Investments Final Exam

Company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%. An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%, the dividend in the coming year should be

$1.94

Consider a one-year maturity call option and a one-year put option on the same stock, both with striking price $100. If the risk-free rate is 5%, the stock price is $103, and the put sells for $7.50, what should be the price of the call?

$15.26

You purchase one IBM July 120 call contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment.

$200 loss

You write one IBM July 120 call contract for a premium of $4. You hold the option until the expiration date when IBM stock sells for $126 per share. You will realize a ______ on the investment

$200 loss

45 Strike call option on a stock priced at $50 is priced at $6.50. This call has an intrinsic value of ______ and a time value of

$5.00; $1.50

You purchase one IBM July 120 put contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment

$500 loss

Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil is expected to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should be

$60.00

One of my personal favorite ETF"s is EXSJ.DE. It is an ETF that provides exposure to Eastern Europe. The security is denominated in Euros. During the last year, EXSJ.DE has increased from 25 Euros to 35 Euros per share. Dividends were about 1 Euro per share. What is the holding period return in Euros (called the local return)?

(35 + 1 - 25)/25 = 0.44

During the last year, the price of the Euro (exchange rate) has increase from $1.25 to $1.36. Using the EXSJ.DE prices given in the previous example, compute the dollar holding period return.

(35 + 1 / 25) X (1.36 / 1.25) - 1 = 0.5667

What happens at expiration if stock price is less than $100 in part c (what happens to the put, call and stock?) Explain what actions are taken by the holder of the synthetic bond.

-The call is out of the money -The put is in the money -The put is exercised and you receive k = 100 -Thus you paid $96 and receive $100

Portfolio is composed of 40% of asset A and 60% of asset B. The beta of asset A is 1.2 and the beta of asset B is 1.5. The beta of the portfolio is:

1.38

Market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12% and its expected EPS is $5.00. If the firm's plow-back ratio is 40%, its P/E ratio will be

11.54

What is the expected return on a stock with a beta of 0.8, given a risk free rate of 3.5% and an expected market return of 15.5%?

13.1%

Suppose that the market risk premium and the risk-free rate are expected to be 12% and 4%, respectively. If a stock has a beta of 0.80, what is its expected return on the stock?

13.6%

Unsystematic risk of a stock portfolio is 10% . The beta of the stock is 1 and the variance of the market portfolio is 25%. The total risk of the stock portfolio is:

35%

Bond is purchased for 950 and pays a $40 coupon 6 months later. The bond is then sold for $975. The Holding Period Yield on the bond is:

6.84%

Construction Machinery Company has an expected ROE of 11%. The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.

8.25%

Protective puts offer an advantage over stop-loss orders in that

A and C. the stop-loss order will be executed as soon as the stock price reaches the trigger point. the stop-loss order may actually be executed at a price below the trigger price.

Price that the buyer of a call option pays for the underlying asset if she executes her option is called the

A or B. Strike price, exercise price

In an efficient market, which of the following statements are true

A. and B. Technical analysis is of no value. Trends cannot be predicted

Free markets in world trade essentially implies the absence of tariffs (taxes). And more generally it means that there are less "frictions" to trade between nations. The basic effect of free trade is:

All of the above

Malkiel, in "Random Walk .." discusses the Roth IRA. In the Roth IRA.

B and C. Withdrawals after retirement are tax free. You are taxed "up front

American call option allows the buyer to

B and C. buy the underlying asset at the exercise price on or before the expiration date. sell the option in the open market prior to expiration

Is equal to (common shareholders' equity/common shares outstanding).

Book value per share

Suppose I plan to purchase 1000 barrels of oil to be used in my refinery. I want to lock in the price. State two ways that I can do this?

Buy futures contract. Buy call option

Using put-call parity, state the positions necessary to buy dividends (only) using call, puts and the underlying stock.

C = P+S-D-B D = P+S-C-B -Buy put -Buy stock -Sell call -Issue Debt with Face Value K

Industry that benefits most from the drop in crude oil prices is:

Cement and materials companies

Consider the expectations theory of the term structure of interest rates. If the yield curve is downward sloping, this indicates that investors expect short-term interest rates to in the future.

Decrease

Benjamin Graham thought that the benefits from security analysis had _________ over his long professional life.

Decreased

What is the primary advantage of adding foreign securities to your portfolio

Diversification

Option can only be exercised on the expiration date

European

Spot rate for Euros is $1.50, the domestic interest rate is 4% and the foreign rate 5%, Use the cost-of-carry model to solve for the 1 year futures price for Euros.

F = S(1+r-d) = 1.50(1+.04-0.5) = 1.485

Are analysts who use information concerning current and prospective profitability of a firms to assess the firm's fair market value.

Fundamental analysts

Futures contracts have many advantages over forward contracts except that

Futures contracts are tailored to the specific needs of the investor

Top-down analysis of a firm's prospects starts with an analysis of the

Global economy

Underpriced stock provides an expected return which is _______________ the required return based on the capital asset pricing model (CAPM)

Greater than

Constant growth dividend discount model (DDM) can be used only when the __

Growth rate is less than the required return

Suppose that U.S. equity markets represent about 20% of total global equity markets and that the typical U.S. investor has about 98% of their portfolio invested only in U.S. equities. This is an example of

Home country bias

If the Black-Scholes formula is solved to find the standard deviation consistent with the current market call premium, that standard deviation would be called the

Implied volatility

Put with strike price K = $100 costs $2. The maturity = expiration date is in 1 year. Current stock price is $100 and a call costs $6. The stock pays no dividends.

K / (1+r)^t 2-6 + 100 = $96

Malkiel argues that stock returns were very low during the 70's because

Low P/E ratios because of increased perception of risk

Contract maturity the value of a put option is ___________ where K equals the option's strike price and ST is the stock price at contract expiration

Max(0, K- ST)

Contract maturity the value of a call option is ___________ where K equals the option's strike price and ST is the stock price at contract expiration

Max(0, ST -K)

Which Excel formula is used to execute the Black-Scholes option pricing model?

NORMSDIST

Most widely used monetary policy tool is ___

Open market operations

When markets are fairly priced with respect to one another, we say that markets are in equilibrium. The stock market and bond market between 2010 and 2018 appeared to be:

Out of equilibrium. Bond prices are relatively too low.

Common stock pays an annual dividend per share of $2.10. The risk-free rate is 7% and the risk premium for this stock is 4%, Ift he annual dividend is expected to remain at $2.10, what is the value of the stock.

P = 2.10 / 0.11 = 19.09

Which one of the following refers to the possibility of expropriation of assets, changes in tax policy and the possibility of restrictions on foreign exchange transactions?

Political risk

Before expiration the time value of an out-of-the money stock option is

Positive

Investor who goes long in a futures contract will _____ any increase in value of the underlying asset and will _____ any decrease in value in the underlying asset

Receive; pay

Some successful principles for stock picking according to Malkiel are

Trade as little as possible

Most professionally managed equity funds _

Underperform the S&P 500 index on both raw and risk-adjusted return measures

Suppose that you purchased a call option on the S&P 100 index. The option has an exercise price of 680 and the index is now at 720. What will happen when you exercise the option

You will receive $4,000.

Clearing corporation has a net position equal to

Zero

Protective put strategy is

a long put plus a long position in the underlying asset.

Proponents of the Efficient Markets Hypothesis typically advocate

a passive investment strategy

American put option can be exercised

any time on or before the expiration date.

Buyers of call options __________ required to post margin deposits and sellers of put options __________ required to post margin deposits.

are not; are

Futures contracts __________ traded on an organized exchange, and forward contracts __________ traded on an organized exchange.

are; are not

Terms of futures contracts __________ standardized, and the terms of forward contracts __________ standardized

are; are not

Normal range of price-earnings ratios for the S&P500 Index is

between 10 and 20

If the stock price increases, the price of a put option on that stock __________ and that of a call option __________.

decreases, increases

Futures contract the futures price is

determined by the buyer and the seller when they initiate the contract

What is the primary disadvantage of adding foreign securities to your portfolio

exchange rate risk

All else equal, call option values are lower

for high dividend payout policies

High P/E ratios tend to indicate that a company will _______, ceteris paribus

grow quickly

Low P/E ratios tend to indicate that a company will _______, ceteris paribus.

grow slowly

Futures contract

is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the contract.

Bonds with "good features" will have lower YTMs than otherwise equivalent bonds. Therefore, convertible bonds will have _______ YTMs than otherwise equivalent non-convertible bonds.

lower

European call option can be exercised

only on the expiration date.

Before expiration, the time value of an in the money stock option is always

positive

Price that the buyer of the option pays to acquire the option is called the

premium.

If the currency of your country is depreciating, the result should be to ______ exports and to _______ imports.

stimulate, discourage

Recent empirical research indicates

that real rates of return on stocks are positively correlated with inflation

The maximum loss a buyer of a stock call option can suffer is equal to

the call premium.

According to the put-call parity theorem, the value of a European put option on a non-dividend paying stock is equal to:

the call value plus the present value of the exercise price minus the stock price.

Option Clearing Corporation is owned by

the exchanges on which stock options are traded.

Put option on a stock is said to be out of the money if

the exercise price is less than the stock price.

All of the following factors affect the price of a stock option except

the expected rate of return on the stock

One of the problems with attempting to forecast stock market values is that

the level of uncertainty surrounding the forecast will always be quite high

Covered call position is

the simultaneous purchase of a call and sale of a put on the same stock.

All the inputs in the Black-Scholes Option Pricing Model are directly observable except

the variance of returns of the underlying asset return.

If you increase the number of stocks from 5 to 30 in your portfolio, you can expect that

unsystematic risk of your portfolio will decrease

Investors want high plowback ratios

whenever ROE > k.

Firm has a required rate of return k. Investors want high plowback ratios when firms

whenever ROE >k