Financial Economics Exam Review

1. When the expectation hypothesis does not hold: forward rate is

equal/larger/ smaller than the expected short rate?
2. What is the Consumption CAPM pricing equation for market
portfolio? Comment.
3. If the standard deviation for market return is 20%, the expected
return 5%, risk free rate 2%, draw the SML. Would you hold a
security with beta equal to 0.5 and expected return 5%?
4. What is the separation property in the selection of optimal
complete portfolio?
5. If the modified duration of a bond is equal to 5 years. The
volatility of the __ in market interest is 2%, what is the volatility
of a percentage change in the price of the bond
6. The expected return on equity is 10%, the expected return on the
bond is 5%, the respective standard deviations are 20% and 5%,
the correlation coefficient 1 and the risk free rate 0. What is the
optimal complete portfolio whose target volatility is 30% and
one borrows at the risk free rate of 0. What if you cannot borrow
but instead short the bond? Comment. In that case you would
have 2 ways to proceed: