The Candidate questions for the final exam.

1. (5) Please explain ‘short position’ when you

construct your portfolio. (page 171)

2. (5) Please explain the figure 8.2. (p. 180)

3. (15) Please construct a riskless portfolio R using

the following information.
“Suppose that the rates of Securities U and V are
perfectly positively correlated. Let Xu and Xv be the
proportions in which an investor allocates funds
between these two securities to construct Portfolio
R. We shall now determine the values of Xu and Xv
that will make Portfolio R riskless.” (p. 194)

4. (10) Please explain arbitrage and equilibrium

when two risky securities have perfectly positively
correlated rate of return. (p.197)

5. (20) Please explain how to derive Capital Market

Line and interpret the meaning of the Line.
(p.220, p.210)

6. (20) Please explain how to derive Security Market

Line and interpret the meaning of the Line.
(p.223, p.229)
7. (5) Explain what the characteristic lines are and
how to estimate beta. (p.212)

8. (5) Explain a problem of agency by providing an

example of enforcing payouts of Free Cash Flows.
(section 13.5)

9. (20) Given the following information, please show

the capital structure of the two firms, and explain
why the high debt equity ratio help the firm to
reallocating resources when consumers’
preferences change. (p.324)
 We assume that the discount rate of the bond and stock of Firm L is 0.11
and 0.14 respectively, and that of Firm H is 0.12 and 0.16 respectively.
Suppose that a shift in consumer preferences causes each firm’s net annual
earnings to decrease from $100,000 to $60,000. And suppose that if each
firm were to liquidate, the bondholders and the shareholders of that firm
could reinvest the capital in a new firm that would generate annual net
earnings of $90,000.

10. (20) Please fill out the vacancies in the table

below and explain the problem of agency with
asset substitution. (p.332)