UNIVERSITY OF MAURITIUS

FACULTY OF LAW AND MANAGEMENT

SECOND SEMESTER EXAMINATIONS

MAY/JUNE 2013

PROGRAMME BSc (Hons) International Business Finance

BSc (Hons) Banking and Finance

MODULE NAME QUANTITATIVE FINANCE II

Wednesday
DATE MODULE CODE DFA2033Y(3)
29 May 2013

09.30-12.30
TIME DURATION 3 Hours
Hours

NO. OF NO. OF QUESTIONS

4 4
QUESTIONS SET TO BE ATTEMPTED

INSTRUCTIONS TO CANDIDATES

Answer ALL Questions.

Answer Question 4 in a separate Answer Booklet.

 QUANTITATIVE FINANCE II

Question 1

(a) A data set is fit using a second order model given by

= + + + + + + .

The Model Summary Output is as follows:

Regression Statistics
Multiple R 0.957
R Square 0.915
Adjusted R Square 0.831
Standard Error 3.948
Number of Observations 11

ANOVA Table
Sum of Mean Sum of F Test Significance F
df Squares Square Statistics (p-value)
Regression a 844.2 168.8 e 0.010
Residual b c d
Total f 922.2

Lower Upper
Variables Coefficients Standard Error Test Statistics P-value 95% 95%
Intercept 2.27 43.19 0.00 92.17 103.84
4.00 1.35 2.95 0.03 0.52 7.48
7.35 1.35 5.43 0.00 3.87 10.83
-0.88 1.53 -0.58 0.59 -4.80 3.05
-4.66 1.53 -3.05 0.03 -8.58 -0.73
5.00 1.97 2.53 0.04 -0.07 10.07
(i) Discuss the strength of the relationship between the response and explanatory
variables developed due to the second order model.
(ii) Write down the ANOVA table by completing all its missing values (a, b, c, d, e, f)
and discuss the significance of the model and its coefficients.
(iii) What is the value for the point estimate of given by ?
(iv) Write down the regression fitted equation with the known parameters.

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 QUANTITATIVE FINANCE II

(v) Estimate the value of when = 2 and = 3.

[2+ 6 + 2 + 2 + 1 marks]

(b) Derive the autocovariance (ACVF) and autocorrelation (ACF) functions of the
MA(2) process given by
= + + ,
for = 0, ±1, ±2, …, where { }~ (0, ).

[6 marks]

(c) Investigate whether the following ARMA process { } is stationary, causal and
invertible given that { } denotes white noise:

− + = + + .

[6 marks]

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Question 2

Consider the quarterly financial data set which will be decomposed into an additive seasonal-
trend model: = + +

Quarter
1st 2nd 3rd 4th
1st 7.0 9.4 10.3 12.8
Year 2nd 15.0 17.4 18.2 19.9
3rd 23.2 25.4 26.4 29.0
4th 31.3 33.6 35.6 37.0

(i) Calculate the centered moving average (CMA) values for this time series.

(ii) Compute seasonal indexes for the 4-quarters based on the CMA values.

(iii) Find the equation of the fitted linear trend to the CMA values.

(iv) Hence, forecast the financial data value for the four quarters of the 5th Year.
[5 + 5 + 10 +5 marks]

̅
[Linear Regression Formula: = − ̅, = ]
( ̅)

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 QUANTITATIVE FINANCE II

Question 3

The monthly airline passenger time series, first investigated in Box and Jenkins (1976), is
considered a classic time series.

(i) Figures 1(a) and 1(b) show the time series plot of the data and of its logarithm
series respectively. Argue that taking logarithm transformation to the data is an
appropriate step.
[4 marks]

Figure 1(a): Air Passengers time series plots.

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 QUANTITATIVE FINANCE II

Figure 1(b): Log(Air Passengers) time series plots.

(ii) Figures 2(a) and 2(b) show the first difference plot on the transformed data and
its corresponding sample ACF plot. Make appropriate interpretations.
[4 marks]

Figure 2(a): First difference of Log(Air Passengers).

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 QUANTITATIVE FINANCE II

Figure 2(b): ACF of the first difference of Log(Air Passengers) time series plots.

(iii) Interpret the ACF of the seasonally differenced and first difference of the
transformed data given in Figure 3. [4 marks]

Figure 3: ACF plot of Seasonal differences with first difference of Log(Air Passengers)

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 QUANTITATIVE FINANCE II

(iv) An (0,1,1) × (0,1,1) time series model was fit to the Log(Air Passengers)
data set using the SPSS software.
(i) Explain the choice of the parameters used.
[4 marks]
(ii) The model output is given as follows:

ARIMA Model Parameters

Estimate SE t Sig.
Constant 1.522E-5 .001 .014 .989
Difference 1
MA Lag 1 .348 .088 3.967 .000
Seasonal Difference 1
MA, Seasonal Lag 1 .562 .088 6.381 .000

Using the known parameters from the output, write down the full expanded
form of the (0,1,1) × (0,1,1) .

[5 marks]
(v) Figures 4(a) and 4(b) show the time series diagnosis plot for the residual of the
fitted model and the forecast plot with a 95% confidence interval respectively.
Discuss the results obtained. [4 marks]

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 QUANTITATIVE FINANCE II

Figure 4(a): Residual ACF and PACF plots.

Figure 4(b): Forecasted plot.

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 QUANTITATIVE FINANCE II

Question 4

Consider the following market data:

Scenario Probability Return Return

Recession 0.1 -5% 5%
Stagnation 0.4 5% 10%
Boom 0.5 10% 30%

(a) Find the expected returns = [ ] and = [ ].

[2 marks]

(b) Show that the variance of is 0.002025 and that of is 0.011225.

[4 marks]

(c) If the correlation between the two assets above is = −0.9, write down the
covariance matrix .

[2 marks]

(d) Find the expected return and the standard deviation on a portfolio
= 0.3 + 0.7 .

[1+2 marks]

(e) Show that the inverse covariance matrix is approximately given by

2600 994
= .
994 469
[3 marks]

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(f) Consider the row vectors =[ ], = [1 1] and let the portfolio weights
=[ ]. Use the Lagrange technique to calculate the portfolio weights in the
following constrained optimisation problems:
(i) (Minimum Variance Portfolio)
T T
min : = subject to : = 1.

(ii) (Capital Asset Pricing Model Portfolio)

T
− T
max : Gradient = subject to = 1,
√ T

where the risk-free interest rate = 5%. [4+7 marks]

- END OF QUESTION PAPER -

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