There are two main theories that explain an upward sloping yield curve. The first is the market expectations hypothesis (called ' pure expectations ' ). According to this explanation, the yield curve represents investor expectations of future yields, and forward rates are predictors of future interest rates. The yield curve slopes upwards when investors expect interest rates to go up in the future. Thus, statement I is correct. By the same logic, statement II is incorrect.

The second explanation for an upward sloping yield curve is the liquidity preference theory - according to which investors value liquidity and are prepared to pay more for instruments that mature earlier. Having their money tied up in longer maturity instruments increases all kinds of risks, and therefore longer term instruments are priced lower than instruments maturing earlier. Since the price of instruments that mature earlier is higher, their yield is lower than that of longer dated securities, thereby leading to an upward sloping yield curve. Therefore statement III is correct.

Statement IV actually explains why an yield curve may be downward sloping - in fact an inverted yield curve is considered an indicator of an upcoming recession. Therefore statement IV does not explain an upward sloping yield curve, and is therefore not a correct choice for the answer.

Thus statements I and III correctly explain an upward sloping yield curve. Other choices are incorrect.

The mean can be calculated quite easily as a weighted average, and in this case it is 0.6*5% + 0.4*3% = 4.2%.

The variance can be calculated with the formula for portfolio variance as = (0.6^2)*(20%^2) + (0.4^2)*(5%^2) + 2*(-0.6)*0.6*0.4*20%*5%=0.01192. Therefore the volatility of this portfolio is SQRT(0.01192)=10.92%

All the statements given are true, except that standard deviations cannot be averaged to get the portfolio standard deviation unless the assets are perfectly positively correlated. Therefore Choice ' d ' is the false statement, and the correct answer.

For a portfolio of uncorrelated assets, ie correlations being equal to zero, variances can be added together to get portfolio variance. Also, regardless of correlations, portfolio returns are always the weighted average of asset returns, and just averages will do in this case as the portfolio is said to be equally weighted across the assets. A correlation of zero produces a risk level less than that possible with positive correlations.

Investors have differing view of the market, which means differing view of expected returns, correlations and volatilities. Not only do they have differing views, these views change frequently as new information reveals itself. Accordingly, each investor has their own version of the efficient frontier. Once investors have determined their efficient frontiers, they will determine the extent of risk they wish to hold. If they had identical views, they would have held the same portfolio. But they do not, and if they did, there would be very little trading in the markets.

All the above statements are true except statement I which is false due to differing investor expectations.

(Re statement IV: If investors have different risk appetites, their portfolio will vary in the split between the risky and the riskfree assets. But inside the ' risky ' assets bundle the proportion of the assets will be identical. Ie, they would express their varying risk appetites by varying how much of the risky bundle and the riskfree asset they hold, but inside the risky bundle the proportion of the different risky assets will be the same.)

A CLN is a form of a funded credit derivative. The investors in the note are the protection sellers, and receive the CDS premiums in addition to any risk free rate on their investment. If a default occurs, the money put up by the investors in the CLN is used to make good the party that has brought the protection.

Therefore if a default occurs, the investors in a CLN do not receive their entire investment back, but only what remains after fullfilling their obligations on the credit protection, plus any premiums that might have been earned. In return for this risk, the CLN yields the risk free rate plus the CDS premiums. Only Choice ' d ' is correct, all other options are incorrect.

Futures initial margins are determined by the exchange. SPAN is the name of a framework the CME uses to determine margins. Only Choice ' d ' is correct.

Generally, it is not a good idea to exercise an option early as any more upside in the remaining period to expiry is being sacrificed. However, if an extraordinarily large dividend is coming due, and this dividend is larger than the interest foregone from holding the option, it may be a good idea to exercise the option early. In such cases, the exercise needs to happen before the ex-dividend date and not afterwards. Choice ' b ' is therefore the correct answer.

Even if the option is deep in the money and delta is approaching 1, and exercise upon maturity is almost a certainty, it would still always be better to sell the option than exercise it . Therefore Choice ' a ' is incorrect. Choice ' c ' is correct in all cases except when a large dividend is coming in. Choice ' d ' is not correct because an early exercise needs to happen prior to the ex-dividend date and not afterwards.

Systematic risk refers to market risk that cannot be diversified away. Specific risk relates to the unique risk from the securities selected in the portfolio, and these can be diversified away by adding other securities to the portfolio. Diversifiable risk is risk that can be diversified away, ie the same as specific risk. Portfolio risk is the total risk of the portfolio that includes both specific and systematic risk.

This question addresses the key differences between futures and forward contracts. Forward contracts are over the counter (OTC) instruments, while futures are exchange traded. Therefore Choice ' b ' is not a true statement.

Futures contracts require an initial margin to be paid to the exchange, and gains and losses to be settled daily, while forward contracts generally settle only at the maturity of the contract. Therefore Choice ' a ' is a true statement.

The exchange is the counterparty in a futures contract, and through its system of initial and variation margins guarantees the performance of the contract. Futures therefore have very little credit risk when compared to forwards. Therefore Choice ' c ' is a true statement.

Because futures gains and losses give rise to daily cash flows, while the P & L on forward contracts is settled only at the end of the contract, the timing differences create small pricing differences between the two. Therefore Choice ' d ' is a true statement.

Given a choice, decision makers will maximize expected utility. The four basic axioms on which the principle of maximizing expected utility is based are:

- Transitivity of choice,

- Continuity of choice,

- Independence of choice, and

- Stochastic dominance.