Coursework Autumn 2016
Answer all of the 8 questions. The number of marks for each question is indicated; marks add to 100. You must use your own words and explain
everything. Use a standard file type, such as *.docx, *.pdf, or *.odt to compile your answers and upload your work to the Moodle submission point for
the coursework task.
1 The no-arbitrage condition must hold if there is just one investor who prefers more to less, and he or she is able to form an optimal portfolio.
Why just one investor? How does the ability to form an optimal portfolio contradict the existence of an arbitrage opportunity? (15 marks)
2 What is the difference between a state price and a martingale probability? (10 marks)
3 Is a martingale necessarily a random walk? Is a random walk necessarily a martingale? Explain. (5 marks)
4 Characterise the information set assumed to be impounded in asset prices in the case of semi-strong-form market efficiency and contrast it with the
other two forms. (10 marks)
5 Investors in risky assets must bear the unsystematic risk associated with those assets. Explain what compensation they receive for bearing this
risk. (10 marks)
6 Set out the market model, in ex ante and ex post terms, in equations and in words, making sure that everything in the two equations is explained
explicitly. (15 marks)
7 Consider the Security Market Line (SML). (25 marks in total)
a. Identify a point on the line where the asset has the same expected return as the market portfolio. What is the value of this asset’s beta? [8
marks]
b. Identify another point on the line, where the expected return on the asset is just the risk-free rate of return. What is the value of this asset’s
beta? What risk premium does the holder of this risky asset earn? [8 marks]
c. Identify a third point on the SML, where the expected return on the asset is less than the return on the risk-free asset. What is the beta?
Explain whether, and why, an investor might wish to hold this asset. [9 marks]
8 In the neoclassical analysis on which the CAPM is founded, investors are assumed to care only about the mean and variance of asset returns. Do you
think this assumption is sound? (10 marks)
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