Financial Modeling Exam Wallstreet Prep:Questions & Answers

Financial Modeling Exam Wallstreet Prep:Questions &
Answers
Financial modeling - ANSWERIs concerned with the application of finance theory to
real world data using spreadsheet packages such as Excel

Three Components of Financial modeling - ANSWER1) Data-Prices, returns, earnings
2) Financial theory- CAPM or option pricing model
3) Model- excel spreadsheet or a VBA subroutine

Most important element of applied finance - ANSWERData - Market, accounting, or
economic

Market data - ANSWERincludes the prices and returns of equities, bonds, currencies,
commodities, and derivatives

Accounting data - ANSWERincludes balance sheets, income statements and cash
flow statement information for individual companies, sectors or economies

Economic data - ANSWERincludes information about the economy, such as output,
employment and prices for individual countries or groups of countries

Simple return - ANSWER= (newest price-old price)/old price

Log returns - ANSWERused for continuously compounded returns = ln(new
return/old return)

Beta - ANSWERslope of the best fitting line in a scatter plot of a stock return against
the market return = covariance.s(market simple returns, all company simple
returns)/var.s(all market simple returns). Estimating Beta daily may create problems
since not all stocks are traded daily

Estimating beta using regression tool - ANSWERdata analysis-regression-
y.range=market simple returns- x.range=company simple returns-ok
X Variable 1 = the estimated slope coefficient

measurement error in estimate of beta - ANSWERanything above or below 1 are
likely to be too high/low so we want to adjust it to 1 then multiply it by our slope
coefficient

risk free rate of interest - ANSWERthe rate of return on a risk free asset. Treasury
bills are said to be a risk free asset

long position - ANSWERportfolio weight for an asset greater than zero

, short position - ANSWERportfolio weight for an asset less than zero. This is also
known as short sold

portfolio expected return= - ANSWERportfolio weights*expected returns

transpose function - ANSWERchanges a vertical matrix to a horizontal once and vise
versus

mmult function - ANSWERcan take a 3*4 matrix and multiply it by a 4*2 matix

mini verse function - ANSWERgives the identity matrix where when multiplied by
itself will equal the original matrix

Covariance Matrix - ANSWERthe square symmetric matrix that gives the variance of
each asset on the diagonal, and the covariance between each pair of assets on the
off diagonal terms

=mmult(transpose(all portfolio simple returns-transpose(mean of portfolio simple
returns)),all portfolio simple returns))/(sample size)-1)

Minimum variance frontier - ANSWERset of all portfolios that have the lowest
standard deviation given the expected return

efficient portfolios - ANSWERset of all portfolios that have the highest standard
deviation given the expected return

efficient frontier - ANSWERset of all portfolios that are efficient

Black (1972) - ANSWERshows that when short sales are allowed, any combination of
two minimum variance portfolios is itself a minimum variance portfolio

To find efficient frontier - ANSWERSet Target Cell: variance of portfolio
Minimize the variance
By changing: weights of portfolio
Constraints: the total of weights =100%

If you want the expected return to be a certain rate have a dumby cell equal to what
you want and have another constraint set to your target expected return

The capital market line (CML) - ANSWERWhen there is a risk free asset, the (CML) is
the straight line that connects the risk free asset with the tangency portfolio (P*)
with the global minimum variance portfolio (GMVP). To find P* we use the Sharpe
Ratio

Sharp Ratio - ANSWERUsed to find tangency portfolio (P*).

=(expected return-risk free rate)/sqrt(variance of portfolio).