FINANCIAL MODELLING AND

D E R I VAT I V E S
TUTORIAL 1 2022-2023

1
INTRODUCTION (1)
• Contact quizzes and tutorials
• Discussion board on Canvas, Discord or e-mail (Dutch or English): m.a.dijkstra@vu.nl
• In short:
• There will be 5 tutorials in total (not in week 4).
• The questions are solved during the tutorial and do not need to be solved before the
tutorial.
• Each tutorial discusses ± 15 questions (so a total of ± 75 questions)
• If you answer 40 or more questions correctly, you add 1 point to your Quiz-grade
• Participating in the tutorials is a good preparation for the quizzes

2
INTRODUCTION (2)
• The first and final question ask for your student number and name, which are needed for the grading.
So even if you arrive late/leave early, you can still earn points if you missed one of the two questions.
• Make sure you enter it correctly!! Entering your student number correctly makes it easy for me to
find you in a lot of data, and you want to be found! Deal sweetener: Any student that inputs their
student number correctly for every week of the tutorial gets 5 bonus points on the tutorial!
• You are allowed to use your books, the lecture slides, a calculator etc. The only condition is that you do
not share your solution with all of the other students
• Working together is fine and encouraged, copying answers thoughtlessly is not
• Each question has a time limit (set arbitrarily). I’ll tell you when your time is almost up.
• Today’s topic will cover chapters 3 – 4 of Berk and DeMarzo as refresher and chapter 10
• Solutions will be posted on canvas later this week

3
QUESTION 0
• Please fill in your name and student number on Mentimeter in the following format:
• Student number, name
• Example: 1234567, Mark Dijkstra
• Please insert your information correctly, especially your student number! This makes
grading easier. Deal sweetener: Any student that inputs their student number
correctly for every week of the tutorial gets 5 bonus points on the tutorial!

4
QUESTION 1
• If the cost of capital is 9%, what is the PV of $296.57 paid in year 11?
A. $113.93
B. $114.93
C. $752.06
D. $758.65

5
QUESTION 1
• If the cost of capital is 9%, what is the PV of $296.57 paid in year 11?
× 1+𝑟 𝑁

Dollars today Dollars in N

years
𝑁
÷ 1+𝑟
𝐶𝐹 296.57
• 𝑃𝑉 = = = $114.93
1+𝑟 𝑁 1.0911

• The correct answer is: B

• More information: Chapter 3 - 4 of Berk and DeMarzo

6
QUESTION 2
• Consider the following investments with a yearly cash payout that starts next year
and will last indefinitely. Investment A pays out €8 every year, while investment B
pays out €6 next year and grows by 2% annually. At what discount rate do you
prefer investment A to B?
A. Over 6%
B. Over 8%
C. Over 12%
D. Over 16%

7
QUESTION 2
CF
• Present value perpetuity: 𝑃𝑉 =
r−g

8 6
• Set up a mathematical equation for the present value of A and B
𝑟 𝑟−0.02
and solve for r.

Year 0 1 2 3 4 5

Cash flow A 0 8 8 8 8 8
Cash flow B 0 6 6.12 6.24 6.37 6.49

8
QUESTION 2
8 6
• Set up a mathematical equation for the present value of A and B and solve for r.
𝑟 𝑟−0.02
• 𝑃𝑉 𝐴 > 𝑃𝑉(𝐵)
8 6
• >
𝑟 𝑟−0.02
• 8 𝑟 − 0.02 > 6𝑟
• 8𝑟 − 6𝑟 > 8 ∙ 0.02
• 𝑟 > 0.08
• The correct answer is: B
• More information: Chapter 4 of Berk and DeMarzo

9
QUESTION 3
• A perpetuity of 60$ per year with the first payment later today is discounted at a
rate of 10%. What is the present value?
A. $545
B. $660
C. $6,000
D. $6,600

10
QUESTION 3
• “A perpetuity is a stream of equal cash flows that occur at regular intervals and
last forever (…). The perpetuity formula assumes that the first payment occurs at
the end of the first period” (Chapter 4 of Berk and DeMarzo).
𝐶𝐹1 60
• 𝑃𝑉 = 𝐶𝐹0 + = 60 + = 60 + 600 = $660
𝑟 0.10

• The correct answer is: B

• More information: Chapter 4 of Berk and DeMarzo
Year 0 1 2 3 4 5

Cash flow 60 60 60 60 60 60
11
QUESTION 4
• You have set your sights on a new iPhone 13 Pro Max. You have two options:
1. A 2-year plan which includes the phone at €58 a month
2. Buy the phone for €977 now and get a 2-year sim-only plan for €23 a month.
• The consumer credit rate is quoted at 3% per year (.25% per month). What is the present
value of the payments in option 1?
A. €535.12
B. €684.82
C. €982.26
D. €1,349.43

12
QUESTION 4
• “An annuity is a stream of N equal cashflows paid at regular intervals (…). Note
that just as with the perpetuity, we adopt the convention that the first payment
takes place at date 1, one period from today.” (Chapter 4 of Berk and DeMarzo).
𝐶 𝐶 𝐶 𝐶 𝐶 1
• 𝑃𝑉 = + + ⋯+ = σ𝑁
𝑛=1 = 1−
1+𝑟 1+𝑟 2 1+𝑟 𝑁 1+𝑟 𝑛 𝑟 1+𝑟 𝑁

Month 0 1 2 23 24

Cash flow 0 €58 €58 €58 €58

13
QUESTION 4
𝐶 1 58 1
• 𝑃𝑉 = 1− = 1− = €1,349.43
𝑟 1+𝑟 𝑁 0.0025 1.002524

• The correct answer is: D

• More information: Chapter 4 of Berk and DeMarzo

• Note:
• Equivalent n-period discount rate = 1 + 𝑟 𝑛 − 1 (Chapter 5 Berk and DeMarzo)
1
• 1 + 0.03 12 − 1 = 0.0025 = 0.25% per month.

14
QUESTION 5
• You have set your sights on a new iPhone 13 Pro Max. You have two options:
1. A 2-year plan which includes the phone at €58 a month
2. Buy the phone for €977 now and get a 2-year sim-only plan for €23 a month.
• The consumer credit rate is quoted at 3% per year (.25% per month). Option 1 was valued at
€1,349.43. Now calculate the present value of option 2. Which option should you take?
A. Option 1 since the PV is higher
B. Option 1 since the PV is lower
C. Option 2 since the PV is higher
D. Option 2 since the PV is lower

15
QUESTION 5
𝐶 1 23 1
• 𝑃𝑉 = 1− + 𝐶𝐹0 = 1− + 977 = €1,512.12
𝑟 1+𝑟 𝑁 0.0025 1.002524

• €1,349.43 costs option 1 < €1,512.12 (costs option 2)

• The correct answer is: B
• More information: Chapter 4 of Berk and DeMarzo

Month 0 1 2 23 24

Cash flow €977 €23 €23 €23 €23

16
The varianc

QUESTION 6
Q6 Which of the following statements is FALSE?
A. The variance increases with the magnitude of the deviations from the mean
B. The variance is the expected squared deviation from the mean
C. Two common measures of the risk of a probability distribution are its variance
and standard deviation
D. If the return is riskless and never deviates from its mean, the variance is equal to
one

17
QUESTION 6
• If the return is riskless and never deviates from its mean, the variance is equal to
one
• If the return is riskless and never deviates from its mean, the variance is zero.

• The correct answer is: D

• More information: Chapter 10 of Berk and DeMarzo

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QUESTION 7
Which of the following equations is INCORRECT?
A) 𝑉𝑎𝑟 𝑅 = 𝑆𝐷(𝑅)
B) 𝑆𝐷 𝑅 = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖 − 𝐸(𝑅) 2
C) 𝑉𝑎𝑟(𝑅) = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖 − 𝐸(𝑅) 2
D) 𝐸(𝑅) = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖

19
QUESTION 7
Which of the following equations is INCORRECT?
A) 𝑉𝑎𝑟 𝑅 = 𝑆𝐷(𝑅)
B) 𝑆𝐷 𝑅 = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖 − 𝐸(𝑅) 2
C) 𝑉𝑎𝑟(𝑅) = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖 − 𝐸(𝑅) 2
D) 𝐸(𝑅) = σ𝑖 𝑝𝑟𝑜𝑏𝑖 × 𝑅𝑖

Answer: A
𝑆𝐷 𝑅 = 𝑉𝑎𝑟(𝑅)

20
QUESTION 8
• You observe the following returns on Greenleaf Phamaceutical’s equity:
10% -20% 12% 40% 55%

• What was the average return on Greenleaf’s shares over this five-year period?
A. 9.67%
B. 11.40%
C. 18.94%
D. 19.40%

21
QUESTION 8
1 1 𝑁
• 𝑅ത = 𝑅1 + 𝑅2 + ⋯ + 𝑅𝑁 = σ 𝑅
𝑁 𝑁 𝑛=1 𝑛
1
ത
• 𝑅 = 0.1 − 0.2 + 0.12 + 0.40 + 0.55 = 0.1940 = 19.40%
5

• The correct answer is: D

22
QUESTION 9
• You observe the following returns on Greenleaf Pharmaceutical’s equity:
10% -20% 12% 40% 55%

• What was the standard deviation of the return on Greenleaf’s shares over this five-year
period (remember: average return was 19.4%)?
A. 6.77%
B. 8.47%
C. 26.03%
D. 29.10%

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 2
0.10 − 0.194 0.008836

2
−0.20 − 0.194 0.155236

2
0.12 − 0.194 0.005476

2
0.40 − 0.194 0.042436

QUESTION 9 0.55 − 0.194 2

0.126736

1 Sum 0.33872
• 𝑉𝑎𝑟 𝑅 = 𝜎 2 = σ𝑛𝑖=1 𝑅𝑖 − 𝑅ത 2
𝑛−1 Variance 1
5−1
∙ 0.33872 = 0.08468

• 𝑆𝐷 𝑅 = 𝜎 = 𝑉𝑎𝑟(𝑅)
• Note: Use n – 1 when you have a sample of realized returns (not a population).
1
• 𝑉𝑎𝑟 𝑅 = ሾ 0.10 − 0.194 2 + −0.20 − 0.194 2
+ 0.12 − 0.194 2
+ 0.40 − 0.194 2
+
5−1
0.55 − 0.194 2 ሿ = 0.0847

• 𝑆𝐷 𝑅 = 0.0847 = 0.2910 = 29.10%

• The correct answer is: D
• More information: Chapter 10 of Berk and DeMarzo

24
QUESTION 10
Abramis Brama produces canned tuna. Which of the following shark-related risks is
not diversifiable?
A. Shark bits are found in the tuna, leading to a product recall
B. A worldwide fear of shark attacks hampers international trade
C. CEO Ulf Torkelsson is killed by sharks while he is on holidays
D. Abramis Brama Tuna is featured in the movie Shark Tale 2, boosting sales

25
QUESTION 10
• “Fluctuations of a stock’s return that are due to firm-specific news are independent
risks. This type of risk is also referred to as firm-specific, idiosyncratic, unique or
diversifiable risk.” (Chapter 10 of Berk and DeMarzo).
• Events related to the CEO or the risk of a product recall are related to a specific
firm and are diversifiable risks.
• A fear that hampers international trade is systematic risk.
• The correct answer is: B

26
QUESTION 11
What is the expected return of a portfolio invested 25% each in A and B and 50% in C?
The probability of a boom is 35% and the probability of a bust is 65%.
Return A B C
Boom 7% 15% 33%
Bust 13% 3% -6%

A. 8.35%
B. 9.61%
C. 12.88%
D. 14.65%

27
QUESTION 11
• 𝐵𝑜𝑜𝑚: 𝐸 𝑅𝑝 = 0.25 ∙ 0.07 + 0.25 ∙ 0.15 + 0.5 ∙ 0.33 = 0.22

• 𝐵𝑢𝑠𝑡: 𝐸 𝑅𝑝 = 0.25 ∙ 0.13 + 0.25 ∙ 0.03 + 0.5 ∙ −0.06 = 0.01

• 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛: 𝐸 𝑅𝑝 = 0.35 ∙ 0.22 + 0.65 ∙ 0.01 = 0.0835

• The correct answer is: A

28
QUESTION 12
What is the standard deviation of a portfolio invested 25% each in A and B and 50% in
C? The probability of a boom is 35% and the probability of a bust is 65%.
Return A B C
Boom 7% 15% 33%
Bust 13% 3% -6%

A. 10.0%
B. 13.7%
C. 82.1%
D. 100.3%

29
QUESTION 12
• 𝐵𝑜𝑜𝑚: 𝐸 𝑅𝑝 = 0.25 ∙ 0.07 + 0.25 ∙ 0.15 + 0.5 ∙ 0.33 = 0.22

• 𝐵𝑢𝑠𝑡: 𝐸 𝑅𝑝 = 0.25 ∙ 0.13 + 0.25 ∙ 0.03 + 0.5 ∙ −0.06 = 0.01

• 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛: 𝐸 𝑅𝑝 = 0.35 ∙ 0.22 + 0.65 ∙ 0.01 = 0.0835

2 2
• 𝑉𝑎𝑟 𝑅𝑝 = 0.35 0.22 − 0.0835 + 0.65 0.01 − 0.0835 = 0.0100

• 𝑆𝐷 𝑅𝑝 = 𝑉𝑎𝑟 𝑅𝑝 = 0.0100 = 10%

• The correct answer is: A

30
QUESTION 13
Suppose we have collected 504 daily returns (2 years) 𝑟1 , 𝑟2 , … , 𝑟504 for Demon
Cleaner Detergent’s stock. Let 𝑟ҧ be the average daily return. It is known that
σ504 𝑟
𝑖=1 𝑖 − 𝑟ҧ 2
equals 0.205. The yearly volatility for Demon Cleaner’s stock is:
A. 0.10%
B. 3.2%
C. 32%
D. 51%

31
QUESTION 13
2 2
• 𝜎𝑎𝑛𝑛𝑢𝑎𝑙 = 𝜎𝑑𝑎𝑙𝑖𝑦 ∙ 252 𝜎𝑎𝑛𝑛𝑢𝑎𝑙 = 𝜎𝑑𝑎𝑖𝑙𝑦 ∙ 252

2
• 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑑𝑎𝑖𝑙𝑦 𝐷𝑒𝑚𝑜𝑛 𝐶𝑙𝑒𝑎𝑛𝑒𝑟 =
1
504−1
∙ σ504
𝑖=1 𝑟𝑖 − ത𝑟 1
= 504−1 ∙ 0.205 = 0.000408

1
• 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑦𝑒𝑎𝑟𝑙𝑦 𝐷𝑒𝑚𝑜𝑛 𝐶𝑙𝑒𝑎𝑛𝑒𝑟 = 504−1 ∙ 0.205 ∙ 252 = 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑑𝑎𝑖𝑙𝑦 ∙ 252 = 0.000408 ∙ 252 =
0.1027

• 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑦𝑒𝑎𝑟𝑙𝑦 𝐷𝑒𝑚𝑜𝑛 𝐶𝑙𝑒𝑎𝑛𝑒𝑟 = 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑦𝑒𝑎𝑟𝑙𝑦 = 0.1027 = 0.320

• The correct answer is: C

32
QUESTION 14
The covariance between daily stock returns for construction company stocks Dozer
and Truckfighters is 0.035. The variance is equal to 0.52 for Dozer and 0.28 for
Truckfighters. The correlation between the returns of Dozer and Truckfighters is:
A. 0.02
B. 0.09
C. 0.46
D. 0.6

33
QUESTION 14
• Variance-Covariance matrix: 0.52 0.035
0.035 0.28
𝐶𝑜𝑣 𝐷𝑜𝑧𝑒𝑟,𝑇𝑟𝑢𝑐𝑘𝑓𝑖𝑔ℎ𝑡𝑒𝑟𝑠 0.035
• 𝜌 𝐷𝑜𝑧𝑒𝑟, 𝑇𝑟𝑢𝑐𝑘𝑓𝑖𝑔ℎ𝑡𝑒𝑟𝑠 = = = 0.09
𝑆𝐷 𝐷𝑜𝑧𝑒𝑟 ∙𝑆𝐷 𝑇𝑟𝑢𝑐𝑘𝑓𝑖𝑔ℎ𝑡𝑒𝑟 0.52 0.28

• The correct answer is: B

• More information: Chapter 11 of Berk and DeMarzo

34
QUESTION 15
Consider the following (yearly) covariance matrix between stocks A and B:
0.057 −0.02
−0.02 0.24
What is the yearly volatility of a portfolio that has $2000 invested in A and $3000
invested in B?
A. 29.31%
B. 30.12%
C. 66%
D. 81%

35
QUESTION 15
• The covariance matrix should be read as follows:
A B
Var(A) A 0.057 -0.02 Cov(A,B)
B -0.02 0.24

Cov(A,B) Var(B)

• Note that 𝑉𝑎𝑟 𝐴 = 𝐶𝑜𝑣 𝐴, 𝐴 = 0.057

1 2 1
• σ𝑇𝑡=1 𝑅𝐴,𝑡 − 𝑅ത𝐴 = σ𝑇𝑡=1(𝑅𝐴,𝑡 − 𝑅ത𝐴 )(𝑅𝐴,𝑡 − 𝑅ത𝐴 )
𝑇−1 𝑇−1

36
 0.057 −0.02
−0.02 0.24

QUESTION 15
• 𝑉𝑎𝑟𝑝 = 𝑤𝐴2 ∙ 𝑉𝑎𝑟𝐴 + 𝑤𝐵2 ∙ 𝑉𝑎𝑟𝐵 + 2 ∙ 𝑤𝐴 ∙ 𝑤𝐵 ∙ 𝐶𝑜𝑣(𝐴, 𝐵)
2,000 3,000
• 𝑤𝐴 = = 0.4 𝑤𝐵 = = 0.6
2,000+3,000 2,000+3,000

• 𝑉𝑎𝑟𝑝 = 0.42 ∙ 0.057 + 0.62 ∙ 0.24 + 2 ∙ 0.4 ∙ 0.6 ∙ −0.02 = 0.0859

• 𝑆𝐷𝑝 = 0.0859 = 0.2931 = 29.31%

• The correct answer is: A

• More information: Chapter 11 of Berk and DeMarzo

37
QUESTION 16
Consider the following (yearly) covariance matrix between stocks A and B:
0.057 −0.02
−0.02 0.24
What is the yearly volatility of a portfolio that consists of a long position of $2000 in A
and short position of $1000 in B?
A. 4.3%
B. 20.8%
C. 54.8%
D. 74.0%

38
 0.057 −0.02
−0.02 0.24

QUESTION 16
• 𝑉𝑎𝑟𝑝 = 𝑤𝐴2 ∙ 𝑉𝑎𝑟𝐴 + 𝑤𝐵2 ∙ 𝑉𝑎𝑟𝐵 + 2 ∙ 𝑤𝐴 ∙ 𝑤𝐵 ∙ 𝐶𝑜𝑣(𝐴, 𝐵)
2,000 −1,000
• 𝑤𝐴 = = 2 𝑤𝐵 = = −1
2,000−1,000 2,000−1,000

• 𝑉𝑎𝑟𝑝 = 22 ∙ 0.057 + −1 2 ∙ 0.24 + 2 ∙ 2 ∙ (−1) ∙ −0.02 = 0.548

• 𝑆𝐷𝑝 = 0.548 = 74.03%

• The correct answer is: D

• More information: Chapter 11 of Berk and DeMarzo

39
QUESTION 17
• Please fill in your name and student number on Mentimeter in the following format:
• Student number, name
• Example: 1234567, Mark Dijkstra
• Please insert your information correctly, especially your student number! This makes
grading easier. Deal sweetener: Any student that inputs their student number
correctly for every week of the tutorial gets 5 bonus points on the tutorial!

40
 TUTORIALS&QUIZZES
• Wednesday (tomorrow):
• Tutorials (9, 11, 13.30 Chiarlo) – HG07A32
• Q&A (15.30 Dijkstra) followed by Fun with Finance
• Thursday: Quiz
• 7:00 – 21:00
• Correct answers are shown after 22:00
• Use a decimal point and a comma as thousands separator
• For example: 12,345.67

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