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Assignment 1 is due Sunday 2nd September and contributes 25% to the assessment of this course.
INSTRUCTIONS
Please up load one (and one only) either word or pdf file. For the excel sections please just take screen
shots of your work to show some of your workings then cut and paste into your document. For the maths
sections, if you prefer you can hand write and scan and also add to word doc.
QUESTION 1
Suppose you would like to model various financial processes and are trying to determine the appropriate mathematical
functions to use. Please name and write down the general form of the equation for the most appropriate mathematical
function in each of these situations.
(a) A time series process where the dependent variable changes by a constant absolute amount each period.
(b) A time series process where the dependent variable changes by a constant percentage amount each period.
(c) A situation where there is a constant elasticity relationship between the dependent and independent variables.
(d) For your answers in parts (b) and (c), write down the general forms of these functions using logarithms.
(2 marks)
QUESTION 2
(a) Calculate both the average discrete and average continuous monthly returns for the following dividend adjusted
share price and market index.
Share Price Market Index
Date Rit Rmt.
August-17 $1.55 1,175.00
September-17 $2.10 1,200.00
October-17 $2.45 1,305.00
November-17 $2.85 1,505.00
(b) Has this share under or over performed relative to the market?
(c) Suppose this share has a beta of 1.9 (i = 1.9) and the annual risk free rate is 0.02. Would you invest? 1
(1.5 marks)
QUESTION 3
For the following functions:
2
0 = 200x - 10x + 350
2
0 = 2x +20x + 5
2
0 = 6x + 5x - 20
(a) What are their discriminates?
(b) What is the significance of these discriminates?
(c) Complete the square and thereby solve for x for these equations (please do this both by hand and using the
excel solver, excel instructions are on the following page).
(d) Use excel to graph these functions.
1
Be careful to ensure that you are using only data of the same frequency.
To use the solver (part (c)):
2
construct the formula for the equation 0 = 200x – 10x + 350; in B1 SUM(C1: E1), C1
=200*C2^2, D1 = -10*C2, E1 = +350, C2 the starting value for x.
go to solver (tools or formula), Set Cell $B$1, Equal To 0, By Changing C2, Solve.
keep trying different starting values of x until you have found all solutions.
if you have trouble go to help.
(2 marks)
(3 marks)
QUESTION 5
Find the derivative with respect to x for these functions:
(a) y = 10 + 5x + x-2
(b)
(4 marks)
QUESTION 6
For the equation y = 2 + 3 + 4x2 + 5x3
(a) Find the equation for the linear approximation when x = 3.
(b) Find the equation for the quadratic approximation, also when x = 3.
(c) Using excel to graph of the original function and the linear and quadratic approximations (same graph).
(1.5 marks)
QUESTION 7
(a) A pension fund must pay $10,000 at the end of each of the next five years. Find the Present Value and Duration
for this set of payments using a discounted rate of 0.06 or 6 %.
(b) Verify your answer to part (a) using excel.
(c) Suppose the fund invests in a portfolio of two and five year zero-coupon bonds, and needs to satisfy the
conditions to immunize its bond portfolio. It uses this portfolio to make these five payments of $10,000. Find
the proportion of the fund allocated to 5-year bonds.
(3 marks)
2
QUESTION 8 (use excel for this question)
Assume you have four different bonds:
B1 - A two year bond with a nominal rate of 3.5% per annum
B2 - A five year bond with a nominal rate of 4.5 % per annum
B3 - A ten year bond with a nominal rate of 5.5 % per annum
B4 - A twenty-five year bond with a nominal rate of 6.5 % per annum
All these bonds have six monthly coupons and a face value of $2,000. Calculate their present values, Macauly
durations and convexities using a YTM of 6% (YTM = 0.06).
(3 marks)
(5 marks)