172a final Q2

The mutual fund theorem states that __________________.

all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio

The strong-form version of the efficient market hypothesis states that stock prices reflects ______________ information relevant to the firm.

all publicly available as well as company inside

The difference between the fair and actually expected rate of return on a stock is called the stock's _____.

alpha

A mutual fund portfolio manager:

chooses stocks advantageously within the asset class.

Empirical tests of the strong-form version of the efficient market hypothesis indicate that ______________ are generally able to achieve superior returns.

company insiders

In an efficient market, portfolio management:

does not require emphasis on diversification.

The plowback ratio is also referred as the ______________.

earnings retention ratio

The intrinsic value of a share of common stock is:

equal to the present value of expected future net cash flows.

Portfolio diversification benefits ______________.

exist whenever security returns are less than perfectly positively correlated

In Fama and French's three-factor model, ______________ and ______________ are added to the market index to explain average returns.

firm size; book value to market value ratio

The book-to-market effect refers to the finding that firms with high ratios of book value to market value tend to have annual returns ______________ returns for firms with lower ratios.

greater than

Holding all else equal, a company's P/E ratio increases if ______________.

growth opportunities increase

The slope of the security characteristic line ____________.

measures the average response of an individual security's return to changes in the market return

KS Corp. has an ROE of 20% and a plowback ratio of 60%. The coming year's earnings are expected to be $4 per share. The firm's market capitalization rate is 16%. What is the present value of the firm's growth opportunities?

$15.00

E-Energy has just developed the most efficient electric battery for bicycles on the market. As a result, it is expected that free cash flow to equity per share will be $4 at the end of year 1 and $6 at the end of year 2. Then, E-Energy's growth rate will stabilize at 5% per year indefinitely. E-Energy's cost of equity is 15%. What is E-Energy's market value per share?

$55.65

The standard deviation of the rate of return for Stock A is 25%, and the standard deviation of the rate of return for Stock B is 30%. The covariance of the returns on Stock A and Stock B is 0.06. What is the correlation coefficient between the returns on Stock A and Stock B? Cov(rA,rB) = ρAB × σA × σB

.8

You invest $8,000 in stock A with a beta of 1.4 and $12,000 in stock B with a beta of 0.8. The beta of this formed portfolio is ______________.

1.04

John Mathew has a $800,000 fully diversified portfolio. He subsequently inherits XYZ company common stock worth $200,000. His financial adviser provided him with the following estimates: The original portfolio has expected monthly returns of 0.34%, and standard deviation of monthly returns of 1.19%. XYZ Company has expected monthly returns of 0.63% and standard deviation of monthly returns of 1.48%.The correlation coefficient of XYZ stock returns with the original portfolio returns is .20. The inheritance changes Mathew's overall portfolio, and he is deciding whether to keep the XYZ stock. Assuming Mathew keeps the XYZ stock, calculate the standard deviation of his new portfolio which includes the XYZ stock.

1.05

Katherine expects the market rate of return this year to be 12%. The expected rate of return on a stock with a beta of 1.2 is currently 14%. If the market return this year turns out to be 10%, what is the revised expected rate of return on the stock?

11.60%.

A stock with a current market price of $30 per share just paid a dividend of $2 per share. Dividends are expected to grow indefinitely at 5% per year. What is the required rate of return?

12%

Suppose that two risky portfolios, Portfolio A and Portfolio B, are perfectly negatively correlated. Portfolio A has an expected rate of return of 10% and a standard deviation of the rate of return of 20%. Portfolio B has an expected rate of return of 12% and a standard deviation of the rate of return of 30%. Portfolio A and Portfolio B are combined in such a way that the combination has a standard deviation of zero. What is the weight of portfolio A?

16.20

Compute the expected rate of return for the following two-stock portfolio: Stock Er Stdev weight A 18% 40% .7 B 12 28% .3

16.20% E(r) = (0.7 × 18%) + (0.3 × 12%) = 16.20%

For a portfolio, assume that E(rP)=25%, rf =5%, and E(rM) =15%. What is the beta of this portfolio?

2

A stock has an estimated rate of return of 15.5% and a beta of 1.5. The market expected rate of return is 10% and the risk-free rate is 3%. The alpha of the stock is ______________.

2%

A company expects to pay dividend of $7 next year that is expected to grow at 6%. It retains 30% of earnings. The rate of return is 10%. Calculate the ROE and the amount that the company's stock should sell.

20%, $175.00

A portfolio is composed of two stocks, A and B. For Stock A, the standard deviation of the rate of return is 20%. For Stock B, the standard deviation of the rate of return is 30%. Stock A comprises 40% of the portfolio while Stock B comprises 60% of the portfolio. What is the standard deviation of return for the portfolio if the correlation coefficient between the returns for A and B is 0.5?

23.065

XYZ Company's earnings are $9 per share and the capitalization rate is 18%, assuming that the no-growth value of the firm is $50. The actual price of the stock is $40, implying that the present value of growth opportunity is -$10. The P/E ratio is ___________.

4.44

Jensen Corp. has an expected excess return of 3% for the coming year. The company's beta is 0.8 and the expected market rate of return is 10%. Suppose that the actual market rate of return is 13%. Based on this information, what is your revised expectation for Jensen's excess return?

5.4%

Find the risk-free rate given that the expected return on stock is 17.88%, the expected return on the market portfolios is 16%, and the beta for stock is 1.2.

6.6%

Samuel Paul has invested in a project which has a 0.8 chance of doubling his investment in a year and a 0.2 chance of halving his investment in a year. What is the standard deviation of the rate of return on this investment?

60.0%

The current market price of Southwest Technology's common stock is $30 per share. Southwest just paid a $2 dividend. Its dividend is expected to grow by 5% in the coming year. The required rate of return for Southwest is 15%. What are Southwest's dividend yield and its capital gains yield?

7%; 8%

The expected return on a stock with a beta of 1.5 is 15%. If the expected risk-free rate of return is 3%, what should be the market risk premium?

8%

Which one of the following stocks is relatively more risky when held in a well-diversified portfolio? Stock stdev beta ABC 30% 1.2 XYZ 40% 1.6

A) XYZ because its beta is higher.

The efficient market hypothesis suggests that investors should:

adopt a passive portfolio management strategy.

Which of the following must be true about the present value of growth opportunities (PVGO)?

If ROE = required rate of return, then PVGO = 0.

Which term denotes the ratio of alpha to standard deviation of residual return?

Information ratio

Which of the following is NOT an assumption in the development of the capital asset pricing model?

Investors pay taxes on returns and incur transaction costs on trades in securities.

Which of the following statements is relevant to the Arbitrage Pricing Theory?

Its central insight emerges by considering highly diversified portfolios for which residual risk may be effectively ignored.

Which of the following observation is true of the Security Market Line?

Its slope is the risk premium of the market portfolio.

Which of the following portfolios cannot lie on the efficient frontier

Portfolio Y

Which of the following is a ratio that can be used for comparative valuation if the firm is a start-up with no earnings?

Price to sales ratio

A company's stock price will increase with an increase in its plowback ratio if the company's ______________.

ROE > required rate of return

Which of the following is a valid comparison between the CAPM and the APT?

The APT gets us to the expected return-beta relationship without requiring many of the unrealistic assumptions of the CAPM.

Which of the following statements is most likely to be true for a zero-growth stock?

The stock's price one year from today should be the same as its current price, assuming that its required return is the same in a year.

Proposed explanations of market anomalies, such as the P/E effect and the small-firm effect, include all of the following, except:

These effects demonstrate effective commercial activity.

Which of the following is an empirical rule concerning betas?

They appear to regress toward mean.

The small-firm-in-January effect refers to the phenomenon that portfolios of small-firm stocks (compared to portfolios of large-firm stocks) have:

abnormal positive returns, primarily in January.

Calculations of the intrinsic value of a stock using multistage growth models, compared to two-stage growth models, should be ______________.

more realistic, because multistage models allow for more flexible, and therefore more realistic, patterns of growth

According to the CAPM, overvalued securities should have ____________.

negative alphas

Stock prices follow a random walk because ____________.

new information is unpredictable

The risk that can be eliminated by diversification is called _________risk, while the risk that remains even after diversification is called _________risk.

nonsystematic; market

Some researchers have found that portfolios of stocks with low P/E ratios ______________.

outperform stocks with high P/E ratios

If stock returns exhibit positive but small serial correlation, this means that ______________ returns tend to follow ______________ returns.

positive; positive

All of the following are areas in which the capital asset pricing model (CAPM) can be used except:

predicting relationships among actual returns on a portfolio.

A common Wall Street rule of thumb is that the growth rate ought to be roughly equal to the __________.

price-earnings ratio

The reversal effect:

suggests that the stock market overreacts to relevant news, so that extreme investment performance is reversed.

For the efficient market hypothesis (EMH):

the semi strong form states that a firm's stock price reflects all publicly available information about a firm's prospects.

The investment opportunity set is ______________.

the set of all available portfolio risk-return combinations

The ______________ form of the efficient market hypothesis implies that there is little or nothing to be gained from technical analysis.

weak

Empirical findings generally show that a typical common stock mutual fund has a ______________.

zero alpha