Faculty of Economics and Business

Academic year 2014-2015

On the first page of this exam form you will find important information about this exam.
Please read the information below before answering any exam questions!

Exam: Investment and Portfolio Theory 2 6012B0234Y

Date and time of the exam: <sample exam>
Duration of the exam: 3 hours
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If you are not registered via SIS for the course component correctly, your exam will not be marked and
registered.

Please write your name and student number on every

sheet of paper you hand in.
Warning against cheating: Do not cheat! Students who are caught in any form of cheating will be
punished, the maximum punishment being exclusion from all exams for a period of one year.
Make sure that your mobile phone is switched off and locked in your briefcase. Your briefcase must be closed
and placed on the floor.
During the exam you are not allowed to go to the toilet without the prior consent of
the coordinating supervisor or invigilator.

Tools allowed: pencil, pen, eraser, ruler, calculator

You are NOT allowed to use graphical/programmable calculator
Specific information on this exam:
This exam consists of 16 multiple choice questions and 4 open questions.
Answer on normal exam paper, there is no separate form for the multiple choice questions. Your
answer should be clear, short, and precise.
The answers should be in English. Answers in any other language will not be taken into consideration
(you will receive 0 points for the particular question).
To obtain full points for the open questions, make sure you clearly explain all steps you take in
calculations and interpret your result.

The results of this exam will be published within 15 working days following the date of the
exam. If the re-sit is scheduled to take place within 6 weeks following the current exam, the
results of the current exam will be published within 12 working days.

Inspection of the exam: there will be an inspection session for the exam and the assignments. Date
and time to be announced on Blackboard.
You are allowed to keep the question form(s) after the examination.

Good luck!

Open questions (50/100 points)

1. Calculate the Black-Scholes value of the following options. Show your calculations:
a. A call with X=100, S = 100, = 0.15, Rf = 0.015, T= 0.75

b. A put with X=60, S = 50, = 0.25, Rf = 0.015, T= 0.4

2. You're trading currency futures, and realize that the interest rates in both currencies has just dropped to zero.
a. Argue what this means for the price of the future relative to the price of the spot, based on a no-arbitrage
argument.

b. Argue how your answer would be influenced if you realize the futures in your portfolio have a beta of 0.15.

c. Argue if this result would be consistent with normal backwardation or with a market that's in contango.

3. You consider investing in an international mutual fund. The EAFE data, currency appreciation, and fund data
are given below.

Europe
Australasia
Far East

EAFE Weight

Return on
Equity Index

0.30
0.10
0.60

8%
6%
11%

Currency
appreciation
E1/E0 1
-5%
-8%
15%

Managers
Weight

Managers
Return

0.10
0.40
0.50

5%
7%
14%

a. Compute the overall performance

b. Decompose the overall performance into currency selection, country selection, and stock selection. Does the
manager under- or outperform on these attributes? Does the manager under- or outperform overall?

c. Discuss three risks that are particular to international investing, as treated during the lectures.

4. Consider an emerging markets hedge fund.

a. Suppose that you intend to run a style analysis on the hedge fund returns. What are the main differences
between style analysis for mutual funds and style analysis for hedge funds? Why do these differences arise?

b. What kind of factors would you use for this emerging markets fund? Why?

c. During the guest lecture, you have seen quite some time-variation in factor loadings. Using the tools obtained
during this course, how would you deal with this? Why?

Multiple choice questions (50/100 points)

1. The pay-off pattern of a straddle can be replicated by (assume the strike prices and quantities can be chosen
to fit the desired pattern):
A. A long position in the stock, a long position in a put, and a short position in the risk-free asset.
B. A short position in a call, and a long position in a put.
C. A short position in a put, and a short position in the stock.
D. A long position in the risk-free asset, a long position in the call and a long position in the stock.
E. None of the above.

2. You can trade a put option with a price that corresponds to an implied volatility of 150%. You believe the real
volatility is 100%. Which of the strategies below would allow you to earn a profit, while keeping a delta-neutral
portfolio? (assume that the quantities you buy or sell can be adjusted to match this criterion)
A. Buy the put, and also buy call options.
B. Buy the put, and also go short in put options (that are priced according to the Black-Scholes model) which are
further out-of- the-money
C. Sell the put, and also sell call options.
D. Sell the put, buy the underlying asset.
E. This is not possible with the strategies above.

3. Suppose you are short in stock index futures. You bought these last year, at that time the futures price was
$570. Your initial investment equals the margin deposit, and was $285,000.00. Today, the spot price is $830.
Which of the following is certainly true?
A. The future contract will have a beta of zero.
B. You'll profit if the index rises even further.
C. You would have lost the same amount of money if you would have sold short stocks for $285,000.00 a year
ago, instead of buying the futures.
D. You could prevent additional losses by buying a new stock index future.
E. We cannot be certain that any of the answers above are true.

4. How can you best approximate a digital call option using only standard European options, the risk-free asset
and the underlying stock?
A. Go long in the put option, and short the underlying stock, such that your short position has a delta two times
as high as the delta of the put.
B. Short an out-of-the-money put, short the stock, go long in the risk-free object.
C. Go long in an in-the-money call option, and go short in the stock.
D. Go long in calls and go short in calls (by the same amount) with a strike price just above the strike price of the
long calls. Repeat till out of money to invest.
E. None of the above.

5. You need to check the difference between gold on the spot market (where it trades for $1,270.00 an ounce)
and futures with a 6 month maturity. Gold pays no dividends. Assume the interest rate is 0.2%. The storage costs
are 1% a year. Assume discrete interest rates. What is the future price?
A. $1,264.91
B. $1,270.00
C. $1,271.27
D. $1,276.33
E. None of these answers.

6. A client of yours owns a portfolio of $20 million, invested in the AEX. Assume that index currently trades at
400. She wishes to hedge herself against losses resulting from a level below 350, and is willing to give up upwards
potential beyond a return of +20% on the current portfolio, and pay or receive a fixed amount if need be (which
shouldn't be included in return calculations). What would you tell her?
A. Buy puts with strike 350, sell calls with strike 480, and she has to pay the difference in premiums.
B. Buy puts with strike 350, sell calls with strike 480, and she can receive the difference in premiums.
C. Buy calls with strike 480, sell puts with strike 350. It's unclear if this will cost her money or give additional
proceeds.
D. Sell the stock she currently owns, buy calls at X = 350, buy puts with X = 480. It's unclear if this will cost her
money or give additional proceeds.
E. None of the above is correct.

7. Suppose you want to speculate that the price of an asset goes from $1,000 to $2,000. Which investment
strategy would provide you with the highest amount of leverage, compared to your initial investment?
A. Invest $1 million in a long future, trading at $1,000, with an initial margin of 10%.
B. An investment in T-bills (yielding 1%) for $800,000, and $200,000 invested in long call options with X = 1000
for 80 / option.
C. An investment of $1 million in long call options with X = 1000 for 80 / option.
D. An investment of $1 million in long call options with X = 1200 for 20 / option.
E. There is insufficient information to answer the question.

8. You observe the following in the market:

* The price of stock Drab paint, Inc. is $12 right now. The risk free rate is 2% a year.
* A put with X=15 and T=0.4 is trading at $3.10.
Which set of observations below is correct?
A. The call with X=15, T=0.4 could be worth $0.35.
B. The call with X=15, T=0.4 will have an intrinsic value strictly bigger than zero.
C. The call with X=15, T=0.4 could be worth $0.42, but no less.
D. The put option does not give sufficient information to calculate the value of the call with the same strike price
and maturity.
E. None of the above is correct.

9. A mutual fund has a 12b-1 fee of 1% and an expense ratio of 0.5%. You invest $1,000 in the fund, which will
earn you a guaranteed annual return of 6%. How much money will you have after 2 years?
A.
B.
C.
D.
E.

$1,054.40.
$1,092.03.
$1,101.90.
$1,191.02.
None of the above is correct.

10. You perform a style analysis for a mutual fund. Which of the following statements is NOT correct?
A. The factor loadings should be restricted so that they are non-negative.
B. The factor loadings should sum to one.
C. The R2 measures return variability due to style or asset allocation.
D. Adding more factors to the model causes a bias in the results.
E. All of the above are correct.

11. You consider investing in only one of two different stocks, and you have no other investments. Stock A has an
expected excess return of 3% with a volatility of 2% and a beta of 0.75, while stock B has an expected return of
4.5% with a volatility of 4% and a beta of 1.25. Which stock would you invest in?
A.
B.
C.
D.
E.

Stock A, because it has a higher Treynor ratio.

Stock A, because it has a higher Sharpe ratio.
Stock B, because it has a higher Treynor ratio.
Stock B, because it has a higher Sharpe ratio.
None of the above is correct.

12. A recently established hedge fund is considering its compensation structure. Their NAV is $50 and the
volatility of their annual returns is 40%. The continuously compounded risk-free rate is 3%. The fund will set a
20% incentive fee on its total return. Based on their past performance, the high water mark will be $55. It is now
January 1, and the fee is annual. What is the value of the annual incentive fee according to the Black-Scholes
formula?
A.
B.
C.
D.
E.

$1.2317.
$1.3228.
$1.7138.
$2.3674.
None of the above is correct.

13. It is known that hedge fund databases tend suffer from backfill bias and survivorship bias. What is the
direction of these biases?
A.
B.
C.
D.
E.

Backfill bias results in an upward bias of returns, survivorship bias in a downward bias.
Backfill bias results in a downward bias of returns, survivorship bias in an upward bias.
Both result in an upward bias of returns.
Both result in a downward bias of returns.
None of the above is correct.

14. Which of these statements is NOT true about international stock returns and international diversification?
A.
B.
C.
D.
E.

A common factor seems to underlie the movement of stock returns around the world.
Correlations between countries may increase in a crisis.
When the exchange rate risk is hedged, it is the home currency return that is relevant to judge performance.
Political risk matters when investing internationally.
None of the above is correct.

15. Which performance measure is appropriate when the investment under consideration will be part of a large,
actively managed portfolio?
A.
B.
C.
D.
E.

The Sharpe ratio.

The Treynor ratio.
The M2 measure.
The information ratio.
None of the above is correct.

16. Consider a mutual fund that has the following portfolio.

Stock A
Stock B
Stock C

Shares
750,000
250,000
350,000

Price
$40
$35
$50

The fund manager sells all holdings of stock C, and replaces them with 500,000 shares of stock D at $35 per share.
What is the portfolio turnover rate?
A.
B.
C.
D.
E.

25.93%.
27.57%.
31.11%.
40.00%.
None of the above is correct.

Appendix Normal distribution

d
N(d)
d
N(d)
d
N(d)
d
N(d)
d
N(d)
-2.5 0.00621
-2 0.02275
-1.5 0.06681
-1 0.15866
-0.5 0.30854
-2.49 0.00639
-1.99 0.0233
-1.49 0.06811
-0.99 0.16109
-0.49 0.31207
-2.48 0.00657
-1.98 0.02385
-1.48 0.06944
-0.98 0.16354
-0.48 0.31561
-2.47 0.00676
-1.97 0.02442
-1.47 0.07078
-0.97 0.16602
-0.47 0.31918
-2.46 0.00695
-1.96
0.025
-1.46 0.07215
-0.96 0.16853
-0.46 0.32276
-2.45 0.00714
-1.95 0.02559
-1.45 0.07353
-0.95 0.17106
-0.45 0.32636
-2.44 0.00734
-1.94 0.02619
-1.44 0.07493
-0.94 0.17361
-0.44 0.32997
-2.43 0.00755
-1.93 0.0268
-1.43 0.07636
-0.93 0.17619
-0.43 0.3336
-2.42 0.00776
-1.92 0.02743
-1.42 0.0778
-0.92 0.17879
-0.42 0.33724
-2.41 0.00798
-1.91 0.02807
-1.41 0.07927
-0.91 0.18141
-0.41 0.3409
-2.4 0.0082
-1.9 0.02872
-1.4 0.08076
-0.9 0.18406
-0.4 0.34458
-2.39 0.00842
-1.89 0.02938
-1.39 0.08226
-0.89 0.18673
-0.39 0.34827
-2.38 0.00866
-1.88 0.03005
-1.38 0.08379
-0.88 0.18943
-0.38 0.35197
-2.37 0.00889
-1.87 0.03074
-1.37 0.08534
-0.87 0.19215
-0.37 0.35569
-2.36 0.00914
-1.86 0.03144
-1.36 0.08691
-0.86 0.19489
-0.36 0.35942
-2.35 0.00939
-1.85 0.03216
-1.35 0.08851
-0.85 0.19766
-0.35 0.36317
-2.34 0.00964
-1.84 0.03288
-1.34 0.09012
-0.84 0.20045
-0.34 0.36693
-2.33 0.0099
-1.83 0.03362
-1.33 0.09176
-0.83 0.20327
-0.33 0.3707
-2.32 0.01017
-1.82 0.03438
-1.32 0.09342
-0.82 0.20611
-0.32 0.37448
-2.31 0.01044
-1.81 0.03515
-1.31 0.0951
-0.81 0.20897
-0.31 0.37828
-2.3 0.01072
-1.8 0.03593
-1.3 0.0968
-0.8 0.21186
-0.3 0.38209
-2.29 0.01101
-1.79 0.03673
-1.29 0.09853
-0.79 0.21476
-0.29 0.38591
-2.28 0.0113
-1.78 0.03754
-1.28 0.10027
-0.78 0.2177
-0.28 0.38974
-2.27 0.0116
-1.77 0.03836
-1.27 0.10204
-0.77 0.22065
-0.27 0.39358
-2.26 0.01191
-1.76 0.0392
-1.26 0.10383
-0.76 0.22363
-0.26 0.39743
-2.25 0.01222
-1.75 0.04006
-1.25 0.10565
-0.75 0.22663
-0.25 0.40129
-2.24 0.01255
-1.74 0.04093
-1.24 0.10749
-0.74 0.22965
-0.24 0.40517
-2.23 0.01287
-1.73 0.04182
-1.23 0.10935
-0.73 0.2327
-0.23 0.40905
-2.22 0.01321
-1.72 0.04272
-1.22 0.11123
-0.72 0.23576
-0.22 0.41294
-2.21 0.01355
-1.71 0.04363
-1.21 0.11314
-0.71 0.23885
-0.21 0.41683
-2.2 0.0139
-1.7 0.04457
-1.2 0.11507
-0.7 0.24196
-0.2 0.42074
-2.19 0.01426
-1.69 0.04551
-1.19 0.11702
-0.69 0.2451
-0.19 0.42465
-2.18 0.01463
-1.68 0.04648
-1.18
0.119
-0.68 0.24825
-0.18 0.42858
-2.17
0.015
-1.67 0.04746
-1.17
0.121
-0.67 0.25143
-0.17 0.43251
-2.16 0.01539
-1.66 0.04846
-1.16 0.12302
-0.66 0.25463
-0.16 0.43644
-2.15 0.01578
-1.65 0.04947
-1.15 0.12507
-0.65 0.25785
-0.15 0.44038
-2.14 0.01618
-1.64 0.0505
-1.14 0.12714
-0.64 0.26109
-0.14 0.44433
-2.13 0.01659
-1.63 0.05155
-1.13 0.12924
-0.63 0.26435
-0.13 0.44828
-2.12
0.017
-1.62 0.05262
-1.12 0.13136
-0.62 0.26763
-0.12 0.45224
-2.11 0.01743
-1.61 0.0537
-1.11 0.1335
-0.61 0.27093
-0.11 0.4562
-2.1 0.01786
-1.6 0.0548
-1.1 0.13567
-0.6 0.27425
-0.1 0.46017
-2.09 0.01831
-1.59 0.05592
-1.09 0.13786
-0.59 0.2776
-0.09 0.46414
-2.08 0.01876
-1.58 0.05705
-1.08 0.14007
-0.58 0.28096
-0.08 0.46812
-2.07 0.01923
-1.57 0.05821
-1.07 0.14231
-0.57 0.28434
-0.07 0.4721
-2.06 0.0197
-1.56 0.05938
-1.06 0.14457
-0.56 0.28774
-0.06 0.47608
-2.05 0.02018
-1.55 0.06057
-1.05 0.14686
-0.55 0.29116
-0.05 0.48006
-2.04 0.02068
-1.54 0.06178
-1.04 0.14917
-0.54 0.2946
-0.04 0.48405
-2.03 0.02118
-1.53 0.06301
-1.03 0.15151
-0.53 0.29806
-0.03 0.48803
-2.02 0.02169
-1.52 0.06426
-1.02 0.15386
-0.52 0.30153
-0.02 0.49202
-2.01 0.02222
-1.51 0.06552
-1.01 0.15625
-0.51 0.30503
-0.01 0.49601

Appendix Normal distribution

d
N(d)
d
N(d)
d
0
0.5
0.5 0.69146
0.01 0.50399
0.51 0.69497
0.02 0.50798
0.52 0.69847
0.03 0.51197
0.53 0.70194
0.04 0.51595
0.54 0.7054
0.05 0.51994
0.55 0.70884
0.06 0.52392
0.56 0.71226
0.07 0.5279
0.57 0.71566
0.08 0.53188
0.58 0.71904
0.09 0.53586
0.59 0.7224
0.1 0.53983
0.6 0.72575
0.11 0.5438
0.61 0.72907
0.12 0.54776
0.62 0.73237
0.13 0.55172
0.63 0.73565
0.14 0.55567
0.64 0.73891
0.15 0.55962
0.65 0.74215
0.16 0.56356
0.66 0.74537
0.17 0.56749
0.67 0.74857
0.18 0.57142
0.68 0.75175
0.19 0.57535
0.69 0.7549
0.2 0.57926
0.7 0.75804
0.21 0.58317
0.71 0.76115
0.22 0.58706
0.72 0.76424
0.23 0.59095
0.73 0.7673
0.24 0.59483
0.74 0.77035
0.25 0.59871
0.75 0.77337
0.26 0.60257
0.76 0.77637
0.27 0.60642
0.77 0.77935
0.28 0.61026
0.78 0.7823
0.29 0.61409
0.79 0.78524
0.3 0.61791
0.8 0.78814
0.31 0.62172
0.81 0.79103
0.32 0.62552
0.82 0.79389
0.33 0.6293
0.83 0.79673
0.34 0.63307
0.84 0.79955
0.35 0.63683
0.85 0.80234
0.36 0.64058
0.86 0.80511
0.37 0.64431
0.87 0.80785
0.38 0.64803
0.88 0.81057
0.39 0.65173
0.89 0.81327
0.4 0.65542
0.9 0.81594
0.41 0.6591
0.91 0.81859
0.42 0.66276
0.92 0.82121
0.43 0.6664
0.93 0.82381
0.44 0.67003
0.94 0.82639
0.45 0.67364
0.95 0.82894
0.46 0.67724
0.96 0.83147
0.47 0.68082
0.97 0.83398
0.48 0.68439
0.98 0.83646
0.49 0.68793
0.99 0.83891

1
1.01
1.02
1.03
1.04
1.05
1.06
1.07
1.08
1.09
1.1
1.11
1.12
1.13
1.14
1.15
1.16
1.17
1.18
1.19
1.2
1.21
1.22
1.23
1.24
1.25
1.26
1.27
1.28
1.29
1.3
1.31
1.32
1.33
1.34
1.35
1.36
1.37
1.38
1.39
1.4
1.41
1.42
1.43
1.44
1.45
1.46
1.47
1.48
1.49

N(d)
d
0.84134
0.84375
0.84614
0.84849
0.85083
0.85314
0.85543
0.85769
0.85993
0.86214
0.86433
0.8665
0.86864
0.87076
0.87286
0.87493
0.87698
0.879
0.881
0.88298
0.88493
0.88686
0.88877
0.89065
0.89251
0.89435
0.89617
0.89796
0.89973
0.90147
0.9032
0.9049
0.90658
0.90824
0.90988
0.91149
0.91309
0.91466
0.91621
0.91774
0.91924
0.92073
0.9222
0.92364
0.92507
0.92647
0.92785
0.92922
0.93056
0.93189

1.5
1.51
1.52
1.53
1.54
1.55
1.56
1.57
1.58
1.59
1.6
1.61
1.62
1.63
1.64
1.65
1.66
1.67
1.68
1.69
1.7
1.71
1.72
1.73
1.74
1.75
1.76
1.77
1.78
1.79
1.8
1.81
1.82
1.83
1.84
1.85
1.86
1.87
1.88
1.89
1.9
1.91
1.92
1.93
1.94
1.95
1.96
1.97
1.98
1.99

N(d)
d
0.93319
0.93448
0.93574
0.93699
0.93822
0.93943
0.94062
0.94179
0.94295
0.94408
0.9452
0.9463
0.94738
0.94845
0.9495
0.95053
0.95154
0.95254
0.95352
0.95449
0.95543
0.95637
0.95728
0.95818
0.95907
0.95994
0.9608
0.96164
0.96246
0.96327
0.96407
0.96485
0.96562
0.96638
0.96712
0.96784
0.96856
0.96926
0.96995
0.97062
0.97128
0.97193
0.97257
0.9732
0.97381
0.97441
0.975
0.97558
0.97615
0.9767

2
2.01
2.02
2.03
2.04
2.05
2.06
2.07
2.08
2.09
2.1
2.11
2.12
2.13
2.14
2.15
2.16
2.17
2.18
2.19
2.2
2.21
2.22
2.23
2.24
2.25
2.26
2.27
2.28
2.29
2.3
2.31
2.32
2.33
2.34
2.35
2.36
2.37
2.38
2.39
2.4
2.41
2.42
2.43
2.44
2.45
2.46
2.47
2.48
2.49

N(d)
0.97725
0.977784
0.978308
0.978822
0.979325
0.979818
0.980301
0.980774
0.981237
0.981691
0.982136
0.982571
0.982997
0.983414
0.983823
0.984222
0.984614
0.984997
0.985371
0.985738
0.986097
0.986447
0.986791
0.987126
0.987455
0.987776
0.988089
0.988396
0.988696
0.988989
0.989276
0.989556
0.98983
0.990097
0.990358
0.990613
0.990863
0.991106
0.991344
0.991576
0.991802
0.992024
0.99224
0.992451
0.992656
0.992857
0.993053
0.993244
0.993431
0.993613