Assignment 2

Full marks: 40 marks

There are FOUR questions in this individual assignment, which account for 15% of the

total course grade. Please answer all parts in the question and make sure that your

responses are clear, concise, and succinct.

You are required to handwrite your answers on the “Standard Answer Sheet” and then

convert your responses into a single PDF file. This PDF file should be uploaded to the

“Assignment 2 Collection Box” on the SOUL platform for your class before the

deadline of 13 Dec 2024 (Fri) at 11:59 pm.

Question One (10 marks)

Suppose Portfolio X, with a 16% expected return and a beta of 1, is a well-diversified

portfolio and the risk-free asset is 8%. Assume also the CAPM holds.

a. Suppose there is no arbitrage opportunity in the market. What should be the

expected return on the market portfolio? Briefly explain your answer.

[2 marks]

b. If Portfolio Y has an expected return of 12% and a beta of 0.25, is there any

arbitrage opportunity in the market? Design a trading strategy for an investor

who wants to make riskless profit without using his money. Show your steps

clearly and explain your answer briefly. [8 marks]

Question Two (5 marks)

A bond, with a face value of $1,000 and a yield to maturity of 6%, currently sells for

$1,050. Suppose that if the yield increases by 25 basis points, the price of the bond falls

to $1,020. What is the Macaulay Duration of this bond? Show your workings and

briefly explain your answer. [5 marks]

Question Three (15 marks)

a. Find the Macaulay duration of a 6% coupon bond making annual coupon

payments if it has four years until maturity, a face value of $1,000 and a yield

to maturity of 6%. Show your workings. [4 marks]

b. What is the Macaulay duration of the bond in part a. if the yield to maturity is

10%? Show your workings. [4 marks]

c. What conclusion can you draw from your answer in part a. and b.? [3 marks]

d. For the bond in part a., find the change in the price of the bond using the duration

rule if the yield to maturity increases from 6% to 6.25%. Show your workings.

[4 marks]

CCBS4024 IPM Assignment 2 2024/25 S1

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Question Four (Total 10 marks)

Suppose the spot price for hogs is $120 and its futures price expiring in one year is

$125. The interest rate for one year is 8%.

a. Determine whether the futures price of hogs is overpriced or underpriced. Show

your workings and briefly explain your answer. [3 marks]

b. Is there any arbitrage opportunity presented in the question? If yes, describe the

transactions necessary to take advantage of this opportunity. How much profit

can be made? Show your workings clearly and briefly explain your answer.

[7 marks]