Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 1: Solution

The correct answer is in bold font

Question 1: The following code will provide the bar plot of a numeric time series x.

(a) barplot(x, ylab="Value", xlab="Date"). Hint: This will construct the relevant bar plot with proper axis names.
(b) plot(x, ylab="Value", xlab="Date"). Hint: This will plot a simple line plot of object ‘x’ over time.
(c) bar(x, ylab="Value", xlab="Date"). Hint: This will result in an error.
(d) barplot(x, y, ylab="Value", xlab="Date"). Hint: This will result in an error as barplot is only appropriate in plotting univariate
series.

Question 2: The following code will provide the density distribution of a numeric variable x.

(a) plot(x). Hint: This will simply plot the observations in the vector.
(b) hist(x). Hint: This will plot the frequency distribution of variable x.
(c) hist(x, prob= T). Hint: This will plot the density distribution of x.
(d) barplot(x). Hint: This will create a bar plot of the values in x, which is not suitable for representing a density distribution.
Question 3: Which of the following commands is used to attach or load the package in R current working session?

(a) attach() Hint: Allows access to objects of the data frame

(b) library() Hint: packages are stored in the library
(c) [Link]() Hint: the package is a collection of R functions, data, and compiled code
(d) detach() Hint: detach removes a database or object library/package from the search path

Question 4: Point out the correct statement.

(a) c() function is used to combine elements in the vector. Hint: v<- c(1,2)
(b) The hash ## symbol is used to assign a value to a variable Hint: a<-5
(c) NA shows undefined values in R. Hint: NA stands for not available
(d) The NaN represents missing values in the dataset. Hint: a = 0/0

Question 5: Point out the correct statement about the c() function:

(a) To extract rows. Hint: x[2, ] to extract 2nd row.

(b) To extract columns. Hint: x[, 2] to extract 2nd column.
(c) To combine elements. Hint: a= c(1,2,5,7)
(d) To extract the rows and columns. Hint: x[2,3] to extract 2nd row and 3rd column.
Question 6: Which of the following statements is correct?

a. “<-” is used to assign the value. Hint: a<-5, assigns 5 to a.

b. “=” is always for testing equality. Hint: 4==5, compares 4 and 5 for equality.
c. “!!=” Is “not-equal-to operator”. Hint: 6!=8, compares 6 is not equal to 8 and returns TRUE.
d. “<” is used for “less than or equal to”. Hint: 4<=7, compares if 4 is less than equal to 7.

Question 7: Which of the following sequence is used to load the in-built data (taking the example of gala data) and view the data in R?

a. [Link](“faraway”), data(“gala”). Hint: there is a need to load the package in the R.

b. [Link](“faraway”), library(faraway), data(“gala”). Hint: view command is used to view the dataset.
c. library(faraway), data(“gala”), View(gala). Hint: there is a need to install the package in the R.
d. [Link](“faraway”), library(faraway), data(“gala”), View(gala). Hint: after installing and loading the required
package, one can load the data and view it.

Question 8: In R studio, typically the codes are written on:

a) script editor. Hint: code is not executed until we run and send it to the console.
b) Console. Hint: evaluation of code takes place in the console.
 c) Environment window. Hint: The environment tab provides meta-project information such as what values you have stored in
variables.
d) Plot window. Hint: Plots tab displays plots, graphs, or charts.

Question 9: Which of the following statement is incorrect?

a) 4^2+5-3 will give the output of 10. Hint: it will follow the BODMAS rule, ^ stands for exponent.
b) 4^2+5-3 will give the output of 18. Hint: it will follow the BODMAS rule, ^ stands for exponent.
c) 4*2+5-3 will give the output of 10. Hint: it will follow the BODMAS rule, * stands for multiplication.
d) 5-3 will give the output of 2. Hint: - stands for subtraction.

Question 10: Which of the following codes is used to extract/check the first few observations from the dataset?

a) tail(). Hint: it is used to read the last few rows of the dataset.
b) head(). Hint: tail function is opposite to that of the head function.
c) View(). Hint: it is used to view the dataset.
d) summary(). Hint: it will give basic statistical measures of each variable.
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 2: Solution

The correct answer is in bold font

Question 1: Which of the following statements is incorrect in the context of security prices in the financial
markets?

(a) The observed price is inefficient. Hint: The Observed price includes noise and hence is inefficient.
(b) Efficient (true) price is unobserved. Hint: Market prices are observed, they include noise and are
hence inefficient.
(c) Efficient (true) price is more volatile. Hint: Observed prices include noise and hence are more
volatile (and inefficient also).
(d) Fundamental information increases the efficiency of prices. Hint: The more fundamental
information incorporated into the prices, the more efficient they are.

Question 2: Which of the following statement is incorrect in the context of market participants?

(a) Noise traders' trading activity instills information in prices. Hint: Noise traders are uninformed
or carry stale information. Their trading activity incorporates noise in prices.
(b) Informed traders' trading activity instills information in prices. Hint: Informed traders are
generally large institutional investors. They spend considerable resources on information
acquisition. Their trading activity incorporates true and fundamental information in prices.
(c) Market makers offer both buy and sell-side quotes. Hint: Market makers have the responsibility
of ensuring the continuous and smooth functioning of the market. So, they offer both-sided
quotes continuously.
(d) Liquidity traders' trading activity instills noise in prices. Hint: Liquidity traders are driven by the
need of trading (buying or selling), they do not have information. Thus, their trading activity instills
noise in prices.

Question 3: Which of the following statements is incorrect in the context of efficient markets?

(a) One cannot make money using public information in a semi-strong efficient market. Hint: If a
market is a semi-strong form efficient, then public information is already incorporated.
(b) One can only make money using private information if the market is strong form efficient. Hint:
If a market is a strong form efficient, then one cannot make money using any information.
(c) If a market is a semi-strong form efficient (and trading on private information is unethical and
illegal) then the best course of action is to stay invested in the market. Hint: If one cannot beat
the market then one should keep investing in the market.
 (d) If a market is weak-form efficient, then one can make money using public information. Hint: A
weak form efficient market incorporates all the information available in past prices. However, all
the public information may not be incorporated.

Question 4: Which of the following statement is incorrect in the context of Risk preferences?

(a) A risk-neutral person is equally happy with getting USD 100 with certainty or making a gamble
that has USD 100 as an expected outcome. Hint: A risk-neutral person is not concerned with the
increase or decrease in the risk of the proposition but with the expected outcome.
(b) A risk-neutral person prefers to gamble more if the risk is increased. Hint: A risk-neutral person
is indifferent to the risk of a gamble, and is only concerned with the expected outcome.
(c) The utility function of a risk-neutral person is linear. Hint: For the risk-neutral person, the
incremental utility for each unit of expected outcome is the same irrespective of the change in
risk profile.
(d) A risk-preferring person would take less reward if the risk of the gamble is increased. Hint: Since
the risk preferring person derives additional utility from the gamble with higher risk, she would
be willing to take the gamble even with a lower reward, if it entails higher risk.

Question 5: In pure limit order book markets, liquidity is provided by

(a) Designated Market Makers. Hint: There are no designated market makers in pure limit order book
markets.
(b) Market orders. Hint: Market orders consume liquidity.
(c) Limit orders. Hint: Limit orders patiently waiting in the order book and provide liquidity to
incoming market orders.
(d) Brokers. Hint: Brokers do not directly trade in financial markets; they route their client’s orders.

Question 6: Compute the relative spread for the best Ask: Rs 230 and the best Bid Rs 225.
𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒𝑆𝑝𝑟𝑒𝑎𝑑
(a) 0%-2%; Hint: 𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑆𝑝𝑟𝑒𝑎𝑑 =
𝑀𝑖𝑑_𝑃𝑟𝑖𝑐𝑒
𝑨𝒃𝒔𝒐𝒍𝒖𝒕𝒆𝑺𝒑𝒓𝒆𝒂𝒅 𝟓
(b) 2%-4%; Hint: 𝑹𝒆𝒍𝒂𝒕𝒊𝒗𝒆 𝑺𝒑𝒓𝒆𝒂𝒅 = = 𝟐𝟑𝟎+𝟐𝟐𝟓 = 𝟐. 𝟐𝟎%
𝑴𝒊𝒅_𝑷𝒓𝒊𝒄𝒆
𝟐
𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒𝑆𝑝𝑟𝑒𝑎𝑑
(c) 4%-6%; Hint: 𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑆𝑝𝑟𝑒𝑎𝑑 = 𝑀𝑖𝑑_𝑃𝑟𝑖𝑐𝑒
𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒𝑆𝑝𝑟𝑒𝑎𝑑
(d) 6%-8%; Hint: 𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑆𝑝𝑟𝑒𝑎𝑑 =
𝑀𝑖𝑑_𝑃𝑟𝑖𝑐𝑒
Question 7: For a rational individual the following is an incorrect statement.

(a) USD 1 today is preferred to USD 1 tomorrow. Hint: Due to the time value of money, rational
individuals always prefer a dollar today to a dollar tomorrow.
(b) A rational individual is a risk-neutral person. Hint: A rational individual is not risk-neutral as she
demands additional premia to bear the extra risk.
(c) A rational individual is a risk-averse person. Hint: A rational individual does not like risk, and would
want an extra premium to bear that risk.
(d) A rational individual would prefer less risk for a given level of return and a higher return for a
given level of risk. Hint: Risk-averse individuals require a certain extra premium to bear additional
risk.

Question 8: An individual is (A) a lender or (B) a borrower if

(a) (A) If he is a consumer (B) If he is a saver. Hint: A consumer spends more in consumption and
less in investment/lending and also may need to borrow to maintain that consumption; a saver
is more of an investor/lender
(b) (A) If he is a consumer (B) If he is an investor. Hint: A consumer spends more in consumption
and less in investment/lending and also may need to borrow to maintain that consumption; an
investor can also be a lender
(c) (A) If he is a saver (B) if he is an investor. Hint: A saver or investor can invest/lend
(d) (A) If he is an Investor (B) if he is a consumer. Hint: An investor can lend; a consumer may
need to borrow to maintain the consumption levels

Question 9: For a rational individual consuming normal goods with positive utility, the following statement
is correct with respect to the marginal utility of consumption.

(a) The marginal utility is constant. Hint: If one consumes more and more of a certain good, the
marginal utility of the consumption is not the same.
(b) The marginal utility of wealth becomes negative. Hint: While the marginal utility of normal goods
such as food or clothing can become negative after excessive consumption, the marginal utility of
wealth never becomes negative.
(c) Marginal utility increases with more consumption. Hint: As one consumes something in excess,
the utility and satisfaction of the consumers do not increase.
(d) Marginal utility decreases after a certain level of consumption. Hint: As one consumes
something in excess, the utility and satisfaction of that consumption start to decrease after a
certain limit.
Question 10: The existence of financial instruments with different interest rates suggests

(a) The difference in taste and preferences. Hint: Unlike goods like food and clothing, tastes and
preferences are not a factor in financial instruments (assuming that investors are rational).
(b) Indicates the uncertainty in the economic and financial environment. Hint: Economic and
financial uncertainty affects the risk of different financial instruments differently. Riskier
instruments are expected to offer a higher rate of interest.
(c) Presence of different opportunity sets. Hint: While, there are different opportunity sets available
to individuals, financial markets facilitate the optimization of the time pattern of consumption
and also across different opportunity sets. Thus, in the presence of efficient markets, different
opportunity sets may not result in different interest rates
(d) Indicates the certainty in the economic and financial environment. Hint: Economic and financial
environment is not certain.
The correct answer in bold font

Question 1: Theoretically, in which of the following situations would you get the largest reduction in risk
by spreading your investment across two stocks?

(a) The two shares are perfectly correlated: Hint: A high level of correlation would result in least
amount of diversification.
(b) There is no correlation: Hint: Zero correlation indicates considerable diversification; however,
further diversification can be achieved with securities having negative correlations.
(c) There is modest negative correlation: Hint: Modest negative correlation can offer considerable
diversification which further increases as the magnitude of negative correlation is increased.
(d) There is perfect negative correlation (𝝆=-1). Hint: Maximum possible negative correlation is -1,
i.e., perfect negative correlation, where maximum diversification benefits are observed.

Question 2: A positive covariance between two securities indicates that.

(a) The two securities move in different directions. Hint: Negative covariance would suggest that the
two securities move in different directions.
(b) The two securities move in the same direction. Hint: Positive covariance (Correlation) indicates
that the securities move in the same direction.
(c) The two securities are low risk, individually. Hint: Covariance of the security does not necessarily
indicate the risk of the two securities individually.
(d) The two securities are high risk, individually. Hint: Covariance of the security does not necessarily
indicate the risk of the two securities individually.

Question 3: Simply adding more securities to the portfolio leads to diversification

(a) By reducing the systematic risk. Hint: Systematic risk cannot be eliminated by adding more
securities to the portfolio.
(b) By reducing the market risk. Hint: Market risk is systematic and cannot be eliminated just by
adding more securities.
(c) By reducing the stock specific/idiosyncratic risk. Hint: Adding more securities to the portfolio
provides diversification by eliminating stock specific diversifiable risk.
(d) This diversification is more if the securities have higher correlation. Hint: The benefits of
diversification are more if securities have low or negative correlation.

Question 4: Theoretically, no diversification is achieved in a stock portfolio.

(a) When all the stocks in the portfolio are perfectly correlated (𝒑𝟏𝟐 ) = 𝟏. Hint. In this case, the
securities move in exact lockstep manner and no diversification is achieved.
(b) When the stocks in the portfolio have no correlation at all (𝑝12 ) = 0. Hint. In this case, the
securities do no move in exact lockstep manner and therefore some diversification is achieved.
 (c) When the stocks in the portfolio have perfect negative correlation (𝑝12 ) = −1. Hint. In this case,
the securities move exactly in opposite manner, and therefore maximum diversification is
achieved.
(d) When the stocks in the portfolio have a correlation that is less than perfect (𝑝12 ) < 1. Hint. For
any correlation that is less than one some amount of diversification due to reduction in risk is
always achieved.

Question 5: For an N-stock portfolio the following is an incorrect statement.

(a) There are N variance (stock specific terms). Hint. The diagonal terms include N 𝑤𝑖2 ∗ 𝜎𝑖2 terms
that are driven by stock specific variance.
(b) There are N*(N-1) covariance terms. Hint. The off-diagonal terms include 𝜌12 ∗ 𝑤1 ∗ 𝜎1 ∗ 𝑤2 ∗ 𝜎2
terms that are N*(N-1) and driven by covariances (correlations).
(c) For a sufficiently large number of securities the variance terms are eliminated. Hint. The
1
2
summation of diagonal terms (𝑁) ∗ 𝜎avg tends to zero as N becomes sufficiently large (N → ∞).
(d) For a sufficiently large number of securities the covariance terms are eliminated. Hint. The
𝑵−𝟏
covariance ̅ 𝒋𝒌
𝝈 are not eliminated as N becomes sufficiently large (N → ∞).
𝑵

Question 6: A portfolio is considered to be efficient if.

(a) No other portfolio offers higher expected returns with the same risk. Hint: A portfolio that
offers highest expected return for a given risk or lowest risk for a given expected return, on the
feasible frontier, is considered as efficient.
(b) It is the risk-maximizing portfolio. Hint: Efficient portfolio should aim to minimize the risk.
(c) There is no portfolio with a higher return. Hint: The efficient portfolio would offer highest return
for a given level of risk. Both risk and return are important parameters in mean-variance
framework of efficient portfolios.
(d) There is no portfolio with a lower risk. Hint: The efficient portfolio would offer lowest risk for a
given level of expected return. Both risk and return are important parameters in mean-variance
framework of efficient portfolios.

Question 7: Identify the incorrect statement.

(a) Bearing more market risk offers higher expected return. Hint: Markets only reward investors for
bearing systematic risk (i.e., market risk).
(b) Adding securities with low correlation among each other may offer diversification. Hint: Adding
securities with low correlation further helps in diversifying the portfolio risk.
 (c) Gold security is risky and therefore a portfolio with a high-proportion of this stock should offer
a higher expected return. Hint: Risk of securities with gold as underlying asset is largely
idiosyncratic in nature and therefore can be diversified. Markets do not reward bearing
idiosyncratic risk.
(d) Investing more and more in risk-free asset decreases the return expectations from the portfolio.
Hint: Risk-free assets offer lower returns that are largely certain. Therefore, a portfolio with higher
investment into risk-free assets lead to lower return expectations.

Question 8: If an investor is holding a security individually, what is the most appropriate risk measure for
him.

(a) Market risk (Beta): Hint: Since the investment is not diversified, the idiosyncratic risk also forms
considerable portion of the investment risk.
(b) Total Risk (Standard Deviation). Hint: Since the investment is not diversified, the investment
risk is the total risk of the stock, that is, standard deviation.
(c) Non-diversifiable risk. Hint: While non-diversifiable risk is one important component of the
investment risk, market risk is also important.
(d) Systematic Risk. Hint: Systematic risk is one important component of the investment risk;
however, the idiosyncratic risk also forms considerable portion of the investment risk.

Question 9: A security's contribution to the risk of a portfolio is

(a) Company specific risk or unique idiosyncratic risk. Hint: Company specific risk can be diversified
by adding more securities to the portfolio.
(b) Diversifiable risk: Hint: Diversifiable risk is eliminated in a portfolio of large number of stocks.
(c) Systematic risk or market risk (beta): Hint: When a security is added to a portfolio, the market
risk (or systematic risk) is not eliminated and therefore contributes to the risk of a portfolio.
(d) Industry risk. Hint: Industry specific risk can be diversified by adding more stocks from different
industries.

Question 10: The betas for the market portfolio and risk-free security are, respectively.

(a) Market: 0; Risk-free: 1. Hint: Market portfolio moves perfectly in sync with the broad market wide
movements, while risk-free security does not move with the market at all.
(b) Market: 1; Risk-free: 0. Hint: Market portfolio moves perfectly in sync with the broad market
wide movements, while risk-free security does not move with the market at all.
(c) Market: -1; Risk-free: 0. Hint: Market portfolio moves perfectly in sync with the broad market
wide movements, while risk-free security does not move with the market at all.
(d) Market: 1; Risk-free: -1. Hint: Market portfolio moves perfectly in sync with the broad market
wide movements, while risk-free security does not move with the market at all.
 Advanced Financial Instruments for Sustainable Bussiness & Decentralized Markets
Week 4: Solution

Correct answer is in bold font

Question 1: Assume that the following assets are correctly priced according to the security market
Line (CAPM).
𝑅̅1 = 6%, 𝛽1 = 0.5 ; 𝑅̅2 = 12%, 𝛽2 = 1.5. What is the value of risk-premium (𝑅̅𝑀 − 𝑅𝑓)
(a) 1%-3%. Hint. 𝑅̅𝑖 = 𝑅𝑓 + 𝛽𝑖 ∗ (𝑅̅𝑀 − 𝑅𝑓 ). 𝑅̅2 − 𝑅̅1 = (𝛽2 − 𝛽1 ) ∗ (𝑅̅𝑀 − 𝑅𝑓 ).
(b) 3%-5%. Hint. 𝑅̅𝑖 = 𝑅𝑓 + 𝛽𝑖 ∗ (𝑅̅𝑀 − 𝑅𝑓 ). 𝑅̅2 − 𝑅̅1 = (𝛽2 − 𝛽1 ) ∗ (𝑅̅𝑀 − 𝑅𝑓 ).
(c) 5%-7%. Hint. 𝑹 ̅ 𝒊 = 𝑹𝒇 + 𝜷𝒊 ∗ (𝑹̅ 𝑴 − 𝑹𝒇 ). 𝑹
̅𝟐 − 𝑹̅ 𝟏 = (𝜷𝟐 − 𝜷𝟏 ) ∗ (𝑹 ̅ 𝑴 − 𝑹𝒇 = 𝟏𝟐−𝟔 = 𝟔%
̅ 𝑴 − 𝑹𝒇 ). 𝑹
𝟏.𝟓−𝟎.𝟓
̅ ̅ ̅ ̅ ̅
(d) 7%-9%. Hint. 𝑅𝑖 = 𝑅𝑓 + 𝛽𝑖 ∗ (𝑅𝑀 − 𝑅𝑓 ). 𝑅2 − 𝑅1 = (𝛽2 − 𝛽1 ) ∗ (𝑅𝑀 − 𝑅𝑓 ).

Question 2: The following is incorrect for market model.

(a) Market model is one of the models in single-index models family. Hint: Market model is part of single index family models, where market
is the single factor.
(b) Market model allows for the influence of other factors such as industry effect. Hint: While market model employs market factor to explain
the security returns, it does not deny the presence of other influences such as industry.
(c) For market model, the covariance across residuals (ei, ej) has to be equal to zero for different securities i and j. Hint: Since, the
market model accepts the presence of other factors (that are not part of the model), it allows the residuals across stocks (ei, ej) to
be correlated with each other.
(d) Market model is less restrictive and closer to reality than a strict single index model. Hint: Since market model accepts the presence of
other unknown factors, it is less restrictive and closer to reality.
Question 3: If you are tracking 200 securities, and assume single index model for simplifying correlation structure. How many estimates are
needed?

(a) 0-200. Hint: Estimates of expected returns, standard deviation, and sensitivity of the security to the index; expected returns and standard
deviation of the index.
(b) 200-400. Hint: Estimates of expected returns, standard deviation, and sensitivity of the security to the index; expected returns and standard
deviation of the index.
(c) 400-600. Hint: Estimates of expected returns, standard deviation, and sensitivity of the security to the index; expected returns and standard
deviation of the index.
(d) 600-800. Hint: Estimates of expected returns (200), standard deviation (200), and sensitivity of the security to the index (200);
expected returns and standard deviation of the index (2) = 602.

Question 4: The following statement is incorrect about APT

(a) It is based on the law of one price. Hint: The theoretical underpinning behind APT is the arbitrage argument that assets with the identical
risk and have the same price.
(b) CAPM is more general description of asset pricing than APT. Hint: CAPM specifies that market is the only possible influence,
while APT is not restricted only to market.
(c) APT does not require the conventional mean-variance framework. Hint: Unlike the conventional mean variance framework, APT relies on
factors (or influences) and the sensitivity of a security to these influences.
(d) APT requires homogenous expectations. Hint: Similar to CAPM, APT also considers homogenous expectations in terms of expected returns
and risk.

Question 5: The following statement is incorrect about APT.

(a) The return generating process in APT comes from single/multi-index models. Hint: APT derives the equilibrium returns from single/multi-
index models.
 (b) The contribution of APT is to obtain the equilibrium model of asset pricing from return generating process. Hint: The incremental
contribution of APT is to reach from return generating process of index models to the equilibrium asset pricing.
(c) The equilibrium APT relation includes, expected return term, sensitivity (bi's), return premium (λ), and residual terms (ei's). Hint:
The definition of equilibrium asset pricing should not carry the residual term.
(d) If APT model is well specified then correlation across error terms (ei, ej) should be close to zero. Hint: APT assumes that only relevant
influences are APT factors (or indices) in the model. Thus, error terms (ei, ej) should not be correlated.

Question 6: The following statement is incorrect about APT

(a) The factor sensitivities (bi's) are security specific. Hint: Factor sensitivies are specific to individual securities.
(b) The return-premiums (λj's) are security specific. Hint: Return premiums are factor (or index) specific.
(c) APT can be tested on small number of stocks. Hint: APT does not require identification of a large number of stocks that are required to
construct the market portfolio.
(d) In practical situations, test of CAPM is often argued to be the tests of APT. Hint: Since, it is difficult to find the market portfolio accurately,
the test of CAPM are essentially the tests of single factor APT.

Question 7: If you are tracking 100 securities, and assume multi-index model with five (5) indices for simplifying correlation structure. How many
estimates are needed.
(a) 300-500. Hint. Estimate of expected return and risk for the stock, expected return and risk for each index, and correlation between the stock
and each of the index.
(b) 500-700. Hint. Estimate of expected return and risk for the stock, expected return and risk for each index, and correlation between the stock
and each of the index.
(c) 700-900. Hint. Estimate of expected return and risk for the stock (200), expected return and risk for each index (2*5=10), and
correlation between the stock and each of the index (100*5=500). Total=710.
(d) 900-1100. Hint. Estimate of expected return and risk for the stock, expected return and risk for each index, and correlation between the
stock and each of the index.
Questions 8-10: The following information is given about four securities.
Security
A B C D
Alpha (𝛼𝑖 , 𝑖𝑛 %) 1.5 2.5 0.5 3.5
Beta (𝛽𝑖 ) 2 1.5 1 1
Sigma residual (𝜎𝑒𝑖 , in %) 2.5 1.5 2.5 3.5

Assume that the single-index model of the following form holds

𝑅𝑖𝑡 = 𝛼𝑖 + 𝛽𝑖 ∗ 𝑅𝑚𝑡 + 𝑒𝑖𝑡
Also, it is given that the expected returns on the market 𝑅̅𝑚 = 7% and standard Deviation on market 𝜎𝑚 = 6%.

Question 8: The expected returns of securities A, B, C, and D will lie in the following intervals

a) Security A= (13%-15%), Security D = (9%-11%). Hint: 𝑅̅𝑖 = 𝛼𝑖 + 𝛽𝑖 ∗ 𝑅̅𝑀

b) Security B= (12%-14%), Security C=(6%-8%) Hint: 𝑹 ̅ 𝑩 = 𝜶𝑩 + 𝜷𝑩 ∗ 𝑹
̅ 𝑴 = 𝟐. 𝟓% + 𝟏. 𝟓 ∗ 𝟕% = 𝟏𝟑. 𝟎% ; 𝑹
̅ 𝑪 = 𝜶𝑪 + 𝜷𝑪 ∗
̅ 𝑴 = 𝟎. 𝟓% + 𝟏. 𝟎 ∗ 𝟕% = 𝟕. 𝟓%
𝑹
c) Security A= (13%-15%), Security B=(12%-14%). Hint: 𝑅̅𝑖 = 𝛼𝑖 + 𝛽𝑖 ∗ 𝑅̅𝑀
d) Security D=(8%-10%), Security B= (12%-14%). Hint: 𝑅̅𝑖 = 𝛼𝑖 + 𝛽𝑖 ∗ 𝑅̅𝑀

Question 9: Assuming an equally weighted portfolio of these securities A, B, C, and D, what is the correct interval for the alpha and beta of the
portfolio (Refer to Que 8).
 𝟏 𝟏
(a) Alpha= (1%-3%), Beta =(1.0-1.5). Hint: 𝜶𝑷 = ∑ 𝒘𝒊 𝜶𝒊 = (𝟏. 𝟓 + 𝟐. 𝟓 + 𝟎. 𝟓 + 𝟑. 𝟓) = 𝟐. 𝟎%; 𝜷𝑷 = ∑ 𝒘𝒊 𝜷𝒊 = (𝟐. 𝟎 + 𝟏. 𝟓 +
𝟒 𝟒
𝟏. 𝟎 + 𝟏. 𝟎) = 𝟏. 𝟑𝟕𝟓
(b) Alpha= (3%-5%), Beta =(0.0-1.0). Hint: 𝛼𝑃 = ∑ 𝑤𝑖 𝛼𝑖 ; 𝛽𝑃 = ∑ 𝑤𝑖 𝛽𝑖
(c) Alpha= (3%-5%), Beta =(1.0-1.50). Hint: 𝛼𝑃 = ∑ 𝑤𝑖 𝛼𝑖 ; 𝛽𝑃 = ∑ 𝑤𝑖 𝛽𝑖
(d) Alpha= (1%-3%), Beta =(1.5-2.0). Hint: 𝛼𝑃 = ∑ 𝑤𝑖 𝛼𝑖 ; 𝛽𝑃 = ∑ 𝑤𝑖 𝛽𝑖

Question 10: Assuming an equally weighted portfolio of these securities A, B, C, and D, what is the correct interval for the expected return and
risk (standard deviation) of the portfolio (Refer to Que 8 and 9).

(a) Risk= (4%-6%), Expected returns =(8%-10%). Hint: Expected Return (𝑅̅𝑃 ) = 𝛼𝑃 + 𝛽𝑃 ∗ 𝑅̅𝑀 ; Risk 𝜎𝑃2 = 𝛽𝑃2 𝜎𝑚
2
+ ∑𝑁 2 2
𝑖=1 𝑋𝑖 𝜎𝑒𝑖
(b) Risk= (6%-8%), Expected returns =(10%-12%). Hint: Expected Return (𝑅̅𝑃 ) = 𝛼𝑃 + 𝛽𝑃 ∗ 𝑅̅𝑀 ; Risk 𝜎𝑃2 = 𝛽𝑃2 𝜎𝑚2
+ ∑𝑁 2 2
𝑖=1 𝑋𝑖 𝜎𝑒𝑖
(c) Risk= (8%-10%), Expected returns =(11%-13%). Hint: Expected Return (𝑹 ̅ 𝑷 ) = 𝜶𝑷 + 𝜷𝑷 ∗ 𝑹 ̅ 𝑴 = 𝟐. 𝟎% + 𝟏. 𝟑𝟕𝟓 ∗ 𝟕% =
𝟏
𝟏𝟏. 𝟔𝟐𝟓%; Risk 𝝈𝟐𝑷 = 𝜷𝟐𝑷 𝝈𝟐𝒎 + ∑𝑵 𝟐 𝟐 𝟐
𝒊=𝟏 𝑿𝒊 𝝈𝒆𝒊 = (𝟏. 𝟑𝟕𝟓 ∗ 𝟔) + ( ∗ (𝟐. 𝟓𝟐 + 𝟏. 𝟓𝟐 + 𝟐. 𝟓𝟐 + 𝟑. 𝟓𝟐 )) = 𝟔𝟗. 𝟕𝟓; 𝝈𝑷 = 𝟖. 𝟑𝟓%
𝟒𝟐
(d) Risk= (8%-10%), Expected returns = (8%-11%). Hint: Expected Return (𝑅̅𝑃 ) = 𝛼𝑃 + 𝛽𝑃 ∗ 𝑅̅𝑀 ; Risk 𝜎𝑃2 = 𝛽𝑃2 𝜎𝑚
2
+ ∑𝑁 2 2
𝑖=1 𝑋𝑖 𝜎𝑒𝑖
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 5 : Solution

Correct answer is in bold font

Ques 1: Which one of the following statements is incorrect in the context of carbon credits.

a) One carbon allowance carries the right to emit one tonne of carbon emissions.
b) Concept of carbon credits is originated from Kyoto Protocol.
c) Concept of carbon credits is originated from Montreal Protocol
d) Carbon credits create a monetary incentive for companies to reduce their carbon
emissions.
Hint: The concept of carbon credits emerged during the Kyoto Protocol discussions and is an
integral part of today's environmental economics. Carbon credits refer to a certificate which
gives the right to emit one tonne of carbon dioxide to the holding firms.

Ques2: Which of the following is incorrect about “Grandfathering.”

a) Under Grandfathering approach, allowances are allocated for free.

b) Grandfathering approach is used to postponethe auction of allowances.
c) Grandfathering approach considers historical emissions during the allocation of
allowances.
d) Grandfathering approach is not the default approach used to allocate allowances as of
Phase III in EU-ETS
Hint: Grandfathering approach is not used to postpone the auction of allowances, as it is an
approach of free allocation of allowances.

Ques 3: Which of the following is correct about Auctioning.

a) Auctioning is the default method for allowance allocation as of Phase III in EU-ETS.
b) Auctioning of allowances generates revenue for the government.
c) Auctioning of allowances generates revenue for the participating firms.
d) Both a) and b)
Hint: In Phase 3 of EU-ETS, the auctioning approach is used as the primary approach of
allowance allocation, and it also generates revenue for government.

Ques 4: Which one of the following best describes the impact of the overallocation of permits
on carbon prices (ceteris paribus, i.e., all else remaining the same).

a) Rise in carbon prices

b) Decline in carbon prices.
c) No change in carbon prices
d) No change in participated firms’ stock prices
Hint: Overallocation of carbon permits leads to low demand for allowances, which in turn
leads to a decline in carbon prices.

Ques 5: Which of the following incorrectly defines the backloading of allowances.

a) Backloading of allowances is a measure to allocate allowances freely.

b) Backloading of allowances is a short-term measure to deal with high price volatility in
carbon market.
c) Backloading of allowances deals with surplus of allowances.
d) Backloading of allowances includes the postponement of auctioning of allowances.
Hint: Backloading of allowances is not the name of any approach to allocating allowances. It
is a short-term measure to deal with the surplus of allowances by postponing their auctions.

Ques 6: Which of the following statements is/are true about carbon taxes?

a) It provides certainty on emission level reductions.

b) The carbon prices are set by predefined tax rates.
c) The carbon prices are determined by market forces.
d) Both a) and c)

Hint: Under carbon taxation, carbon prices are set by predefined tax rates whereas under
ETS prices are determined by market forces.

Ques 7: Which of the following was the main reason behind the lethal downturn of carbon
prices at the end of Phase 1 of EU-ETS?

a) Over allocation of allowances

b) Restriction on banking of allowances
c) Under allocation of allowances
d) Both a) and b)
e) Both b) and c)
Hint: At the end of Phase 1 of EU-ETS, over-allocation and restrictions on the banking of
allowances led to a surplus of allowances, which was the main reason behind the downturn in
the value of carbon prices.

Ques 8: Market Stability Reserve (MSR) aims to:

a) Reduce high-price volatility

b) Cancel the total number of allowances in circulation.
c) Address the supply and demand imbalance
d) Both a) and c)
e) Both b) and c)
Hint: MSR addresses the current surplus of allowances and improves the system’s resilience
to major shocks by adjusting the supply of allowances to be auctioned. This further reduces
the price volatility.

Ques 9: Which of the following is correct about Benchmarking.

a) Benchmarking approach of allowance allocation generates revenues for government.

b) Benchmarking approach is used to freely allocate the allowances.
c) Benchmarking approach considers historical emissions during allowance allocation.
d) Benchmarking is a relatively easier approach to implement than Grandfathering.
Hint: Both grandfathering and benchmarking approach are used for free allocation of
allowances.

Ques 10: Which one of the following best describes the impact of underallocation of permits
on carbon prices (ceteris paribus, i.e., all else remaining the same).

a) Rise in carbon prices.

b) Decline in carbon prices.
c) No change in carbon prices.
d) No change in participated firms’ stock prices.
Hint: Underallocation of carbon permits leads to high demand for allowances, leading to a
rise in carbon prices.
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 6 : Solution

Correct ans is in bold font

Ques 1: Which of the following incorrectly describes the Clean Development Mechanism
(CDM)
a) CDM is a flexible project-based mechanism under Kyoto protocol for GHG reduction.
b) The CDM allows emission-reduction projects in developing countries by an
industrialized country to earn certified emission reduction (CER) credits.
c) Under CDM, 1 CER is equivalent to two tons of CO2.
d) Under CDM, CER credits can be used by installations to meet Kyoto targets.
Hint: CDM is a project-based mechanism where CER credits are earned, which can be used
to meet greenhouse gas emission reduction targets. Each CER credit carries the right to emit
one ton of carbon.

Ques 2: Which one of the following statements best describes the relationship between
energy consumption and carbon prices.
a) High energy consumption decreases carbon prices.
b) Low energy consumption increases carbon prices.
c) High energy consumption increases carbon prices.
d) High energy consumption has no impact on carbon prices.
Hint: High energy consumption increases carbon emissions, increasing the demand for
allowances and elevated carbon prices

Ques 3: Which one of the following statements is incorrect in the context of EU-ETS.
a) EU-ETS stands for European Union Emission Trading Scheme
b) EU-ETS aims to incentivize the installations to invest in green and renewable
technologies.
c) UK-ETS is part of the EU-ETS
d) EU-ETS is the world’s first and most successful emission trading scheme till date.
Hint: The UK-ETS came into force on 1 January 2021 to replace the UK’s participation in
EU-ETS, which was established in 2005.

Ques 4: How carbon prices in EU-ETS are linked to investment in green and renewable
technologies.
a) Lower carbon prices result in more investment in green and renewable technologies.
b) Higher carbon prices result in more investment in green and renewable
technologies.
 c) There is no relationship between carbon prices and investment in green and renewable
technologies
d) Higher Carbon prices in EU-ETS result in a decrease in investment in green and
renewable technologies.
Hint: Higher economic activity results in more emissions, and thus a higher demand for
carbon allowances. This higher demand results in higher prices and motivates installations to
decrease emissions by investing in green and renewable technologies.

Ques 5: Which of the following is incorrect about the Market Stability Reserve.
a) MSR aims to reduce the high price volatility in the carbon market.
b) MSR improves the system's resilience to major shocks by adjusting the supply of
allowances to be auctioned.
c) MSR results in the cancellation of the total allowances in circulation.
d) MSR aims to address the demand and supply imbalances in the EU-ETS.
Hint: MSR does not cancel the total allowance in circulation. Instead, it includes
transfers/release of allowances in/from the reserve.

Ques 6: Which of the following incorrectly describes Joint Implementation (JI).

a) JI is a flexible project-based mechanism under Kyoto protocol for GHG reduction.
b) JI allows emission-reduction projects in an industrialized country by another
industrialized country to earn Emission reduction units (ERU) credits.
c) Under JI, 1 ERU is equivalent to one ton of CO2.
d) Under JI, ERU credits can be used by installations to meet Kyoto targets.
e) All the options are correct.
Hint: JI is also a project-based mechanism where ERU credits are earned, which can be used
to meet greenhouse gas emissions reduction targets. Each ERU credit carries the right to emit
one ton of carbon.

Ques 7: Which one of the following statements best describes the relationship between
weather (temperature) and carbon prices.
a) Unanticipated changes in temperature increase carbon prices.
b) Unanticipated change in temperature has no impact on carbon prices.
c) Unanticipated temperature changes do not affect the demand for carbon allowances.
d) Unanticipated changes in temperature decrease carbon prices.
Hint: Unanticipated change in temperature, for example, extreme cold weather, increases the
energy consumption, which in turn increases the demand for carbon allowances and increases
the carbon prices.

Ques 8: Which of the following statements is/are true about emission trading schemes?
 a) ETS are easy to administer compared to carbon tax.
b) ETS provides a secondary market for carbon allowance trading.
c) ETS generates revenue for the government.
d) Both b) and c)
e) Both a) and b)
Hint: Emission Trading Schemes require a complex market structure to facilitate the trading
of carbon allowances. Under ETS, the auctioning of allowances generates revenue for the
governments.

Ques 9: Which of the following is a market-based approach to reducing GHG emissions

introduced under the Kyoto Protocol?
a) Emission Trading
b) Clean Development Mechanism
c) Joint Implementation
d) All of the above
Hint: To meet emission reduction targets, the Kyoto Protocol introduced three market-based
mechanisms, i.e., Clean Development Mechanism, Joint Implementation, and Emission
Trading.

Question 10: Which of the following is incorrect in the context of carbon markets.
(a) Carbon markets are market based policy tool for mitigation of climate change
(b) Carbon markets aim to fix the price of carbon
(c) Carbon markets aim to fix the emission levels
(d) Carbon markets help efficient price discovery of emissions

Hint: Carbon markets are a cap-and-trade-based tool, which caps the emission levels and lets
the carbon/emission price emerge based on market supply and demand forces and efficient
discovery of prices. It is a market-based tool for a non-market good (that is, carbon
emissions).
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets
Week 7: Solution

The correct answers are in bold.

Question 1-7: You obtain the following sample ACF and PACF correlations. Also assume 100
observations.
Lag 1 2 3 4 5 6 7 8
ACF 0.420 0.104 0.032 0.06 -0.138 0.042 -0.018 0.074
PACF 0.632 0.381 0.268 0.199 0.205 0.101 0.096 0.082

1) For 95% confidence interval (app. Z stat.= 1.96), what are the significant lags for the
ACF process.
A. 0
B. 1
C. 2
D. 3
E. None of all

Hint: 95% confidence interval=

Lag 1 2 3 4 5 6 7 8
ACF 0.42 0.104 0.032 0.06 -0.138 0.042 -0.018 0.074
Significant TRUE FALSE FALSE FALSE FALSE FALSE FALSE FALSE

As per ACF, significant lags are Lag 1 only.

2) For 95% confidence interval (app. Z stat.= 1.96), what are the significant lags for the
PACF process.

A. 1,2
B. 1,2,3
C. 1,2,3,4,5
D. 1,2,3,4,5,6
E. None of all
 Hint: 95% confidence interval=

Lag 1 2 3 4 5 6 7 8
PACF 0.632 0.381 0.268 0.199 0.205 0.101 0.096 0.082
Significant TRUE TRUE TRUE TRUE TRUE FALSE FALSE FALSE

As per PACF, significant lags are: Lag 1, Lag 2, Lag 3, Lag 4, and Lag 5.

3) Based on part 1 and 2 what can be said about the nature [ARMA(p,q)] of the process.

(1) This is an AR(1) process

(2) This is an ARMA process
(3) This is MA(1) process
(4) This is MA(2) process
(5) This is AR(2) process

Hint: This is MA(1) Process. Since ACF is only significant at lag 1, while PACF is
geometrically declining.

4) Compute the BP (Box-Pierce) statistic for the process for the three lags (ACF).
(1) 0-15
(2) 5-10
(3) 10-15
(4) 15-20

Ans:

5) In the previous question (4), if the critical value at 5% is 14 and at 1% is 22. What do we
infer from theBP statistics.
 (1) At least one of the coefficients is statistically significant at 1% level
(2) At least one of the coefficients is statistically significant at 5% level
(3) All the coefficients are statistically significant at 1% level
(4) All the coefficients are statistically significant at 5% level
(5) None of the all

Ans: Box test is a joint test of significance for all the autocorrelation values. The null
hypothesis (H0): None of the coefficients are significant. Alternative (H1): At least one
of the coefficients is significant. Given the critical values and our test statistic
( , at 5% confidence we can reject the null. That is at least 1 autocorrelation
coefficient is significantly different from zero. At 1% confidence we cannot reject the
null, and therefore, we say that none of the coefficient is significantly different from zero.

6) Compute the LB (Ljung-Box) statistics for the process of the three lags (ACF).

(1) 0-15
(2) 5-10
(3) 10-15
(4) 15-20

Ans: Ljung-Box (LB) Stat.

7) In the previous question (6), if the critical value at 5% is 14 and at 1% is 22. What do we
infer from the LB statistics.
(1) At least one of the coefficients is statistically significant at 1% level
(2) At least one of the coefficients is statistically significant at 5% level
(3) All the coefficients are statistically significant at 1% level
(4) All the coefficients are statistically significant at 5% level
(5) None of the all
 Ans: Ljung-Box (LB) test is a joint test of significance for all the autocorrelation values.
The null hypothesis (H0): None of the coefficients are significant. Alternative (H1): At
least one of the coefficients is significant. Given the critical values and our test statistic
( , at 5% confidence we can reject the null. That is at least 1 autocorrelation
coefficient is significantly different from zero. At 1% confidence we cannot reject the
null, and therefore, we say that none of the coefficient is significantly different from zero.

Question 8-10: Consider the following price process:

8) If the characteristic equation is of the following form: , then

identify and .
1. = (-1, -0.5) and = (0.5, 1)
2. = (-1, -0.5) and = (-1, -0.5)
3. = (0.5, 1) and = (0.5, 1)
4. = (0.5, 1) and = (-1, -0.5)
5. None of all
Ans: The characteristic equation can be written as: . Using
the lag operator, . Or, .
Thus, .

9) In the previous question (8), identify the roots (R1 and R2) of the characteristic equation.

(1) R1 = (-2, -1.5) and R2 = (0.5, 1)

(2) R1 = (-1, -0.5) and R2 = (0.5, 1)
(3) R1 = (-0.5, 0) and R2 = (0.5, 1)
(4) R1 = (-0.5, 0) and R2 = (0, 0.5)
(5) None of all
Ans: To get the roots of this equation: =0, solving this process, we get
Two roots, L=0.7577and -1.9352. All roots must be greater than 1 for the process to be
stationary. This process is non-stationary.
10) In the previous question (9), What can be said about this process [ARIMA(p,q, r)].

(1) ARIMA (1,1,0)

(2) ARIMA (1,0,1)
(3) ARIMA (2,1,0)
(4) ARIMA (2,1,1)
(5) None of the all
Ans: This is ARMA(2,1,0) process. [Because, there are 2 AR terms, zero MA terms, and it is
integrated of order 1. ]
Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 8: Solution

The correct answers are in bold

1. The daily standard deviation of returns is 10% for 1000 past historical observations. What
is the best estimate of volatility for a three-day period, if historical volatility model is
assumed?

(a) 10%-15% Hint:

(b) 15%-18% Hint: =
(c) 18%-21% Hint:
(d) 21%-24% Hint:
(e) None of the above Hint:

2. Which of the following is not a characteristic of financial market returns (relative to

normal distribution)?

(a) Positive skewness. Hint: Financial market returns exhibit negative skewness.
(b) Fat tails. Hint: Financial market returns exhibit excess kurtosis, that is high peakedness
and fat tails.
(c) Higher peakedness around center. Hint: Financial market returns exhibit excess kurtosis,
that is high peakedness and fat tails.
(d) Autocorrelation in returns across periods. Hint: In financial markets, information arrives
in a piecemeal manner, and therefore, returns are autocorrelated
(e) Negative Skewness. Hint: Financial market returns exhibit negative skewness.

3. Volatility clustering suggests that:

(a) High volatility with rising prices. Hint: Volatility clustering means high periods of
volatility occur together in clusters, similarly, low periods of volatility cluster together
(b) Low Volatility with falling prices. Hint: Volatility clustering means high periods of
volatility occur together in clusters, similarly, low periods of volatility cluster together
(c) High volatility with falling prices. Hint: Volatility clustering means high periods of
volatility occur together in clusters, similarly, low periods of volatility cluster together
(d) None of the above. Hint: Volatility clustering means high periods of volatility occur
together in clusters, similarly, low periods of volatility cluster together
4. Leverage effect suggests that:

(a) Periods of rising prices occur together. Hint: High volatility with falling prices. Equity
prices decline with falling prices. This leads to increase in leverage, and in turn, more
risk, thus giving push to rising volatility levels.
(b) Periods of falling prices occur together. Hint: High volatility with falling prices. Equity
prices decline with falling prices. This leads to increase in leverage, and in turn, more
risk, thus giving push to rising volatility levels.
(c) Periods of high volatility occur together. Hint: High volatility with falling prices. Equity
prices decline with falling prices. This leads to increase in leverage, and in turn, more
risk, thus giving push to rising volatility levels.
(d) None of the above. Hint: High volatility with falling prices. Equity prices decline
with falling prices. This leads to increase in leverage, and in turn, more risk, thus
giving push to rising volatility levels.

5. Financial Markets do not exhibit the following characteristics:

(a) Non-Normality. Hint: Heteroscedasticity (non-constant variance), non-normality,

leverage effect, and volatility clustering are some of the stylized properties of financial
markets.
(b) Leverage effect. Hint: Heteroscedasticity (non-constant variance), non-normality,
leverage effect, and volatility clustering are some of the stylized properties of financial
markets.
(c) Volatility clustering. Hint: Heteroscedasticity (non-constant variance), non-normality,
leverage effect, and volatility clustering are some of the stylized properties of financial
markets.
(d) Homoscedasticity. Hint: Heteroscedasticity (non-constant variance), non-normality,
leverage effect, and volatility clustering are some of the stylized properties of
financial markets.
(e) Heteroscedasticity. Hint: Heteroscedasticity (non-constant variance), non-normality,
leverage effect, and volatility clustering are some of the stylized properties of financial
markets.

6. Which of the following models do not account of volatility clustering?

(a) ARCH. Hint: Both Auto-regression conditional heteroscedasticity (ARCH) and

Generalized ARCH (GARCH) models account for volatility clustering
(b) GARCH. Hint: Both Auto-regression conditional heteroscedasticity (ARCH) and
Generalized ARCH (GARCH) models account for volatility clustering.
(c) Historical Volatility models. Hint: Historical models assume identically and
independently distributed returns; hence do not account for volatility clustering
(d) None of the above. Hint: Historical models assume identically and independently
distributed returns; hence do not account for volatility clustering

7. A good EWMA model of volatility offers:

(a) Relatively lower weight to recent volatility levels compared to historical volatility levels.
Hint: A good EWMA model should give more weight to recent periods; this is unlike
historical volatility models that assign equal weight to all the periods
(b) Relatively higher weight to historical volatility levels compared to recent volatility levels.
Hint: A good EWMA model should give more weight to recent periods; this is unlike
historical volatility models that assign equal weight to all the periods
(c) Relatively higher weight to recent volatility levels compared to historical volatility
levels. Hint: A good EWMA model should give more weight to recent periods, not
equal weight to all the periods
(d) None of the above. Hint: A good EWMA model should give more weight to recent
periods; this is unlike historical volatility models that assign equal weight to all the
periods

8. Which of the following does not require non-negativity constraints in parameters?

(a) Autoregressive Conditional Heteroscedasticity (ARCH). Hint: By design, there is nothing

in ARCH model to ensure positive parameters, hence non-negativity constraints are
needed
(b) Generalized ARCH (GARCH). Hint: By design, there is nothing in GARCH model to
ensure positive parameters, hence non-negativity constraints are needed
(c) GJR-GARCH. Hint: By design, there is nothing in GJR-GARCH model to ensure
positive parameters, hence non-negativity constraints are needed
(d) E-GARCH. Hint: The model estimates log of conditional volatility. Therefore, the
estimate is exponential of the predicted value. Thus, external non-negativity
constraints are not required.
(e) All of the above require non-negativity constraints in parameters. Hint. E-GARCH model
estimates log of conditional volatility. Therefore, the estimate is exponential of the
predicted value. Thus, external non-negativity constraints are not required.

9. Value at risk (VaR) models consider:

(a) Maximum loss if extreme events were to happen. Hint: VaR models focus on the
maximum loss with a given confidence interval.
(b) Minimum loss in a normal scenario with a given confidence level. Hint: VaR models
focus on the maximum loss with a given confidence interval.
(c) Expected loss in a normal scenario with a given confidence level. Hint: VaR models
focus on the maximum loss with a given confidence interval.
(d) Maximum loss in a normal scenario with a given confidence level. Hint: VaR models
focus on the maximum loss with a given confidence interval.

10. Daily mean return is 1%, and daily SD=5%, with Z=-2.326 (99%), what is the correct
interval for 1% daily VaR (loss in magnitude terms). Assume normally distributed
returns.

(a) 4%-8%. VaR= Mean+Z*SD

(b) 8%-10%. VaR= Mean+Z*SD
(c) 10%-12%. Hint: VaR= Mean+Z*SD=1%-2.326*5%=-10.63% or loss of 10.63%
(d) 12%-14%. VaR= Mean+Z*SD
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 9: Solution

Question 1: Which of the following statements is incorrect in the context of blockchain

distributed leaders?

(1) Distributed legers are shared, replicated, and synchronized among the members of a
decentralized network.
(2) There is no central authority, and all the participants agree by consensus.
(3) Every transaction or record has a unique time-stamp and cryptographic signature.
(4) The ledger is auditable and immutable.
(5) If all the members agree, then only a historical record can be modified.
Hint: All the statements are correct, except (5). In the context of blockchain distributed
ledgers, once a transaction (a block) is validated and appended, it cannot be changed in the
future. That is why it is called immutable.

Question 2: Which of the following is incorrect in the context of a distributed blockchain

network?

(1) Blockchain is a tamper-evidentshared digital ledger that records transactions on a peer-to-

peer network.
(2) A blockchain network comprises a sequential chain of blocks that are cryptographically
hash-linked.
(3) As new blocks are confirmed and validated by the members, they are added to the chain.
(4) Cryptographic primitives (Hash functions, digital signatures, etc.) ensure that only
authentic transactions are verified.
(5) A third-party verification further ensures the robustness of the system.
Hint: All the statements are correct, except (5). No third-party verification is conducted on
distributed blockchain networks.

Question 3: Which of the following statements is true in the context of distributed

blockchain?

(1) Between the most recent conflicting blocks, the longer block is adopted.
(2) To compromise a blockchain, the attacker needs to compromise 51% of the nodes.
(3) In the case of a permissioned blockchain, the owner (or central authority) authorizes
the nodes that can publish new blocks
(4) In a permissioned blockchain, member nodes typically govern the operations
(5) All the statements are correct
Hint: All the statements provided are correct.
Question 4: While applying blockchain technology to business, which of the following is not
an important consideration?

(1) The business involves transactions across multiple parties that do not trust each other
(2) The business needs to ensure a secure history of transactions and a record of digital assets
(3) The transactions have a threat of a malicious attacker (E.g., a cyberattack)
(4) The multiple distrusting parties do not want to involve a central authority
(5) All the participants know and trust each other.
Hint: All the statements are correct except (5). Blockchain is more suitable for applications
where multiple distrusting users transact with each other.

Question 5: Which of the following does not accurately describe the distributed blockchain
networks?

(1) Execute, verify, and record the transactions into cryptographically chain-linked blocks
(2) Member nodes across a peer-to-peer network can access and verify this blockchain-
based ledger without requiring any central authority
(3) Blockchain network utilizes consensus mechanisms for verifying data blocks
(4) The success of the network depends on how much the member nodes trust each
other
(5) Practically, it is almost impossible to change the information in data blocks without
getting caught

Hint: All the statements are true except (4). A blockchain network does not require the users
to trust each other.

Question 6: Which of the following statements is not true in the context of smart contracts?
(1) Smart contracts are not governed by any regulatory authority
(2) These are electronic contracts authenticated by the use of blockchain technology
(3) The contract specifies the rights and obligations of those entering into the contract
(4) The performance of a smart contract requires validation by a third party.
(5) In a manner, smart contracts are digital reflection of traditional contracts

Hint: All are correct except (4). Smart contracts do not require a regulatory body or third-
party verification.

Question 7: Which of the following is an important problem solved by distributed

blockchains and the corresponding cryptographic protocols?

(1) Blockchain solves the problem of “double spending”

 (2) Blockchain facilitates transactions between distrusting parties in the absence of a
central authority
(3) Blockchain facilitates immutable record-keeping and verification of transactions with
the help of cryptographic protocols
(4) Blockchain provides a tamper-evident and tamper-proof distributed ledger
(5) All the statements are correct
Hint: All the statements are correct and self-explanatory.

Question 8: Which of the following is not an issue associated with typical blockchain
applications (E.g., Bitcoin)?

(1) Use of Bitcoin in illegal applications (drugs) due to the anonymity provided to users
(2) Losing assets due to the loss of the private key in the digital signature infrastructure
(3) Tax avoidance to transact anonymously
(4) Attack of malicious users on one or a few of the member nodes
(5) Excessive consumption of energy in the proof-of-work consensus mechanism.
(6) Problem of spending the same money (or asset) more than once

Hint: Blockchains are robust to attack on one or a few of the member nodes. Since a
malicious attack has to corrupt more than 50% of computing resources to compromise a
network.

Question 9: Which of the following is not correct in the context of the proof-of-work (PoW)
consensus mechanism?

(1) PoW is hard to solve but easy to verify

(2) PoW requires exhaustive computations and therefore large energy consumption
(3) PoW requires hashing a large number of strings until a predefined condition (the
solution) is produce – Mining
(4) The successful miner performing PoW and adding new blocks are rewarded in the
form of native currency
(5) These miners are motivated by the welfare of the blockchain
Hint: All the statements are correct except (5). The miners are motivated by selfish monetary
interest. However, the monetary benefit induces them to act in the best interest of the
blockchain network.

Question 10: Which of the following is not a correct comparison between a distributed
permissionless blockchain vs. a permissioned blockchain?

(1) In a permissionless system, member nodes collectively validate the addition of new
blocks, in a permissioned system, either the central authority or the authorized nodes
only have access to the ledger
(2) In a permissionless system, there is no trusted central party
 (3) As compared to a permissioned system, a permissionless system is not exposed to a
single point of attack on the central authority that can compromise the entire system
(4) Typically, permissioned blockchains require proof-of-work while permissionless
blockchains use proof-of-stake consensus mechanisms.
Hint: All the statements are correct except (4). Proof-of-work is more of a feature for
permissionless blockchains to avoid a central authority.
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 10: Solution

Question 1: Which of the following is a correct statement in the context of cryptographic

hash functions?

(1) Hash functions take string data as input and produce a fixed-size output
(2) Hash function is collision resistant, hiding, and puzzle-friendly
(3) One of the important hash functions used is SHA256.
(4) All the statements are correct.
Hint: Blockchain employs encryption technologies such as secure hash algorithms
(SHA256). They are an integral part of blockchain in verifying the integrity of information. A
hash function applied to data (“hashing”), creates a unique output (“digest”), which helps in
verifying the data. Even the smallest change in input will result in a different output digest. It
takes input in the form of strings and produces a fixed-size output. It has three key properties.
First, Hiding: Given the output of the hash function, there is no feasible way to identify or
reveal the input. This is also called preimage resistant. Hash functions are collision-resistant,
which means two inputs do not hash to the same output. A collision occurs when two distinct
inputs produce the same output. Lastly, puzzle friendliness means Knowing some part of the
input does not make it easy to identify or guess the output.

Question 2: Match the correct pairs

(1) Hiding (2) Collision Resistant (3) Puzzle friendliness

(A) Knowing some part of the input does not make it easy to identify or guess the output
(B) Knowing the output, there are no feasible ways to identify or guess the input
(C) Two inputs do not result in the same output

(1) 1-B, 2-C, 3-A

(2) 1-B, 2-A, 3-C
(3) 1-C, 2-B, 3-A
(4) 1-C, 2-A, -3-B
(5) 1-A, 2-C, -3-B

Hint: Hiding or preimage resistant: Knowing the output, there are no feasible ways to
identify or guess the input.

Collision Resistant: Two inputs do not result in the same output.

Puzzle friendliness: Knowing some part of the input does not make it easy to identify or
guess the output.
Question 3: With respect to SHA-256, which of the following is an incorrect statement?

(A) It has 256 bits

(B) It has 32 Bytes
(C) It creates 2^256 possible digest values
(D) It has 256 Bytes
Hint: SHA256 has 256 bits. One Byte is 8 bits, so 32 bytes in SHA. One bit represents 0 or
1, two values. So, 256 bits represent 2^256 possible digest values.

Question 4: Which of the following is a correct statement in the context of digital signatures?

(1) Only the authorized party should be able to make their own signature.
(2) Anyone who can see the signature should be able to verify if it is valid.
(3) The signature should be tied to a particular document (or piece of information).
(4) All the statements are correct.
Hint: A Digital signature is similar to a handwritten signature in the sense that (a) only
authorized parties should be able to make their signatures, (b) Anyone who can see should be
able to verify the signature, and (c) the signature is tied to a particular document.

Question 5: Which of the following is correct in the context of asymmetric-key

cryptography?

(1) Asymmetric-key cryptography involves a public and a private key

(2) Those who hold the public key should be able to verify the signature
(3) The private key is private and can not be determined based on the knowledge of the
public key.
(4) The transactions are digitally signed with the private key and verified using the public
key
(5) All the statements are correct.
Hint: All the statements are correct and self-explanatory.

Question 6: Which of the following does not accurately depict the Byzantine general’s
problem in the context of blockchain.

(1) The central authority may act in an autocratic manner.

(2) The message sent between the generals may be intercepted
(3) The generals need to communicate and coordinate in a secure manner.
(4) One of the generals may become rogue and send conflicting information to other
generals.
(5) The generals need to reach a consensus on a commonly agreed-upon battle plan.
Hint: The Byzantine generals’ problem is a game theory problem that deals with how
dispersed parties reach a consensus in the absence of a central authority. For example, how do
members of a network agree when they can not trust or verify each other’s identity. How to
coordinate in case one or a few members are not acting in the best interest of the group. How
to communicate and coordinate for a common action plan.

Question 7: Which of the following is not true about consensus mechanisms and miners in
the context of a blockchain.

(1) Miners act selfishly for the well-being of other members.

(2) Miners are motivated to mine and perform for the reward (e.g., native currency)
(3) Miners and members are generally mutually distrusting.
(4) Consensus protocol ensures verification and documentation of transactions in the
absence of a centralized authority.
(5) In case of two valid chains in a blockchain network, the longer chain is viewed as
correct and adopted.

Hint: All the statements except (1) are correct as stated. Miners do not act selfishly for the
well-being of other members. They are simply incentivized and motivated for rewards (such
as native currency).

Question 8: Which of the following is not a correct statement about some of the stylized
properties of a blockchain.

(1) There is a head (or genesis block) that represents the agreed-upon initial state of the
system.
(2) The blocks are verified with the consensus model and added to the system.
(3) Every block is linked to the previous block and carries the previous block headers’
hash digest.
(4) Each user can verify every block independently without any central authority.
(5) For a new block to be added, at least one member should verify it.
Hint: All the statements are a correct depiction of a blockchain except (5). Forthe addition of
a new block, majority of members must come to a consensus about the veracity of this block,
and only then can it be added.

Question 9: Which of the following is incorrect in the context of incentives related to

consensus mechanisms?

(1) Block reward entails the inclusion of a transaction in the new block on behalf of the
node that creates the new block.
(2) Block reward incentivizes the nodes to publish and verify the information correctly
(3) Nodes publishing new blocks get a share of transactions as a transaction fee
 (4) Over the long term, the block reward incentive is expected to decrease, and the
transaction fee is expected to be the major incentive
(5) Over long-term transaction fee incentive is expected to decrease, and block
reward is expected to be the major incentive
Hint: Under the Proof-of-work (PoW) consensus mechanism, the node that created/published
a new block is incentivized through two mechanisms. (a) Block reward mechanism: The node
gets to include a special transaction on this block. This transaction is a coin creation
transaction in which the newly created coin will typically go to the node’s address, which is a
reward for the service of creating a new block. This mechanism incentivizes honest positive
behaviour because the node will only get this reward if other nodes accept this transaction.
However, over the long run, the block reward keeps getting lower and lower and is expected
to stop after a certain time. After this, only the transaction fee reward is expected to be the
major incentive. The creator or publisher of a new block is also expected to get a transaction
fee incentive, which is the difference between the total transaction value of the new block
(input) and the output value. The node that creates/publishes the new block gets this
difference or transaction fee. As the block reward runs out, transaction fees will become more
and more important to ensure the quality of service.

Question 10: Which of the following is incorrect regarding the Proof-of-Stake (PoS)
consensus model.

(1) The members validating a block put a certain amount of ownership (e.g., native
currency) at stake
(2) A higher stake in blockchain results in a higher likelihood of getting selected
(3) If a validator submits bad transactions, they risk losing their stake in the blockchain
(4) A verified transaction earns rewards, thus leading to an incentive to act positively
(5) However, Proof-of-stake is more energy intensive than proof-of-work
Hint: All the options as provided are correct, except (5). Proof-of-stake is less energy-
consuming than Proof-of-work. PoW requires solving exhaustive computations that consume
a lot of energy.
 Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 11: Solution

Question 1: For distributed blockchain networks, which of the following is an incorrect

statement?

(1) There are many competing nodes aiming to publish the next block in expectation of
rewards and transaction fees
(2) These nodes are distrusting users motivated by the desire for financial benefits
(3) When a user joins the network for the first time, they agree to the initial state of the
system – the genesis block
(4) If there are multiple competing chains, the longer chain is considered correct as more
work is put into it.
(5) If there are multiple competing chains, the longer chain is selected as it provides
more power and resources
Hint: All the statements are correct, except (5). Across multiple competing chains, the longer
chain is preferred as more work is put into this chain.

Question 2: For the proof-of-work (PoW) consensus model, the following is a correct
statement.

(1) For PoW, solving the computationally intensive puzzle is difficult, but verifying the
solution is easy
(2) Publishing nodes expend computation effort, time, and resources to solve the puzzle
(3) This involves finding the correct nonce value, which, when hashed with the block
header, gives the target hash (or digest)
(4) Once a publishing node has performed its work (solved the puzzle), it sends its block
with a valid nonce to other nodes in the network for verification.

(5) All the statements are correct.

Hint: All the statements are correct.

Question 3: For the proof-of-stake (PoS) consensus model, the following is an incorrect
statement.

(1) PoS model is based on the idea that the user who has more stake will want the system
to succeed
(2) PoS model uses the amount of stake as a factor to determine the user publishing new
blocks
(3) Unlike PoW, PoS does not require resource-intensive computations
(4) PoS is computationally intensive
Hint: All the statements are correct except (4). PoS is computationally less intensive.

Question 4: Which of the following is not a correct statement comparing the digital form of
fiat currency and cryptocurrency?

(1) Fiat currencies are backed by the promise of central banks, cryptocurrencies are not
(2) Fiat currencies require trust in central banks, cryptocurrencies utilize cryptographic
protocols to generate trust
(3) Fiat currency transaction records are maintained by central banks,
cryptocurrencies do not require transaction records
(4) Fiat currencies are backed and issued by central banks, cryptocurrencies do not engage
central/regulatory authorities
(5) Cryptocurrencies use cryptographic mechanisms while fiat currencies use the trust and
authority of central banks and national governments
Hint: All statements except (3) are correct. Cryptocurrencies maintain transaction records that
can be verified with the help of blockchain cryptographic mechanisms.

Question 5: Which of the following is not true regarding cryptographic protocols?

(1) Each transaction record is hashed to create a hash output (digest) of a fixed length
(2) For one input, only one hash digest is possible
(3) It is highly improbable to find another input to generate the same hash digest
(4) The hashing operation enables the detection of any tampering with the transaction data
(5) If a hash is recomputed on a given input, it will generate a different hash digest.

Hint: All the statements are correct, except (5). If a hash is recomputed on a given data, it
should generate the exact same output. This property makes it easy to identify whether the
transaction data was tampered.

Question 6: Which of the following is not true regarding digital signatures?

(1) Each transaction block is signed with a digital signature, binding the sender to the
transaction
(2) Digital signatures require public key cryptography, involving a public and private key
(3) The user can sign the transaction with a private key and share the public key with the
intended recipients (members of the blockchain), which can be used by network
participants to verify the signature
(4) The private key is only known to the owner, while the public key is shared with various
users to identify the signatory
 (5) If the private key is lost, the user has to convince other members of the node about
the user’s veracity

Hint: All the statements are correct except (5). If the private key is lost, the owner loses assets
owned through the private key and cannot recover them without the key.

Question 7: Which of the following is not true regarding the blocks on the blockchain?

(1) A distributed ledger is formed with a chain of append-only transaction blocks in

chronological order, containing hash digests of the transaction
(2) The first block is a genesis block containing the first entry in the ledger
(3) All the subsequent blocks include the hashed information of the previous block in the
header, thus linking these blocks in chronological order
(4) Once a block is added, it cannot be altered retrospectively without compromising the
entire blockchain
(5) As the chain grows with time, it becomes easier to compromise

Hint: All the statements are correct except (5). As the chain grows bigger, more and more
blocks are added, and it becomes infinitely difficult to change or alter the information.

Question 8: Which of the following is not correct in the context of forking in a blockchain?

(1) Forking is referred to when the blockchain splits into two paths and requires resolution
(2) Unresolved forks represent competing blockchains
(3) Typically, forks occur during platform updates that are incompatible with the previous
platform codes
(4) A hard fork occurs when an update results in blocks that are not compatible with nodes
operating with older software
(5) Typically, forking happens when a malicious node creates a separate blockchain,
resulting in split ends

Hint: All the statements are correct except 5. Typically, forking is a result of platform updates.
Typically, those nodes that do not upgrade may face difficulty in adding blocks as their chain
may split and create a fork compared to those that have upgraded.

Question 9: How do cryptocurrencies deal with malicious users?

(1) Utilizing Merkle tree
(2) Utilizing a consensus system
(3) Incorporating permissionless model
(4) None of the above
Hint: The consensus systems usually promote non-malicious behaviour by rewarding
(incentivizing) the publishers (miners) of protocol-conforming blocks with a native
cryptocurrency.

Question 10: What does the puzzle friendliness property of the hash function mean?
(1) It is difficult to guess the input value for a hash function from its output.
(2) It is easy to guess the input value for a hash function from its output.
(3) One little difference in input, the output will be totally different.
(4) A little change in input will have no impact on the output.
(5) None of the above

Hint: The puzzle-friendliness property of a hash function means that even if someone has
partial knowledge of the input, it should be computationally difficult for them to predict or
obtain the corresponding output. Also, for a given output it is almost impossible to guess the
input.
Advanced Financial Instruments for Sustainable Business and Decentralized Markets

Week 12: Solution

Ques 1: What does ESG in “ESG investing” stands for?

a) Environmental, social and government.
b) Environmental, social and governance.
c) Environmental, sustainability and government.
d) All of the above
Hint: ESG in "ESG Investing" stands for E: Environmental, S: Social, and G: Governance.
Moreover, sustainability is a broader term encompassing the long-term impact of ESG
investing. Governance refers to corporate board structures and shareholder rights, not to
broader government issues.

Ques 2: Which of the following options are correct in the context of ESG Scores?
a) ESG score measures the company’s ESG performance based on verifiable reported
data in the public domain.
b) ESG Controversy score incorporates the impact of significant controversies on the
overall ESG scoring.
c) Both a and b
d) None of the above
Hint: ESG score and ESG controversy score are used to analyse the overall ESG scoring.

Ques 3: Which of the following is not generally expected for companies that score well on
ESG metrics relative to companies scoring less well?
a) They are better able to anticipate environmental change risks and opportunities.
b) They enjoy valuation premiums due to changing investor concerns and preferences.
c) They are more likely to grow rapidly and offer higher short-term returns.
d) None of the above
Hint: Companies that are scoring well on ESG metrics are expected to have low ESG-related
risks and, hence, offer lower expected returns.

Ques 4: What is the result of an analyst failing to correctly model the risks and opportunities
associated with ESG?
a) Systematic underestimation of high ESG performers and overestimation of ESG
under performers.
b) Systematic overestimation of both high ESG performers and ESG under performers.
c) Systematic underestimation of both high ESG performers and ESG under performers.
 d) Systematic overestimation of high ESG performers and underestimation of ESG under
performers.
Hint: Failing to model the ESG related risks and opportunities leads to systematic
underestimation of high ESG performers and overestimation of ESG under performers.

Ques 5: Screening method/approach in which firms are ranked within each industry or market
sector based on CSR criteria and subsequently, only those firms in each industry are selected
which pass a minimum threshold, is called:
a) Best-in-class Screening
b) Positive Screening
c) Negative Screening
d) None of the above
Hint: The best-in-class approach for sustainable investing means finding the companies that
are leaders in their sector in terms of meeting environmental, social and governance (ESG)
criteria.

Ques 6: What impact will a positive ESG rating have on a company's cost of capital?
a) A lower cost of capital.
b) No change to the cost of capital.
c) A higher cost of capital.
d) A more volatile cost of capital.
Hint: Positive ESG rating lowers the cost of capital of the company.

Ques 7: The method of constructing your portfolio so that it excludes or avoids “sin” stocks,
such as tobacco companies, is called:
a) Best-in-class Screening
b) Positive Screening
c) Negative Screening
d) None of the above
Hint: Negative Screening involves removing “sin” stocks from the portfolio.

Ques 8: Say you want to invest to generate measurable social or environmental impact
alongside financial returns. This approach is called:
a) Sin investing
b) Impact investing
c) Positive change investing
d) None of the above
Hint: The approach of investing to generate measurable social or environmental impact,
alongside financial returns, is called impact investing.
Ques 9: The method of screening in which only those companies are selected with a good
ESG record is, called:
a) Best-in-class Screening
b) Positive Screening
c) Negative Screening
d) None of the above
Hint: Positive screening criteria includes adding only those companies to the portfolio that
are good in ESG.

Ques 10: Screening out sin stocks from the portfolio might reduce the financial performance
of the firm. Which theory supports this statement?
a) Portfolio theory
b) Stakeholder theory
c) Agency theory
d) None of the above
Hint: Adding more screening criteria will lead to less diversification benefits and hence
lower financial performance. Portfolio theory supports this argument. Stakeholder and
Agency theory supports the positive relationship between screening criteria and financial
performance.