42%

𝛽𝑝 = 𝛽𝐹 · 𝑤𝐹 + 𝛽𝐸 · 𝑤𝐸 = 𝛽𝐹 · (1-𝑤𝐸 ) + 𝛽𝐸 · 𝑤𝐸 => 0,6=0,2 ∗ (1 − 𝑤𝐸 ) + 0,6 ∗ 𝑤𝐸 =>0,57

26. According to the market, a given stock has an annual return of 10%. The market
portfolio has an annual return of 8%, and the stock's beta is 2.0. The risk-free rate
is 2% (annual). According to the CAPM, this stock is
a. Overpriced.
b. Underpriced.
c. Correctly priced.
d. There is no enough data to say anything about it.

Done (r CAPM 14<10)

27. A fixed income instrument has a given beta. This beta measures,
a. Systematic risk.
b. Specific risk.
c. Total risk.
d. None of the above. There is no beta for fixed income instruments.

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28. Compute the beta of this portfolio (weights in parenthesis): Telefónica (25%), BBVA
(40%), and the rest in risk-free rate. Telefónica's beta is 1.2, and BBVA is 1.6.
a. Between 1.10 and 1.20.
b. Between 0.93 and 0.95.
c. Less than 0.90.
d. None of the above.

Similar done

29. Choose the correct answers:

a. An assumption of CAPM is the absence of information asymmetries
between investors.
b. CAPM model assume that there are transaction costs.
c. Markowitz's model shows that assets with higher systematic risk provide
higher returns.
d. Short-selling is banned within the Markowitz's model.

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T7. Fixed income.

1. Determine the correct answer.

a. A defensive stock will have a beta equal to 1.

b. The bond beta is always equal to zero.
c. The bond duration measures the probability of default.
d. The duration of a bond portfolio rises if the weight of the bond with
greatest duration rises.

2. Compute the duration of a 3-year bond, annual coupon rate of 6%, 4% interest rate
and face value equal to 1,000€. Repayment is at par:
a. 2.72 years.
b. 2.84 years.
c. 3.00 years.
d. 3.60 years.

60 60 1.060
P0 = + + =
1+0´04 (1+0´04)2 (1+0´04)3
= 57´6923 + 55´4733 + 942´3361 = 1.055´5017
1 60 60 1.060
D=
1.055´5
(1 · 1+0´04
+ 2·
(1+0´04)2
+3·
(1+0´04)3
)=
= 0´000947418 (57´6923 + 110´9467 + 2.827´0084) = 2´8381

How to remember the formula:

𝐷 = 𝑤1 ∗ 𝑦𝑒𝑎𝑟1 + 𝑤2 ∗ 𝑦𝑒𝑎𝑟2 + 𝑤3 ∗ 𝑦𝑒𝑎𝑟3

𝑃𝑉1 𝑃𝑉2 𝑃𝑉3

𝐷= ∗ 𝑦𝑒𝑎𝑟1 + ∗ 𝑦𝑒𝑎𝑟2 + ∗ 𝑦𝑒𝑎𝑟3
𝑃 𝑃 𝑃
1
𝐷 = ∗ (𝑃𝑉1 ∗ 𝑦𝑒𝑎𝑟1 + 𝑃𝑉2 ∗ 𝑦𝑒𝑎𝑟2 + 𝑃𝑉3 ∗ 𝑦𝑒𝑎𝑟3)
𝑃

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3. You read in a newspaper the following information about the prices of different zero-
coupon Spanish Treasury bonds:
Quoted Price in the
Face Value Secondary Market Maturity (years)
1000 990 1
1000 965 2
1000 945 3
1000 910 4
1000 875 5
1000 770 6
According to this information, what is the correct yield curve?

Answer r1 r2 r3 r4 r5 r6
a. 1.23% 1.79% 1.90% 2.38% 2.70% 5.10%
b. 1.01% 1.79% 1.90% 2.83% 3.71% 4.45%
c. 1.01% 1.79% 1.90% 2.38% 2.70% 4.45%
d. 1.01% 1.92% 2.10% 2.83% 3.71% 5.10%

1
1.000 1 1.000 4
Bond 1: ( ) - 1 = 0´0101 x 100 = 1´01%; Bond 4: ( ) - 1 = 0´0238 x 100 = 2´38%
990 910

1 1
1.000 2 1.000 5
Bond 2: ( ) -1= 0´0179 x 100 = 1´79%; Bond 5: ( ) - 1 = 0´0270 x 100 = 2´70%
965 875
1 1
1.000 3 1.000 6
Bond 3: ( ) - 1 = 0´0190 x 100 = 1´90%; Bond d: ( ) - 1 = 0´0445 x 100 = 4´45%
945 770

4. Which of the following statements is false:

a. Fixed income securities are securities that promise their holders the future
payment of predetermined cashflows up to their maturity date.
b. Fixed income securities are securities that promise their holders the future
payment of predetermined constant cashflows up to their maturity date.
c. The value of the bond is equal to the sum of the discounted cash-flows which
are promised, at time 0.
d. The duration of a zero coupon bond is always equal to the time from period
0 to the maturity date of the bond.

5. Compute the modified duration of a 4-year bond, annual coupon rate of 5%, 3%
interest rate and face value equal to 1,000€: --
a. 3.63 years.
b. 3.73 years.
c. 1,074.34€.
d. 50.00€.

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50 50 50 1.050
P0 = + + + = 1.074´3€
1+0´03 (1+0´03)2 (1+0´03)3 (1+0´03)4
= 48´54368932 + 47´12979546 + 45´75708297 + 932´9114003 = 1.074´3€
1 50 50 50 1.050
D=
1.074´342
(1 · 1+0´03
+ 2·
(1+0´03)2
+3·
(1+0´03)3
+4·
(1+0´03)4
)=
= 0´0009308 (1 · 48´54368932 + 2 · 47´12979546 + 3 · 45´75708297 + 4 · 932´9114) =
= 0´0009308 (48´54368932 + 94´25959092 + 137´2712489 + 3.713´645601) =
= 0´0009308 (3.993´72013) = 3´717years

6. A four year Spanish Treasury bond pays an annual coupon of 5% (always at the end
of each period). The spot interest rates from year 1 to 4 are 2%, 3%, 4% and 5%,
respectively. The face value of the bond is 1,000€, and the bond amortization at
maturity is 120% of its face value. Calculate the price of the bond today.
a. 1168.98€.
b. 1437.14€.
c. 1440€.
d. None of the above.

2% 3% 4% 5%

t0 t1 t2 t3 t4
50 50 50 50 50+ 1000 + 200
50 50 50 1.250
P0 = + + + =
1+0´02 (1+0´03)2 (1+0´04)3 (1+0´05)4

= 49´01960784+ 47´12979546 + 44´44981793 + 1.028´378093 = 1.168´977315

7. A twenty year Spanish Treasury bond gives an annual coupon of 3% (always at the
end of each period). The annual interest rate expected in the market next twenty
years is 3%. The face value of the bond is 1,000€, and the repayment (amortization)
is at par. Calculate the price of the bond today.
a. 1,000€.
b. 1,600€.
c. 500€.
d. 750€.

1−(1+0´03)−20 1.000
P0 = 30 · ( )+
(1+0´03)20
= 446´3242458 + 553´6757542 = 1.000
0´03

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8. We know that 0R1=0.03, 0R2=0.04 and 0R3=0.05. Calculate the expected forward
interest rate for the period between years 1 and 3.
a. 4.459%.
b. 6.01%.
c. 5.50%.
d. 4.00%.
(1 + R 3 )3 = (1 + R1 ) (1 + 0F1,3 )2

1´053 = (1´03) (1 + F1,3 )2

1
1,053 2
F1,3 =( ) − 1 = 0,060145
1,03

9. You read in a newspaper the following information about the prices of different zero-
coupon Spanish Treasury bonds:--
Quoted Price in the
Face Value Secondary Market Maturity (years)
1000 985 1
1000 965 2
1000 945 3
1000 930 4
1000 875 5
1000 760 6
According to this information, what is the correct yield curve?

Answer r1 r2 r3 r4 r5 r6
a. 4,68% 2,71% 1,83% 1,90% 1,80% 1,52%
b. 2,52% 2,80% 2,90% 2,83% 3,71% 5,68%
c. 1,52% 1,80% 1,90% 1,83% 2,71% 4,68%
d. 1,52% 1,80% 1,83% 1,90% 4,68% 2,71%

10. Compute the duration of a 4-year bond, annual coupon rate of 7%, 5% interest rate
and face value equal to 1,000€:--
a. 4.12 years.
b. 3.84 years.
c. 3.94 years.
d. 3.64 years.
5% 5% 5% 5%

t0 t1 t2 t3 t4
70 70 70 70 + 1000
1−(1+0´05)−4 1.000
P0 = 70 · ( ) + (1+0´05)4 = 248´2165353 + 822´7024748 = 1.070´9190€
0´05
1 70 70 70 1.070
D=
1.070´919
(1 · 1+0´05
+ 2·
(1+0´05)2
+3·
(1+0´05)3
+4·
(1+0´05)4
)=
= 3´638años

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11. You read in a newspaper the following information about the prices of different zero-
coupon Spanish Treasury bonds:--

Quoted Price in the

Face Value Secondary Market Maturity (years)
1000 990 1
1000 965 2
1000 945 3
1000 910 4
1000 875 5
1000 770 6

The yield curve is:

a. b.

c. d.
1
1.000 1 1.000 4
Bond 1: ( ) - 1 = 0´0101 x 100 = 1´01% ; Bond 4: ( ) - 1 = 0´0238 x 100 =
990 910
2´38%

1 1
1.000 2 1.000 5
Bond 2: ( ) - 1 = 0´0179 x 100 = 1´79% ; Bond 5: ( ) - 1 = 0´0270 x 100 =
965 875
2´70%

1 1
1.000 3 1.000 6
Bond 3: ( ) - 1 = 0´0190 x 100 = 1´90% ; Bond 6: ( 770 ) - 1 = 0´0445 x 100 =
945

4´45%
Sol. a.

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12. The Spanish Treasury has issued today a zero coupon bond with three years
maturity. The bond provides a return of 1.08%, calculate the proportional change of
its price if the ECB decreases interest rates by 0.25%.
a. Its price will increase by 0.33%.
b. Its price will decrease by 0.33%.
c. Its price will increase by 0.74%.
d. None of the above.

D=3 => Dm =3/1,0108 = 2´99

∆p
= -Dm · ∆𝑌 = -2´99 · (-0´25) = 0´74
p

13. Consider the following term structure of interest rates. R1 = 8.75%; R2 = 7.75%; R3 =
6.48%; R4 = 5.25%. Calculate the forward implicit rate for a two year loan that starts
in one year (0F1,3).--
a. Between 3.05% and 3.15%.
b. Between 4.60% and 4.70%.
c. Between 5.25% and 5.45%.
d. None of the above.

(1 + R 3 )3 = (1 + R1 ) (1 + 0F1,3 )2

1´06483 = (1´0875) (1 + F1,3 )2

1
1,06483 2
F1,3 =( ) − 1 = 0,05363
1,0875

14. Calculate the Price of a bond issued by Telefonica that has 3 years maturity, and pays
an annual coupon equal to 5%. The nominal value of the bond is €1,000 euros. The
term structure of interest rates is flat, and the annual risk free interest rate is 1% for
all maturities. The credit rating of Telefonica Bonds is BBB+, which implies a risk
Premium of 1% (annual) for all maturities.
a. €1086.52, approximately.
b. €975.62, approximately.
c. €1190.72, approximately
d. €871.21 , approximately

Discount factor = YTM=Rf+ spread= 0,01+ 0,01=0,02

50 50 50+1000
ALTERNATIVE 1: P0 = + + =
1+0´02 (1+0´02)2 (1+0´02)3

= 49´01960784 + 48´05843906 + 989´4384513 = 1086´5164€

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1−(1+0´02)−3 1.000
ALTERNATIVE 2: P0 = 50 · ( ) + (1+0´02)3 = 144´1941636 + 942´3223345
0´02
= 1.086´5164€

15. If the two year spot interest rate is 2.5% and the three year interest rate is 1.66%.
Who would get higher final return, an investor that invests in two year maturity risk
free bonds or investor that invests in in three year risk free bonds?
a. The investor that invests in two year bonds gets higher returns.
b. The investor that invests in three year bonds gets higher returns
c. They would both get the same.
d. None of the above

𝐹𝑉= 1.000(1 + 0´025)2 = 1.050´625€ in 2 years.

𝐹𝑉 = 1.000(1 + 0´0166)3 = 1.050´631€ in 3 years.

16. Indicate the INCORRECT answer:

a. Interest rate risk refers to the possibility that the value of a fixed income
portfolio decreases with an increase of the market interest rate.
b. The lower is the interest rate, the higher is the price of the bond.
c. The higher is the credit rating of a company, the higher is the return offered
by its bonds.
d. Credit risk refers to the possibility that a bond issuer does not fulfill its
payment obligations

17. Given the following term structure of interest rates,

Maturity (years) 1 2 3 4 5
Spot interest rate 3,5% 4,5% 5,0% 5,4% 5,75%

Compute the forward interest rate from year t=1 to year t=3 (0f1,3), and the forward
interest rate from year t=4 to year t=5 (0f4,5), respectively,
a. 0f1,3=5.76%; 0f4,5= 7.16%
b. 0f1,3= 5.00%; 0f4,5= 6.54%
c. 0f1,3= 4.54%; 0f4,5= 9.32%
d. None of the above.
(1 + R 3 ) = (1 + R1 ) (1 + 0F1,3 )2
3

1´053 = (1´035) (1 + F1,3 )2

1
1,053 2
F1,3 =( ) − 1 = 0,057581
1,035

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(1 + R 5 )5 = (1 + R 4 )4 (1 + 0F4,5 )1

1
1,05755
F4,5 =( ) − 1 = 0,071616
1,0544

18. Compute the price of zero-coupon bond issued by the Spanish Treasury, with
maturity 1 year, face value 1000 euros and repayment value at par. The credit rating
of the bond is BBB, implying that this bond pays a spread of 300 basis points (1 basis
point = 0.01%) over the risk-free rate. Assume that the (annual) risk-free rate is 1%.
--
a. The price of the bond is 978.39 euros.
b. The price of the bond is 961.54 euros.
c. The price of the bond is 1001.23 euros.
d. The price of the bond is 990.10 euros.

YTM= rf+ spread= 1%+3%

1.000
P0 = = 961´5384€
1+0´04

19. Today is January 1st, 2012. Compute the duration of a Treasury bond with coupon
5.5%, maturity January 1st, 2015, with amortization at par, and price 986.63 euros.
The IRR (YTM, discount rate) of this bond is 6%. FV 1000--

a. Between 2.1 and 2.3 years.

b. Between 2.4 and 2.6 years.

c. Between 2.7 and 2.9 years.

d. None of the above.

1 55 55 1055
D=
986´63
(1 · 1+0´06
+ 2·
(1+0´06)2
+3·
(1+0´06)3
) = 2´845222051

𝐷 = 𝑤1 ∗ 𝑦𝑒𝑎𝑟1 + 𝑤2 ∗ 𝑦𝑒𝑎𝑟2 + 𝑤3 ∗ 𝑦𝑒𝑎𝑟3

𝑃𝑉1 𝑃𝑉2 𝑃𝑉3

𝐷= ∗ 𝑦𝑒𝑎𝑟1 + ∗ 𝑦𝑒𝑎𝑟2 + ∗ 𝑦𝑒𝑎𝑟3
𝑃 𝑃 𝑃

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20. Spot interest rates for 1, 2 and 3 years are, respectively, 4.5%, 4.0% and 3.8%. The
liquidity premium is 1.2%, and the inflation risk premium is 0.5%. What is the
expected spot rate of 1-year in one-year ahead?

a. 4.8%

b. 4.0%

c. 3.5%

d. 1.8%

1
(1+0´04)2 1
0F1,2 = ( ) - 1 = 0´0350 → 3´5%
(1+0´045)

0F1,2 = E0 [1R1 ] + Liquidity + Inflation risk ; 3´5 = E0 [1R1 ] + 1´2 + 0´5 ;

E0 [1R1 ] = 3´5 - 1´7 = 1´8%

21. Interest rate risk is,

a. Those changes in bond prices due to changes in the crediworthiness that

affect the total value of the bond portfolio.

b. It is negatively correlated with the bond portfolio's volatility.

c. It does not affect to the investor that unwinds her positions before
maturity of the bond portfolio.

d. It can be mitigated by creating a portfolio with duration equal to the

time horizon of the investor.

22. Select the correct answer.

a. The higher the bond's maturity, the lower its duration is.
b. The lower the duration, the higher the bond's price sensitivity to interest
rate changes.
c. The higher the coupons, the lower the bond's duration is.
d. The higher the interest rate, the higher the bond's duration is.

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23. Your portfolio is composed by two bonds: (i) Bond A, coupon 2%, with an
amortization premium of 10%, with 2 years until maturity, price EUR 1,054.73 and
duration 1.981 years; ii) a zero-coupon bond with 4 years until maturity. The face
value of those bonds is EUR 1000, and the term structure is flat and equal to 4%.
Compute the percentage change in portfolio's value when interest rates increase a
1%. The bond's portfolio is equally weighted.

a. Portfolio's value decrease in 2.77%.

b. Portfolio's value increase in 2.77%.

c. Portfolio's value decrease in 2.12%.

d. Portfolio's value increase in 2.12%.

∆P
= -DM · ∆Y =-2,875*1%=-2,875%
P
D 1´981
DMA = = = 1´904807692
1+Y (1+0´04)

4
DMB = = 3´846153846
(1+0´04)

𝐷𝑀𝐴 +𝐷𝑀𝐵
DMP = 2
=2,875

24. Today is April 15th, 2012, and we would like to buy a Spanish Treasury bond with
face value EUR 1000 and maturity December 31st, 2013. This bond pays a 3% coupon
(annual). What is the accrued interest to pay?

a. EUR 30.00

b. EUR 12.25

c. EUR 8.75

d. None of the above.

3´5
P0 = 1.000 · 0´03 · = 8´75€
12

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25. Compute the modified duration of this portfolio:

Asset Weigth Features

Bond 1 30% Strip (zero-coupon) with maturity 5-year

Bond 2 40% Annual coupon: 5%. Maturity: 3 years. Current price:

EUR 950. Face value: EUR 1000.

Bond 3 30% Strip (zero –coupon) with maturity 25 years and 6

months. > 25,5 years

Interest rate curve is flat and equal to 6.9%.

a. Duration: between 10.2 and 10.5 years.

b. Duration: between 9.9 and 10.1 years.
c. Superior to 10.9 years.
d. None of the above.

D 5
DM1 = = = 4´68
1+Y (1+0´069)
1 1 50 50 1000+50
DM2 =
(1+0´069)
∗ ∗( ∗ 1 + (1+0,069)2 ∗ 2 + (1+0,069)3 ∗ 3) = 2´67
950 1+0,069

25´5
DM3 = = 23´85
(1+0´069)

𝐷𝑀𝑃 = 4´68 ∗ 0,3 + 2´67 ∗ 0,4 + 23´85 ∗ 0,3

𝐷𝑃 = 𝐷𝑀𝑃 ∗ (1 + 𝑌) = 10,4 ∗ +1,069 = 11,12 years

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T8. Derivatives.

1. A call option sells for €12 and a put option sells for €8. Both options expire in one
year and the underlying are shares of firm X. The strike price of both options is €33.
What is the value of a long position of a future contract with future price K = 33, and
written on the same asset?
a. The price of the future contract is €-4.
b. The price of the future contract is €+4.
c. The price of the future contract is €+21.
d. The price of the future contract is €+25.

To remember
Call + Rf Asset= Spot + Put
Future/forward = Spot – Rf Asset
 Call – Put = Spot – Rf = Future/Forward

Ct + E(1 + rf )^(−(T-t)) = Pt + St
12-8= St - E(1 + rf ) ^(−(T-t)) =Forward/Future=+4€

2. The current price of a stock is $14, the annual effective risk-free rate is 6% and the
stock does not pay dividends. You want to sign today a 2-year forward contract on
the stock. What would be the future price K fixed in the contract?
a. K is equal to $14.84
b. K is equal to $12.45
c. K is equal to $15.73
d. None of the above

0 = s0 −K(1 + rf )^(-T)
0=14-K(1+6%)^(-2)K=14*1.1236=15.7304

3. The put-call parity defines an equilibrium relationship between the price of call and
a put option when both options:
a. Have the same underlying asset, exercise price but different expiration date.
b. Have the same underlying asset, different exercise price and the same
expiration date.
c. Have the same underlying asset, exercise price and expiration date.
d. Have the same or different underlying asset, but the same exercise price and
expiration date.

4. The quoted price of shares of company GAME TECHNOLOGY is 29$ today. The price
of a call option on the same share is 8$, with a strike of 33$. The price of a put option
on the same share is 12$, with a strike of 33$. If the call and the put have the same

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expiration date, the face value and repayment of a bond with the same expiration
date is 33$, with a price of 28$, which of the following statements is true (only one).
a. Put-call parity holds.
b. Put-call parity doesn’t hold. Then the investment strategy to follow is to buy
the stock and the put, to sell the call and short sell the bond.
c. Put-call parity doesn’t hold. Then the investment strategy to follow is to buy
the call, buy the bond, buy the put and short sell the share.
d. Put-call parity doesn’t hold. Then the investment strategy to follow is to
buy the call, buy the bond, sell the put and short sell the share.

Ct + E(1 + rf )^(−(T-t)) = Pt + St T8 pag 28

8+ 28 <> 12+29
Cheap Expensive

5. The following investment strategy consists of:

a. Sell a put option with a price of 20, buy a call option with a price of 20. The
same underlying asset, the same expiration date and the same strike of 100.
b. Buy a put option with a price of 20, buy a call option with a price of 20. The
same underlying asset, the same expiration date and the same strike of 100.
c. Buy a put option with a price of 20, sell a call option with a price of 20. The
same underlying asset, the same expiration date and the same strike of 100.
d. Sell a put option with a price of 20, sell a call option with a price of 20. The
same underlying asset, the same expiration date and the same strike of 100.

6. Compute the price difference between a call and a put option on the same stock.
The strike price of both options is $40. The stock price is $50, and the (annual) risk-
free rate is 2.35%. The maturity of the options is 1 year.
a. 10.91$.
b. 11.90$.

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c. 50.01$.
d. 9.34$.

Ct + E(1 + rf )^(−(T-t)) = Pt + St

Ct - Pt = St - E(1 + rf )^(−(T-t))

50-40*(1+2.35%)^(-1)=10.918

7. A farmer is worried about the price of wheat in the future. The average price of
wheat during last years has been of 30$/ton. There has been mild weather during
past winter so the crop is expected to surpass all expectations, and the farmer
expects a drop in price. Which of the following strategies is the best one to hedge
against a drop in wheat prices?
a. Short forward with forward price (K) $30.
b. Long forward with forward price (K) $30.
c. Short put option with strike price $30.
d. Long call option with strike price $30.

8. The current price of a stock is $12, the annual effective risk-free rate is 5% and the
stock does not pay dividends. You want to sign today a 1-year forward contract on
the stock. What would be the future price K fixed in the contract?
a. K is equal to $12.6
b. K is equal to $15.7
c. K is equal to $12.0
d. None of the above

0 = s0 −K(1 + rf )^(-T)
0=12-K(1+5%)^(-1)K=12.6

9. Provide the correct answer. The valuation of derivatives is based on two underlying
principles:
a. Replication of portfolio returns and subsequent return risk minimization.
b. The CAPM model and the existence of arbitrage opportunities.
c. Risk minimizing and return maximizing principles.
d. Portfolio replication and the absence of arbitrage opportunities.

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10. Which of the following strategies is similar to a long position in a forward for a given
strike price E and written under a given underlying asset St?

a. Long call position + short put position (if both are written under same
underlying asset as the forward St and have also the same strike (E) and
maturity (T) as the forward).
b. Long call position + long put position (if both are written under same
underlying asset as the forward St and have also the same strike (E) and
maturity (T) as the forward).
c. Long call position + short put position (if both are written under same
underlying asset as the forward St and have also different strike (E) and
maturity (T) than the forward).
d. This question cannot be replied using options.

11. The following diagram presents:

a. Payoffs at maturity T generated by a long position in a call with strike 120 and a
short position in a put written on the same underlying asset St and with the same
strike 120.
b. Payoffs at maturity T generated by a long position in zero coupon bond with
nominal value 100 and a long position in a forward with maturity T written on a
share with strike price 100.
c. The payoffs generated at maturity T for a given long position in a zero coupon
bond with nominal value 100 and a long position in a call with strike price 120
and maturity T.
d. Payoffs generated at T by a simultaneous long position in a call y and put
written on the same underlying asset St and with the same maturity T with a
strike price 100.

12. Mark the correct answer.

a. An American option can only be exercised at maturity.
b. In a forward contract, one party has the obligation to buy (sell) at a
predetermined price, and the other has the option to sell (buy) the asset.

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c. If fan option is “in-the-money”, the investor would loose money if he

exercised the option today.
d. While futures contracts are standardized, forward contracts are not.

13. You have to buy 20 tons of aluminum in 6 months. You care about the rising prices
of aluminum, so you contract a future. Each future contract on aluminum with
maturity 6 monts has a fixed amount of 5 tons. Determine your position in
aluminium futures.

a. Short 20 futures contracts.

b. Long 4 futures contracts.
c. Short 5 futures contracts.
d. None of the above.

14. The shares of the firm Y are trading with a price equal to €26. One year interest rates
are at 5%. Call and put options written on the share Y trade with exercise price equal
to €23 and with one year maturity. Assuming that there are no arbitrage
opportunities mark the correct answer.

a. The call option is more expensive than the put.

b. The put option is more expensive than the call.
c. The call and the put are trading with the same price.
d. One cannot answer this question with the data provided.

Ct + E(1 + rf )^(−(T-t)) = Pt + St T8 pag 28

Ct+23*(1+5%)^(-1)=Pt+26

Ct+21.905=Pt+26

Ct=Pt+4.09Ct>Pt

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15. Mark the correct answer:

a. The payoff of a long position (buy) in a forward contract on Apple with
exercise price 400 at time T can be replicated by a portfolio consisting on a
long position of the stock of Apple and a short position of a zero coupon bond
with maturity T and face value 400.
b. The payoff of a forward contract on Apple with exercise price 400 at time T
can be replicated by a portfolio consisting on a long position on the stock of
Apple and a long position of a zero coupon bond with maturity T and face
value 400.
c. The payoff of a long position of a forward contract on Apple with exercise
price 400 at time T can be replicated by a portfolio consisting on a long
position in a call option on the stock of Apple with maturity T and exercise
price 400, and a short position on a put option on the stock of Apple with
maturity T and exercise price 400.
d. a and c are correct.

16. The stocks of Google are traded at $700. A zero coupon bond issued by the US
treasury with maturity 6 months and face value $1000 is quoted at 990$. The price
of exercise (K) of a forward contract with maturity 6 months on Google stock at the
moment of inception of the contract is,
a. Between €710.05 and €712.5
b. €698.00
c. €700.18
d. None of the above

0 = s0 −K(1 + rf )^(-T)
Rf990=1000/(1+rf)^0.5rf=2.03%
0=700-K(1+2.03%)^(-0.5)K=707.07

17. The manager of American Airlines is worried about a possible increase in crude oil
price volatility. Under this scenario the uncertainty regarding operational costs of
the firm would rise. What strategy with options must American Airlines follow to be
hedged against this possibility?
a. Buy a straddle written on crude oil.
b. Buy put options on the oil crude.
c. Sell call options on the oil crude.
d. Sell a future contract on the oil crude.

18. Select the correct answer:

a. The lower is the option maturity the higher is the CALL price
b. The lower is the option maturity the higher is the PUT price
c. The lower is the volatility of the underlying asset, the higher is the CALL price
d. The higher the volatility of the underlying asset the higher is the CALL price.

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19. Derivatives are priced:

a. Under the requirement of no arbitrage opportunities and the existence

of replicating portfolio (using the underlying asset and the risk free
asset)
b. Using the futures market to replicate the Price of the underlying asset.
c. a and b are correct
d. None of the above

20. Market risk:

a. Can be transferred by means of derivatives.

b. It does not exist in a well-diversified portfolio.
c. Both are true.
d. Both are false.

21. The 1-year risk-free rate is 5%, and stock price of firm Y is EUR 26.00. Assuming that
exists a call and put options written on Y, with strike (K) EUR 23.00 and maturity 1
year. The price of the call (put) option is EUR 5.24 (1.25). Then,

a. Call option is cheap (5.24<5.34). There is an arbitrage by buying call,

shorting put, and short-selling the stock.
b. Call option is cheap (5.24<5.34). There is an arbitrage by shorting call, longing
put and longing the stocks.
c. Put option is cheap (1.25<1.74). There is an arbitrage by longing call, shorting
put, and short-selling the stocks.
d. There is no arbitrage opportunities in this exercise.

Ct + E(1 + rf )^(−(T-t)) = Pt + St
5.24+23*(1+5%)^(-1) ?=1.25+26
5.24+21.904 ?= 1.25+26
5.24 (cheap) <5.345 (expensive)

22. Euribor 6-month is 2.75% (annual), and the future price (K) of a future contract on
Repsol stocks is EUR 7.00, with maturity 6 months, compute the stock price of Repsol
in this moment.

a. EUR 6.9.
b. EUR 6.2.
c. EUR 5.7.
d. EUR 5.3.

0 = s0 −K(1 + rf )^(-T)
0=s0-7*(1+2.75%)^(-0.5)s0=6.9057

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23. This graph depicts,

Pagos Estrategia
(Vencimiento)

a. The payoffs of a portfolio composed by a short call option with strike K, and
a short put option with strike K.
b. The payoffs of a portfolio that expects a low volatility of the underlying.
c. Both are true.
d. Both are false.

24. In January 1st, 2009, the stock price of Repsol was EUR 16.75 euros. The price of a
forward contract for 250 stocks of Repsol with maturity 3 months was EUR 16.9.
Calculate the risk-free rate.

a. 2.56%
b. 3.63%
c. 4.23%
d. None of the above.

0 = s0 −K(1 + rf )^(-T)
0=16.75-16.9*(1+r3months)^(-1/4)r3months=3,63%

25. Derivatives are priced:

a. Using a replicating portfolio.

b. By impossing non-arbitrage conditions between the derivative and the
replicating portfolio.
c. Both are true.
d. Both are false.

26. According to the put-call parity, the put price will increase when,
a. The strike price decreases.

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b. The strike price increases.

c. The strike price does not affects to the option price.
d. None of the above.

Ct + E(1 + rf )^(−(T-t)) = Pt + St

Ct -Pt = St -E(1 + rf )^(−(T-t))

E = price strike

27. Identify the arbitrage opportunity. The risk-free rate is 5% annual.

a. A future contract is priced EUR 18. Its underlying quotes EUR 90, and the
future price (K) is EUR 75.6. There is one-year left to maturity of the
future.
b. The price of a call option is EUR 9 euros. The price of the underlying is
EUR 9.77, and the strike of the option is EUR 5. Another put option on
the same underlying is priced EUR 3.00. The maturity of the options is
1-year.
c. None of the above.
d. A and b are both true.

a. 90-75.6 / (1+5%) ? = 18

18=18 No hay arbitraje

b. Ct + E(1 + rf )^(−(T-t)) = Pt + St

9+5*(1+5%)^(-1)?=3+9.7713.76>12.77

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