Section A (Compulsory) Answer True or False to each of the 24 statements; For each false statement, also explain why the statement is false 1. According to the absolute risk aversion concept, very risk-averse individuals may be unwilling to pay large amounts for insurance if they have high marginal utility. 2. The Arrow risk premium is how much we need to change the asset's return in order to make an investor indifferent between purchasing and not purchasing. 3. The replication strategy is always self-financing, when we are trying to price an option over multi-periods. 4. If the put call parity does hold then there is an arbitrage opportunity. 5. If there are two states of the world and two traded assets the underlying and the bond the option is a redundant asset in that its payoffs can be replicated by a portfolio of the two assets. 6. The independence axiom says that VA, if an individual prefers a lottery with a probability A of outcome and a probability (1入) of outcome z to a lottery with a probability A of outcome y and a probability (1入) of outcome z then she prefers z to y. 7. Negative exponential utility functions are also known as the constant relative risk aversion utility function. 8. The current risk-free rate is 0.5%. The Capital Asset Pricing Model states that it is possible to have an asset with a standard deviation of returns of 15% per year and an expected annual return of 0.5%. 9. Expected utility can be used to compare between risky alternatives. 10. Risk can be diversified away by adding more and more assets to a portfolio. 11. The larger an individual's wealth the smaller the added (marginal) utility received from an additional increase in wealth. 12. The separation theorem is concerned with the choice of a mean-variance efficient portfolio of risky assets. 13. The utility of a £1 gain is larger than the utility of a £1 loss for a risk-averse investor. 14. An ordinal utility function is one that denotes the ranking of preferences and the strength of preferences. 15. The payoff from a short position in a European put option is min(STX, 0).
Section A (Compulsory)
Answer True or False to each of the 24 statements;
For each false statement, also explain why the statement is false
1. According to the absolute risk aversion concept, very risk-averse individuals may
be unwilling to pay large amounts for insurance if they have high
order to make an investor indifferent between purchasing and not purchasing.
3. The replication strategy is always self-financing, when we are trying to price an option over multi-periods.
4. If the put call parity does hold then there is an arbitrage opportunity.
5. If there are two states of the world and two traded assets the underlying and the bond the option is a redundant asset in that its payoffs can be replicated by a portfolio of the two assets.
6. The independence axiom says that VA, if an individual prefers a lottery with a probability A of outcome and a probability (1入) of outcome z to a lottery with a probability A of outcome y and a probability (1入) of outcome z then she prefers z to y.
7. Negative exponential utility functions are also known as the constant relative risk aversion utility function.
8. The current risk-free rate is 0.5%. The
9. Expected utility can be used to compare between risky alternatives.
10. Risk can be diversified away by adding more and more assets to a portfolio.
11. The larger an individual's wealth the smaller the added (marginal) utility received
from an additional increase in wealth.
12. The separation theorem is concerned with the choice of a mean-variance efficient portfolio of risky assets.
13. The utility of a £1 gain is larger than the utility of a £1 loss for a risk-averse investor.
14. An ordinal utility function is one that denotes the ranking of preferences and the strength of preferences.
15. The payoff from a short position in a European put option is min(STX, 0).
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