UNIVERSITY OF HYDERABAD

SCHOOL OF ECONOMICS
EC-527 : Mathematical Finance I - Minor 1

23 October 2020 Duration 75 Minutes Max marks : 25

Note: Answer any FIVE questions. All questions carry equal marks.

Q.1. State, briefly explain and prove the ’Two-Fund Theorem’.

Q.2 Define present value of a future sum. Define and very briefly discuss NPV and IRR in in-
vestment analysis.

Q.3. Consider a person having Rs. 100 for investment today. The investment opportunity availa-
ble has two possibilities: (I) redeem the investment after three years to receive Rs. 250/- or (II)
redeem the investment after four years to receive Rs. 300/-. Then, (i) which is the better option,
if the rate of discount used for present value is 10 % compounded annually? (ii) which is the
better option, if criterion used is internal rate of return?

Q.4. Using present value analysis solve the problem given below: Consider a 8 percent, Rs.
100/- bond (i.e. bond with face value = Rs. 100; and coupon = Rs. 8) with once a year coupon
payments. (a) If this were a perpetual bond, and rate of interest changed from 5 percent to 4
percent, what is percent change in the market value of the bond? (b) If this bond has 1 year to
maturity left, and rate of interest changed from 5 percent to 4 percent, what is percent change
in the market value of the bond?

Q.5. What is the concept of (a) ideal bank; and (b) risk-free return?

Q.6. (a) Define conditional probability and conditional expectation. (b) Consider throw of two
fair dice with n1 and n2 as the outcomes. Let random variable X be defined as : X = n1 + n2 .
Then find conditional expectation, E[X|X ≥ 10].

Q.7. State ’One-fund Theorem’ and briefly elucidate the Capital Market Line (CML).

Q.8. Given two securities 1 and 2, with returns (in percent), R1 and R2 , having means µ1 = 6,
µ2 = 5 and standard deviations, σ1 = 2, σ2 = 1 respectively and covariance σ12 = 0.5. A port-
folio is constructed with return on portfolio as R = αR1 + (1 − α)R2 and (0 ≤ α ≤ 1.0). Then
find the mean and variance of the portfolio, if (a) α = 0.3; and (b) α = 0.5.

Q.9. (a) What is MVP (minimum variance point) and efficient frontier? (b) Find MVP for the
problem given in Q.8.