A stock price is currently $75.

Over each of the next two three-month periods it is

expected to go up by 10% or down by 8%. The risk-free interest rate is 6.5%
per annum with continuous compounding. What is the value of a six-month
European call option with a strike price of $77?
 $3.81
 $3.45
 $4.12
 $3.62

Answer: A, $3.81
The risk neutral probability of an up move, p = (e0.25x0.065-0.92)/(1.1-0.92) = 0.53546
Value of the option = 13.75 x (0.53546)2 x e-0.065x0.5 = $3.82

1. Ron, a financial manager in a consumer goods company is analyzing the annual

sales of 4 years 2005 - 08 of their hair care product. He finds that three factors
determine the sales. The model that he developed is:
Y = b + 3X1 + 4X2 + 6X3
Where Y is the sales (Dependent variable)
Sum of Squared Regression (SSR) = 945. 42
Standard Error of Regression (SER) = 28.23
The proportion of sales that is explained by the regression model is:
A. 0.29
B. 0.49
C. 0.37
D. 0.43

Answer: C, 0.37
Coefficient of Determination i.e. R2 explains proportion of variation explained by the
regression.
R2 = SSR/SST, SER = (SSE/(n-2))1/2 , SST = SSR + SSE.
SSE = 2 x 796.93 =1593.87
Therefore, SSE = 1593.87, SST = 2539.29, R2 = 945.42/2539.29 = 0.37
2. A simple regression model was determined to have the following equation: Y =
a + bX + e. The correlation between X and Y is known to be 0.75. The value of
a is 3, b is 2, Std (X) = 2.5. The value of Std(e) is
A. 4.01
B. 4.41
C. 5.15
D. 4.75
E. Answer: B, 4.41
The standard deviation of Y can be calculated as follows:
Corr(X, Y) =0.75 = b * std(X) / std(Y) = 2 * 2.5/Std(Y)
Std (Y) = 6.67
Std(Y) = SQRT(b2 x std(X)2 + std(e)2 ) = SQRT(4x6.25 + std(e)2)
Std(e) = 4.41

3. In a Treasury bond futures contract, it is known that the cheapest-to-deliver

bond will be a 10% coupon bond with a conversion factor of 1.2458. Also that it
is known that delivery will take place in 270 days. Coupons are payable semi-
annually on the bond. The last coupon date was 50 days ago, the next coupon
date is in 132 days, and the coupon date thereafter is in 315 days. The term
structure is flat and the rate of interest (with continuous compounding) is 8%
per annum. Assume that the current quoted bond price is $135. Then what
would be the quoted futures bond price?
A. $108.97

B. $113.35

C. $122.74

D. $117.18

Answer: A, $108.97
Now, cash price of the bond is obtained by adding to current quoted price the proportion
of the next coupon payment that accrues to the holder.
The cash price is given by,
135 + 50 / (50 + 132) × 5 = $136.37
A coupon of $5 will be received after 132 days (= 0.3616 years).
The present value of this is 5 × e(-0.08×0.3616) = 4.8574
The futures contract lasts for 270 days (= 0.7397 years). The cash future price, if the
contract were written on the 10% bond, would therefore be (136.37 – 4.8574) ×
e(0.08×0.7397) = 139.53
At delivery, there are 138 days of accrued interest. The quoted future price, if the
contract were written on the 10% bond, is calculated by subtracting the accrued interest
139.53 – 5 × 138 / (138 + 45) = 135.76
From the definition of the conversion factor, 1.2458 standard bonds are considered
equivalent to each 10% bond. The quoted futures price should therefore be
135.76/1.2458 = 108.97
4. A non dividend paying stock with volatility of 20% per annum is currently
trading at $50. A European call option on the stock with a strike price of $49
has a time to maturity of 5 months. The risk free rate is 6%. Given that N(0.42)
= 0.6627, N(0.41) = 0.6590, N(0.28) = .6102, N(0.29) = .6140, N(0.62) = .7323
and N(0.63) = 0.7356, the price of the option is
A. $3.78
B. $4.28
C. $3.44
D. $3.14

Answer: A, $3.78
S0 = $50, K = $49, r = 6%, σ = 0.2, T = 5/12
ln( 50 / 49 ) + ( 0.06 + 0.04 / 2 )( 5 / 12 )
d1 = = 0.415
0.2 5 / 12
d 2 = d1 − 0.2 5 / 12 = 0.286

Use interpolation to find N(0.415) and N(0.286) from the given values.
c = 50 x N(0.415) – 49e-0.06x5/12N(0.286) = 50 x 0.661 – 49 x 0.975 x .612 = $3.78

5. Consider the following portfolio of the bonds. Then, what is the value of the
portfolio’s DVBP (Dollar Value per Basis Point)?
Bond Price Par Modified
X 114.24 Amount
$5000 Duration
4.27
Y 89.71 $6000 5.39
Z 127.37 $9000 8.54
A. 15.13
B. 13.75
C. 17.32
D. None of the above
E. Answer: A, 15.13

Par Market Modified Dollar

Bond Price
Amount Value Duration Duration
X 114.24 $5000 $5712 4.27 $24390.24
Y 89.71 $6000 $5382.6 5.39 $29012.21
Z 127.37 $9000 $11463.3 8.54 $97896.58
$151299.0
3

Here, market value of each bond is obtained by multiplying the par amount by the ratio
of the market price divided by 100.
Next, this is multiplying by D* to get the dollar DD. Summing up, we get $151299.03
Multiplying this by 0.0001, we get the DVBP which is 15.13
Hence, option ‘A’ is correct.
6. Security A offers a return of 12% and has a standard deviation of 11%.
Security B has a standard deviation of 13% with a return of 17%. What is the
return and standard deviation of an equally weighted portfolio if the
correlation between A and B is 0.3?
A. 14.50%, 13.88%
B. 14.50%, 9.69%
C. 29.00%, 13.88%
D. 29.00%, 11.78%
E. Answer: B, 14.50%, 9.69%
Return = (.12+.17)/2 = 14.50%
Standard Deviation = Sqrt(0.112*0.52+0.132*0.52+2*0.5*0.11*0.5*0.13*0.3) = 9.69%