Investment Analysis Midterm Agapova Fall 2019

If you believe you have a 60% chance of doubling your money, a 30% chance of gaining 15%, and a 10% chance of losing your entire investment, what is your expected return?

54.5% (.60 x 100%) + (.30 x 15%) + (.10 x -100%) = 54.5%

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.09?

57% and 43% 9%=w1(12%)+(1-w1)(5%);9%=12%w1 +5%-5%w1;4%=7%w1;w1 =0.57;1-w1 =0.43;0.57(12%)+ 0.43(5%) = 8.99%.

Consider the CAPM. The expected return on the market is 16%. The expected return on a stock with a beta of 1.6 is 22%. What is the risk-free rate?

6% 22% = rF + 1.6(16 - rF); rF = 6%

The geometric average of −13%, 15%, and 20% is _________.

6.28% [(1 + −0.13)(1 + 0.15)(1 + 0.20)]1/3 − 1 = 6.28%

You have an APR of 7.5% with continuous compounding. The EAR is _____.

7.79 % EAR = e.075 - 1 = 7.79% e = 2.71828

In a simple CAPM world which of the following statements is (are) correct? I. All investors will choose to hold the market portfolio, which includes all risky assets in the world. II. Investors' complete portfolio will vary depending on their risk aversion. III. The return per unit of risk will be identical for all individual assets. IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

I, II, III, and IV

An investor in a T-bill earns interest by _________.

buying the bill at a discount from the face value to be received at maturity

Security selection refers to the ________.

choice of specific securities within each asset class

An individual who goes short in a futures position _____.

commits to delivering the underlying commodity at contract maturity

If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the __________.

dollar-weighted return

Your timing was good last year. You invested more in your portfolio right before prices went up, and you sold right before prices went down. In calculating historical performance measures, which one of the following will be the largest?

dollar-weighted return

Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________.

equal to 0

Which one of the following measures time-weighted returns and allows for compounding?

geometric average return

When all investors analyze securities in the same way and share the same economic view of the world, we say they have ____________________

homogeneous expectations

Purchases of new issues of stock take place _________.

in the primary market

The dollar-weighted return is the _________.

internal rate of return

Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. You observe that Nicholas had an abnormal return of -1.2% yesterday. This suggests that

investors expected the earnings increase to be larger than what was actually announced.

The variance of a portfolio of risky securities

is the weighted sum of the securities' variances and covariances.

Rational risk-averse investors will always prefer portfolios _____________.

located on the capital market line to those located on the efficient frontier

Systematic risk is also referred to as

market risk, nondiversifiable risk.

A reward-to-volatility ratio is useful in:

understanding how returns increase relative to risk increases.

Risk that can be eliminated through diversification is called ______ risk.

unique firm-specific diversifiable all of these options ^^^^

In a well-diversified portfolio, __________ risk is negligible.

unsystematic

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______.

up; left

Which of the following statistics cannot be negative?

variance

The market portfolio has a beta of _________.

1

Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is _______.

$25.00 6% + 0.75(14% - 6%) = 12%; P = 1.50 / (.12 - .06) = $25.

You find that the bid and ask prices for a stock are $12.65 and $13.40, respectively. If you purchase or sell the stock, you must pay a flat commission of $30. If you buy 300 shares of the stock and immediately sell them, what is your total implied and actual transaction cost in dollars?

$285 300(13.40 − 12.65) + 2(30) = $285

You short-sell 100 shares of Tuckerton Trading Co., now selling for $32 per share. What is your maximum possible gain, ignoring transactions cost?

$3,200 Tuckerton could go bankrupt, with a share price of $0. You could keep the entire proceeds from the short sale. Maximum gain = Proceeds − Minimum possible replacement cost = 100($32) − 100($0) = $3,200

A preferred stock will pay a dividend of $3.00 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

$33.33 3.00 / .09 = 33.33

You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?

$6,000 15y + 5(1 - y) = 11; y = 60%; .60(10,000) = $6,000

Assume you purchased 500 shares of XYZ common stock on margin at $50 per share from your broker. If the initial margin is 75%, the amount you borrowed from the broker is _________.

$6,250 500($50)(0.25) = $6,250

The commission structure on a stock purchase is $75 plus $0.03 per share. If you purchase four round lots of a stock selling for $174, what is your commission?

$87 Commission = 75 + (400 × 0.03) = $87

The arithmetic average of -21%, 35%, and 40% is ________.

(-21% + 35% + 40%) / 3 = 18.00%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 15% and a standard deviation of return of 16.0%. Stock B has an expected return of 11% and a standard deviation of return of 4%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 7%. The proportion of the optimal risky portfolio that should be invested in stock A is _________.

0%

An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of 0.03 and 70 percent in a T-bill that pays 6 percent. His portfolio's expected return and standard deviation are __________ and __________, respectively.

0.081; 0.052 E(rP) = 0.3(13%) + 0.7(6%) = 8.1%; sP = 0.3(0.03)1/2 = 5.19%.

The standard deviation of return on investment A is 18%, while the standard deviation of return on investment B is 13%. If the covariance of returns on A and B is 0.003, the correlation coefficient between the returns on A and B is _________.

0.128 Correlation = 0.003 / [0.18(0.13)] = 0.128

If a portfolio had a return of 12%, the risk free asset return was 4%, and the standard deviation of the portfolio's excess returns was 25%, the Sharpe measure would be _____.

0.32 (12-4)/25 = 0.32

Asset A has an expected return of 14% and a standard deviation of 20%. The risk-free rate is 7%. What is the reward-to-variability ratio?

0.35 (14% - 7%) / 20% = 0.35

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 21%, while stock B has a standard deviation of return of 27%. Stock A comprises 70% of the portfolio, while stock B comprises 30% of the portfolio. If the variance of return on the portfolio is 0.045, the correlation coefficient between the returns on A and B is _________.

0.707 0.045 = (0.72)(0.212) + (0.32)(0.272) + 2(0.7)(0.3)(0.21)(0.27) ρ; ρ = 0.707

Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13 and the risk-free rate is 0.04. The beta of the stock is ___.

1. 13% = [4% +B(13% - 4%)]; 9% = B(9%); = 1.

You have a $60,000 portfolio consisting of Intel, GE, and Con Edison. You put $24,000 in Intel, $16,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and .8, respectively. What is your portfolio beta?

1.053 (24.0 / 60)(1.3)+(16.0 / 60)(1.0)+(20.0 / 60)(0.8)=1.053

You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is

1.08 0.6(1.2) + 0.4(0.90) = 1.08.

You invest $1,150 in security A with a beta of 1.4 and $950 in security B with a beta of 0.8. The beta of this portfolio is _________.

1.13 βp=(1.4)1,150 / 2,100+(0.80)950 / 2,100=1.13

You have the following rates of return for a risky portfolio for several recent years. Assume that the stock pays no dividends. Year (Beginning of Year Price) (# of Shares Bought or Sold) 2014 $105 260 bought 2015 $110 210 bought 2016 $106 235 sold 2017 $109 235 sold What is the geometric average return for the period?

1.25% yr 1 110 - 105 / 105 = 4.76% yr 2 106 - 110 / 110 = -3.64% yr 3 109 - 106 / 106 = 2.83% [(1.05)(1 + -0.0364)(1.0283)]1/3 - 1 = 1.25%

Suppose you pay $9,700 for a $10,000 par Treasury bill maturing in 3 months. What is the holding-period return for this investment?

10,000−9,700/9,700 = 3.09%

Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return

10.4% The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. wA = 14 /(17 + 14)=0.45;wB =1-0.45=0.55. E(RP) = 0.45(12%) + 0.55(9%) = 10.35%.

According to the CAPM, what is the expected market return given an expected return on a security of 13.0%, a stock beta of 1.5, and a risk-free interest rate of 7%?

11% 13.0 = 7 + 1.5 × (MRP); MRP = 10.50%; Expected market return = 7 + 10.50 = 11.00%

If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?

11.24% Nominal rate = (1.08)(1.03) - 1 = 11.24%

You put up $40 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.00. Your HPR was ____

11.5% 4% + ($3.00/40) = 11.5%

An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively.

12%; 15.7% E(rp)=.7(.15)+.3(.05)=12% σ(rp)=.70(.05)12=15.7%

You purchased a share of stock for $30. One year later you received $1.50 as a dividend and sold the share for $32.25. What was your holding-period return?

12.5% ($1.5 + $32.25 - $30)/$30 = 0.125, or 12.5%.

As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent. Your company has a beta of 1.4 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%.

13.8 The hurdle rate should be the required return from CAPM or (R = 4% + 1.4(11%-4%) = 13.8%.

An investment earns 13% the first year, earns 20% the second year, and loses 15% the third year. The total compound return over the 3 years was ______.

15.26% (1.13)(1.20)(1 - 0.15) - 1 = 15.26%

You consider buying a share of stock at a price of $32. The stock is expected to pay a dividend of $1.48 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $35. The stock's beta is 0.7, rf is 5%, and E[rm] = 15%. What is the stock's abnormal return?

2% E[r]=[35 − 32 + 1.48 / 32](100%) = 14% Required return = 5% + .7(15% - 5%) = 12% Abnormal return = 14% - 12% = 2%

Consider the CAPM. The risk-free rate is 8%, and the expected return on the market is 17%. What is the expected return on a stock with a beta of 1.6?

22.4% E[rs] = 8% + 1.6[17% - 8%] = 22.4%

You purchased a share of stock for $61. One year later you received $3.20 as dividend and sold the share for $60. Your holding-period return was _________.

3.61% (60 + 3.20 - 61) / 61 = 3.61%

Over the past year you earned a nominal rate of interest of 8 percent on your money. The inflation rate was 4 percent over the same period. The exact actual growth rate of your purchasing power was

3.8% r = (1+R) / (1+I) -1 ; 1.08% / 1.04% - 1 = 3.8%.

You are considering investing $1,200 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 70% and 30% respectively. X has an expected rate of return of 13%, and Y has an expected rate of return of 12%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately __________ in the risky portfolio. This will mean you will also invest approximately __________ and __________ of your complete portfolio in security X and Y, respectively.

39%; 27%; 12%

An investment provides a 2% return semi-annually, its effective annual rate is

4.04%. (1.02)2 -1 = 4.04%

According to the CAPM, what is the market risk premium given an expected return on a security of 17.0%, a stock beta of 1.4, and a risk-free interest rate of 10%?

5.00% 17.0 = 10 + 1.4 × (MRP); MRP = 5.00%

You invest $2,700 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 12% and a standard deviation of 16% and a Treasury bill with a rate of return of 7%. __________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 12%

75% σC = y × σp 12% = y × 16% y = 12/16 = 75%

An investor purchases one municipal bond and one corporate bond that pay rates of return of 8% and 9.6%, respectively. If the investor is in the 20% tax bracket, his after-tax rates of return on the municipal and corporate bonds would be, respectively, _____.

8% and 7.68%

If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn?

8.74% Real rate = (1.12/1.03) - 1 = 8.74%

The market capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13% and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be _________.

9.09 g = 13% X 0.5 = 6.5%; .5/(.12-.065) = 9.09

Which one of the following is a true statement regarding corporate bonds?

A corporate convertible bond gives its holder the right to exchange it for a specified number of the company's common shares.

Debt securities promise:

A fixed stream of income, A stream of income that is determined according to a specific formula

Which of the following is not a true statement regarding municipal bonds?

A municipal bond is a debt obligation issued by the federal government.

Which of the following is not a financial intermediary?

A real estate brokerage firm

Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that

AR = 15% - (4% + 2.25 (8%)) = -7.0%. A negative abnormal return suggests that there was firm-specific bad news.

Which of the following is not a money market security?

Common Stock

Which one of the following is a true statement?

Common dividends cannot be paid if preferred dividends are in arrears on cumulative preferred stock.

Which of the following are assumptions of the simple CAPM model? I. Individual trades of investors do not affect a stock's price. II. All investors plan for one identical holding period. III. All investors analyze securities in the same way and share the same economic view of the world. IV. All investors have the same level of risk aversion

I, II, and III only

The optimal risky portfolio can be identified by finding: The minimum-variance point on the efficient frontier The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier The tangency point of the capital market line and the efficient frontier The line with the steepest slope that connects the risk-free rate to the efficient frontier

III and IV only

Rank the following types of markets from least integrated and organized to most integrated and organized: Brokered markets Continuous auction markets Dealer markets Direct search markets

IV, I, III, II

__________ assets generate net income to the economy, and __________ assets define allocation of income among investors.

Real, Financial

The expected return on the market portfolio is 17%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.50. Within the context of the capital asset pricing model, _________.

SDA Corp. stock's alpha is -5.50% α = 0.16 - [0.08 + 1.50(0.17 - 0.08)] = -0.0550

Which of the following statements regarding the Capital Allocation Line (CAL) is false?

The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.

Annual percentage rates can be converted to effective annual rates by means of the following formula:

[1 + (APR/n)]^n - 1

According to the capital asset pricing model, a fairly priced security will plot _________.

along the security market line

The ______ measure of returns ignores compounding.

arithmetic average

You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________.

arithmetic average return

After considering current market conditions, an investor decides to place 60% of her funds in equities and the rest in bonds. This is an example of _____ .

asset allocation

Arbitrage is based on the idea that _________.

assets with identical risks must have the same expected rate of return

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

beta

You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of .55. The standard deviation of the resulting portfolio will be ________________.

more than 12% but less than 18% σ^2p = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12).55 = .02592; σ = 16.1%

Diversification is most effective when security returns are _________.

negatively correlated

According to the capital asset pricing model, a security with a _________.

positive alpha is considered underpriced

Consider a Treasury bill with a rate of return of 5% and the following risky securities: Security A: E(r) = .15; variance = .0400 Security B: E(r) = .10; variance = .0225 Security C: E(r) = .12; variance = .1000 Security D: E(r) = .13; variance = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be _________.

security A A has the steepest slope, found as: Slope = (.15 - .05)/(.04).5 = .5000

The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should

sell short the stock because it is overpriced. 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.

If an investor places a _________ order, the stock will be sold if its price falls to the stipulated level. If an investor places a __________ order, the stock will be bought if its price rises above the stipulated level.

stop-loss; buy stop

Investors require a risk premium as compensation for bearing ______________.

systematic risk

in the context of the Capital Asset Pricing Model (CAPM) the relevant risk is

systematic risk.

The weak form of the efficient market hypothesis contradicts

technical analysis, but is silent on the possibility of successful fundamental analysis.

The holding period return on a stock is equal to _________.

the capital gain yield over the period plus the dividend yield

The efficient frontier of risky assets is

the portion of the investment opportunity set that lies above the global minimum variance portfolio.

The term complete portfolio refers to a portfolio consisting of _________________.

the risk-free asset combined with at least one risky asset

The reward-to-volatility ratio is given by _________.

the slope of the capital allocation line

The expected rate of return of a portfolio of risky securities is _________.

the weighted sum of the securities' expected returns

Money market securities are sometimes referred to as cash equivalents because _____.

they are safe and marketable