Explanation
According to the CAPM, the expected return from a risky asset is a function of the contribution of the risky asset to the total risk of the market portfolio. Nothing else matters. All assets are priced according to the risk they bring to the market portfolio, regardless of their individual level of risk. An asset that is very volatile on its own, but has a negative correlation to the market may be priced high, ie have low expected return, because of its impact on the risk of the market portfolio. Therefore Choice 'a' is the correct answer, and the other options are incorrect.
Recall that according to the CAPM = covariancex, y / variancex, where x is the market portfolio and y is the risky asset.
The beta itself is a function of the covariance of the asset's returns with market returns, and therefore only the driver of expected return for an asset is its beta, which is determined by the asset's contribution to portfolio risk. ( = covariance(x, y) / variance(x), where x is the market portfolio and y is the risky asset. )

Explanation
The forward rate from year 2 to year 3 in this case can be derived as =(1.05^3/1.04^2) - 1, or 7.03%. All other answers are incorrect.

Explanation
Energy derivative markets are still not very liquid, and experience high price volatility. This high volatility is responsible for most of the risk in these markets. Choice 'd' is the correct answer.

Explanation
All the choices listed are valid assumptions underlying the BSM option valuation formula except that the BSM formula is based upon the option being exercisable only at expiry. The assumption is that early exercise is not permitted. In other words, BSM applies to European options and not American options. Therefore Choice 'd' represents the correct answer as it is not an assumption underlying Black Scholes.

Explanation
The effectiveness of the hedge is solely determined by the correlation between the position being hedged, and the position being used as the hedge. A hedge can be perfect when correlation is 1, and will be less than perfect when it is anything other than 1.The effectiveness of the optimal hedge is given by the formula (1-2), where is the correlation between the two. Therefore Choice 'a' is the correct answer. Standard deviations affect the hedge ratio, not the effectiveness of the hedge.
(Note: In other texts, hedge effectiveness is explained to be measured by , which is essentially the same as (1-
2), both expressions being functions of . You can use either, being aware that one measures the variance explained, and the other is a measure of the unexplained variance.)