Question

1. On a futures exchange, to make sure that parties do not default on their obligations under the contract, the exchange will require parties to post sufficient _____________ in the form of a __________________ posted in each account to cover any losses.

2. The difference between the average rate of return on a security or a portfolio of securities and its SML relation is called _____________.

3. True/False.  According to the CAPM, an investor with below-average risk aversion will hold more of the risk-free asset.

4. Explain the relationship between the volatility of a stock and the price of the call and put options on that stock (in qualitative terms).  Why is this so?

5. A stock has a beta of 2.5, and the return on the market is expected to be 12% and the risk-free rate is 7%.  What is the total expected return on the stock under the CAPM? (Please show work)

Answer 1

1.parties need to post sufficient MARGIN in-form of a MAINTENANCE MARGIN. These margin are helpful for prevention from default on the obligation under contract.

2. MARKET RISK PREMIUM is the difference between average rate of return on security

or a Portfolio of security and its SML relation.

3. The given statement is FALSE. According to CAPM an investor with below risk aversion will hold less of risk free assets.

4. when volatility of the stock will go up the price of call option option will go up.this is because there is a higher chance of achievement of the strike price through fluctuation in the current market price.

5. CAPM return

= Rf+beta(Rm-Rf)

=7+2.5(12-7)

= 19.5%