1.  Explain why both the standard deviation and the beta measure the risk of an investment. What is the main diference between the two measures?  Explain carefully the relationship between the standard devation and the beta for a diversified portfolio.

2.  "Diversification benefits only arise if investors form large portfolios of uncorrelated assets. " Discuss,  using the  index  model,  whether this statement  is correct,  incorrect or  partially correct.

3.  Describe the main diferences between dealer and broker markets. Do dealers or brokers face more risks? Explain.

4. Suppose you have found a UK stock with a negative beta.  Discuss whether the following statements are correct, incorrect or partially correct:

(i) The stock has a particularly low risk.

(ii) The stock is not attractive to investors because it has a low expected return. (iii) The stock is negatively correlated with most stocks in the UK stock market.

5.  Discuss at least three diferent motives for investing into trading strategies that involve option contracts. Provide an example for each motive.

                                                             Year        A            B

2013    -3.00%    3.00%

2014     1.20%     2.80%

2015    8.00%     4.00%

2016    -5.00%    -8.00%

2017    -2.00%    -3.00%

2018    -6.00%    0.00%

2019    12.00%    3.00%

2020    8.00%     4.00%

2021    4.00%    -1.00%

2022    -2.00%    3.00%

(a)  Estimate the expected returns and the standard deviations of the two stocks.   Also estimate the correlation between the two stocks.  Compare your estimates to average historical values observed in the US or UK equity (stock) market. [ 10 marks ]

(b)  Calculate the expected return and standard deviation of i) an equally-weighted portfolio and ii) a portfolio consisting of 5% investment in stock A. Discuss the standard deviation of portfolio ii) by comparing it to investing in stock B only. [ 5 marks ]

(c) Assume that a risk-free asset with a return of 0.5% is traded in the market in addition to the two stocks A and B. If you want to combine either stock A or stock B with the risk-free asset, which one should you choose and why? [ 5 marks ]

7. An investor short sells 150 shares of a stock for £94 per share.  The initial margin is 60%. Ignore trading costs not explicitly mentioned.

(a) At which stock price does the investor receive a margin call if the maintenance margin is 30%? [ 7 marks ]

(b) Suppose the stock price increases to £120.  How much money does the investor need to add to the margin account to return to a margin of 50%? [ 7 marks ]

(c)  Explain why a margin account is needed for an investor short selling shares of a stock.

Briefly discuss why the margin typically increases during volatile market conditions. [ 6 marks ]

8. Suppose that the FTSE 100 currently stands at 7,000. An investor buys a long straddle by purchasing one call contract (consisting of 100 call options) and an equal number of puts on the index, both of which expire in two months and have a strike of 7,000. The price of one put contract is listed at £325 and each call contract sells for £336.

(a)  Provide a sketch of the payof diagram of the strategy. Explain which view the investor has on the market. [ 6 marks ]

(b) What will it cost to set up the straddle, and how much profit (or loss) does the investor make if the FTSE 100 falls by 750 points by the expiration dates of the options? What if the FTSE 100 goes up by 750 points by expiration? [ 8 marks ]