In my opinion, the best way to prepare for the final exam in Finance 4335 is to read carefully through the Finance 4335 (Fall 2019) Course Overview and make sure that you grasp the intuitions which are behind the topics that appear there. You’ll see a number of formulas in that document that don’t appear on the formula sheet but which are important for exam purposes; e.g., by now, I assume that everyone
- knows how to calculate and rank order risks on the basis of expected utility;
- knows how to apply the standard normal and binomial probability functions;
- is aware that the risk premium
is determined by setting expected utility (E(U(W)) equal to the utility of the certainty equivalent of wealth (WCE ), solving for the WCE , and subtracting WCE from E(W);
- understands that the risk premium (
) is positively related to the degree of risk aversion;
- comprehends that one is risk averse/risk neutral/risk seeking if
is positive/zero/negative;
- understands that the Arrow-Pratt coefficient (-U”/U’) indicates the degree of risk aversion; thus, a decision-maker with logarithmic utility (U = ln W) is more risk averse than a decision maker with power utility ( U = Wn)
- has learned that in a world where investors’ portfolios consist of combinations of the riskless asset and the market portfolio, that only systematic is priced; i.e.,
;
- understands that riskless arbitrage ensures the formation of so-called “arbitrage-free” prices for financial derivatives such as futures/forward and options;
- is aware that option pricing principles can be applied to value the option to default as well as determine the credit risk premium that investors demand from limited liability firms that issue debt.
The formula sheet mostly consists of option-related equations which I don’t expect students to have necessarily memorized, but hopefully y’all also grasp the intuitions upon which these equations are based.
Good luck!