## Examination Paper

Examination Session: May/June 2023

Year:2023

Exam Code:ECON3251-WE01

Title: Financial Theory and Corporate Policy

Release Date/Time: 16 May 2023 – 9:30am

Latest Submission Date/Time: 17 May 2023 – 9:30am

Format of Exam: Take home exam

Duration: 2 hours

Word/Page Limit: 3000 words

Expected form of Submission: Word document using template provided or PDF of

Handwritten Work

and the Exam Code e.g Z012345ECON11111-WE01

Submission method: Turnitin

Instructions to Candidates:

There are TWO sections in this paper.

Answer TWO questions, ONE from each section.

Each section carries equal weight.

Where a question is sub-divided, each sub-part carries the stated weight.

### SECTION A  金融理论与公司政策代考

Question 1

a) An investor is given the following information:

Explaining the method(s) and the underlining concept(s), how could the investor use Arrow-Debreu pure securities to replicate the payoff of security X and security Y? What are the prices of pure security 1 and pure security 2?(20 marks)  金融理论与公司政策代考

b) Explaining the method, compute the capital weights on portfolios of X and Y assets that replicate the payoffs of pure securities 1 and 2. Further consider that an investor has an initial wealth of £1000 — he can short-sell securities; however, he must be able to meet all claims under the occurrence of either state. Explaining the method, what is the maximum number of security Y he could sell (short selling) to buy security X? (investor may buy fractions of shares).(40 marks)

c) Suppose that you have estimated the expected returns and betas of the following five stocks using annual data available for the last 10 years:

The risk-free rate of interest and the expected return on the market are 5% and 14% per annum, respectively.

Explain the extent to which data is consistent with the Capital Asset Pricing Model (CAPM) and whether there is any arbitrage opportunity; what advice would you give to an investor who would like to hold a portfolio with a beta equal to 1? Discuss whether any arbitrage opportunity exists.(40 marks)

### Question 2

a) Discuss the Fisher separation framework in a world with perfect capital markets.(20 marks)

b) A firm has two mutually exclusive projects, generating the following state-contingent cash flows (£) at time T in the future:

The firm has fixed debt payments of £7 and limited liability.

Which project should the firm’s senior manager chose to maximize their expected utility? How would your answer change if you remove the limited liability assumption? Explain.(40 marks)

c) Consider the projects in part (b) and the scenario that the firm is unleveraged. The senior manager’s utility – dependent on wealth – is given by

Explain the concepts of certainty equivalent wealth and Markowitz risk premium; provide a definition of risk aversion; considering this is the only project the firm can take, where the state-contingent cash flow at time T is the only wealth created, determine the risk premium of projects A and project B.(40 marks)

### SECTION B  金融理论与公司政策代考

Question 3

‘Agency problems arise when the interests of shareholders are not aligned with those of managers’.Critically evaluate a formal framework that explains how contracts can be designed to better align the interests of the two parties and reduce the agency problems.(100 marks)

Question 4

‘Mergers and Acquisitions (M&A) are not always guaranteed to succeed’.

Critically evaluate this proposition; to what extent do you agree or disagree with this proposition?

(100 marks)