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1. (a) An investor buys 1000 shares at £60 each. The initial margin requirement
is 50% and the maintenance margin is 30%. If the stock falls to £50, will the
investor receive a margin call?
(b) 500 shares are purchased on margin at the beginning of the year for £30
per share. The initial margin requirement was 55%. Interest of 13% was paid
on the margin loan and no margin call was ever faced. A dividend of £ 1 per
share is received.
i. If the stock were sold for £40 per share at the end of the year, what is
the return for the year?
ii. Calculate the return if the purchase had been made using cash
instead of on the margin.
(c) Through a margin account, 200 shares are short sold for £ 50 per share.
The initial margin requirement is 45%.
i. If the price of the stock rises to £58 per share, what is the actual
margin in the account?
ii. If the price of the stock falls to £42 per share, what is the actual
margin in the account?
(d) Is it true that the potential loss on a short sale is infinite? What is the
maximum return?
2. The following table provides estimates of the mean returns, standard deviations
and correlations of three assets
A B C
Mean 20 15 10
Standard Deviation 40 25 20
ρ AB = 0.2 ρ AC = −0.3 ρ BC = 0.4
Plot the portfolio frontiers (without short selling) when A is combined with B, when A
is combined with C, and when B is combined with C. Using these frontiers sketch
(you can calculate if you wish) the portfolio set when portfolios can contain all three
assets.
4. Describe the Capital Asset Pricing Model, paying particular attention to its
assumptions. What are its implications for portfolio choice and portfolio evaluation?
5. (i) Define the single index model. How does it differ from the CAPM?
(ii) You have estimated a beta of 0.85 for H&M Inc. What factors would you take into
account in adjusting this value?
Assume that returns are generated by a model where the market is the single factor.
The details of the model for three stocks are:
The expected return on the market is 12% with a standard deviation of 18%.
(v) Discuss the limitations of the market model as a guide to portfolio choice.
G.D. Myles
Department of Economics
University of Exeter
Exeter
EX4 4PU
UK.