midterm practice 8

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University of Mississippi *

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Economics

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Jan 9, 2024

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Financial Economics Midterm Practice Question 2: Risk and Return (20 points) a) Explain the relationship between risk and return in financial investments. How does the risk-return trade-off influence investment decisions? b) Define beta in the context of the Capital Asset Pricing Model (CAPM). How is beta used to assess systematic risk? c) Compare and contrast systematic risk and unsystematic risk. Provide examples of each. Question 3: Asset Pricing Models (15 points) a) Discuss the key assumptions underlying the Capital Asset Pricing Model (CAPM). Critically evaluate the realism of these assumptions in real-world financial markets. b) Explain the Arbitrage Pricing Theory (APT) and how it differs from the CAPM in terms of its approach to pricing assets. Question 4: Financial Derivatives (20 points) a) Define financial derivatives and provide examples of common derivatives instruments. b) Explain the basic principles of options trading, including the concepts of call and put options. c) Discuss the risks associated with using financial derivatives and how these risks can be managed. Question 5: Corporate Finance (15 points)
a) Define the concept of cost of capital. How is the cost of capital used in capital budgeting decisions? b) Discuss the Modigliani-Miller theorem and its implications for capital structure decisions. Under what conditions do the theorem's assumptions hold?
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