FIN4504 Final Exam (Hw's 1-10)

A. 0%

6. The proportion of the optimal risky portfolio that should be invested in stock 1 is _________. A. 0% B. 40% C. 60% D. 100%

D. Spiders

6. Which of the following ETFs tracks the S&P 500 index? ________ A. Qubes B. Diamonds C. Vipers D. Spiders

A. 14.0%

7. The expected return on the optimal risky portfolio is _________. A. 14.0% B. 15.6% C. 16.4% D. 18.0%

C. Write call and write put Answer: Remember holding a (long) straddle bets on future price movement. Writing a straddle bets on the stable price.

8. Which of the following strategies makes a profit if the stock price stays stable? _________. A. Hold call and write put B. Hold call and hold put C. Write call and write put D. Write call and hold put

D. 11.00%

1. You put up $50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.50. Your HPR was ____. A. 4.00% B. 3.50% C. 7.00% D. 11.00%

E) 0.065 (6.5%) E(r)= 0.1*20% + 0.6*10% + 0.3*(-5%)

11. An investment has a 10% probability of earning a 20% rate of return, a 60% probability of earning a 10% rate of return and a 30% probability of losing 5%. What is the expected rate of return for this investment? ______. A) 0.045 (4.5%) B) 0.05 (5.0%) C) 0.055 (5.5%) D) 0.06 (6.0%) E) 0.065 (6.5%)

B. decrease Answer: When the firm becomes mature, the investment opportunities decrease

11. Generally speaking, as the firm progresses through the industry life cycle you would expect the PVGO to ________ as a percent of share price. A. increase B. decrease C. stay the same D. no typical pattern can be expected

D). Maturity greater than one year

12. Which of the following is not a characteristic of a money market instrument? _____ A). Liquidity B). Marketability C). Low risk D). Maturity greater than one year

A. a hybrid market

15. The New York Stock Exchange is a good example of _________. A. a hybrid market B. a brokered market C. a dealer market D. a direct search market

C. a passive investment strategy

2. Proponents of the EMH typically advocate __________. A. a conservative investment strategy B. a liberal investment strategy C. a passive investment strategy D. an aggressive investment strategy

B. 10% Answer: ₤55 × 100 × 1.40 = $7,700 (7700/7000) - 1 = 1.10 -1 = 10%

4. After one year, the exchange rate is unchanged and the share price is ₤55. What is the DOLLAR-denominated return? _______ A. 14% B. 10% C. 9.3% D. 7.1%

B. technical analysis

4. Choosing stocks by searching for predictable patterns in stock prices is called ________. A. fundamental analysis B. technical analysis C. index management D. random walk investing

A. the capital allocation line

4. In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called _________. A. the capital allocation line B. the indifference curve C. the investor's utility line D. the security market line

B. the Federal Reserve

4. Initial margin requirements on stocks are set by _________. A. the Federal Deposit Insurance Corporation B. the Federal Reserve C. the New York Stock Exchange D. the Securities and Exchange Commission

D. With a correlation of 1.0, no risk will be reduced

4. Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk? __________. A. Market risk B. Unique risk C. Unsystematic risk D. With a correlation of 1.0, no risk will be reduced

C) put option

5. A ________ gives its holder the right but not the obligation to sell an asset for specified exercise price on or before a specified expiration date. A) call option B) futures contract C) put option D) forward contract E) none of the above

A. Collar

6. What strategy is designed to ensure a value within the bounds of two different stock prices? _______. A. Collar B. Covered Call C. Protective put D. Straddle

B. 6.43% Answer: pound rate of return: -10% dollar rate of return: -3.571% Gain from currency is -3.571% - (-10%) = 6.43%

7. After one year, the exchange rate is $1.50/₤ and the share price is ₤45. How much of your dollar-denominated return is due to the currency change? _______ A. 10.00% B. 6.43% C. 4.34% D. 2.12%

C. 8% 20% = rf + (18% - rf)(1.2); rf = 8%

7. Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate? A. 2% B. 6% C. 8% D. 12%

C. 40.33 Answer: price weighted index is the arithmetic average of the price of the stock included in the index. So the index price=($54+$23+$44)/3=40.33.

7. The Chompers Index is a price weighted stock index based on the 3 largest fast food chains. The stock prices for the three stocks are $54, $23, and $44. What is the price weighted index value of the Chompers Index? _____. A. 23.43 B. 35.36 C. 40.33 D. 49.58

D. 8.47% discount

7. The Stone Harbor Fund is a closed-end investment company with a portfolio currently worth $300 million. It has liabilities of $5 million and 9 million shares outstanding. If the fund sells for $30 a share, what is its premium or discount as a percent of NAV? _________ A. 9.26% premium B. 8.47% premium C. 9.26% discount D. 8.47% discount

B. 12.50 Answer: Based on constant growth DDM, when a firm follows the pay-out policy of dividing its earnings into dividends and reinvestment, the P/E ratio is given by: P/E_1 =(1-b)/(k-ROE*b)=(1-0.5)/(0.10-0.12*0.5)=12.5, where b is the plowback ratio.

7. The 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 50%, its P/E ratio will be _________. A. 8.33 B. 12.50 C. 19.23 D. 24.15

C. 12.0%, 15.7%

8. 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. A. 10.0%, 6.7% B. 12.0%, 22.4% C. 12.0%, 15.7% D. 10.0%, 35.0%

D. $40.25 Answer: In this case the specialist would match the buy order with the lowest limit sell order ($40.25).

8. Consider the following limit order book of a specialist. If a market buy order for 100 shares comes in, at what price will it be filled? ________. Limit Buy Orders Limit Sell Orders Price Shares Price Shares $39.75 100 $40.25 100 $39.50 100 $40.50 100 A. $39.75 B. $40.50 C. $40.375 D. $40.25

B. negatively correlated

8. Diversification is most effective when security returns are _________. A. high B. negatively correlated C. positively correlated D. uncorrelated

D. behavioral finance

8. Models of financial markets that emphasize psychological factors affecting investor behavior are called _______. A. data mining B. fundamental analysis C. charting D. behavioral finance

B. Variance

9. Which of the following statistics cannot be negative? __________ A. Covariance B. Variance C. E[r] D. Correlation coefficient

D. all of the above

1. Risk that can be eliminated through diversification is called ______ risk. A. unique B. firm-specific C. diversifiable D. all of the above

A. decrease, decrease Answer: A lower stock price is beneficial for call writer; a lower stock price is beneficial for put holder.

14. A writer of a call option will want the value of the underlying asset to __________ and a buyer of a put option will want the value of the underlying asset to _________. A. decrease, decrease B. decrease, increase C. increase, decrease D. increase, increase

B. buy stock X because it is underpriced

14. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should _________. A. buy stock X because it is overpriced B. buy stock X because it is underpriced C. sell short stock X because it is overpriced D. sell short stock X because it is underpriced

B. negatively correlated

3. Diversification is most effective when security returns are _________. A. high B. negatively correlated C. positively correlated D. uncorrelated

A). over 60%

3. Financial assets represent _____ of total assets of U.S. households. A). over 60% B). over 90% C). under 10% D). about 30% E). all of the above

E) 0% Answer: Index level on day1: (88+21+11)/3=40; Index level on day0: (90+20+10)/3=40; return=( level on day1- level on day0)/ level on day0=(40-40)/40=0%.

The following three questions (8-10) refer to the table below. Consider the three stocks A, B, and C. Pt represents price at time t, and Vt represents shares outstanding at day t. P0 V0 P1 V1 A 90 10 88 10 B 20 20 21 20 C 10 100 11 100 8. What is the return of the price-weighted index of the three stocks for the period from t=0 to t=1. _____. A) 9% B) 7% C) 4% D) 2% E) 0%

A. $33.00; $3.50 Answer: Maximum per share loss to put writer =-[(0-35) + 2] = 33.00 if stock price is $0 at expiration. Maximum per share gain to call writer = 3.50 if stock price is below $35 at expiration.

. A put on Sanders stock with a strike price of $35 is priced at $2 per share while a call with a strike price of $35 is priced at $3.50. The maximum per share loss to the writer of an uncovered put is __________ and the maximum per share gain to the writer of an uncovered call is _________. A. $33.00; $3.50 B. $33.00; $31.50 C. $35.00; $3.50 D. $35.00; $35.00

D. short-run, long run

1. Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock price behavior. A. short-run, short-run B. long-run, long-run C. long-run, short-run D. short-run, long run

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

1. Rational risk-averse investors will always prefer portfolios _____________. A. located on the efficient frontier to those located on the capital market line B. located on the capital market line to those located on the efficient frontier C. at or near the minimum variance point on the efficient frontier D. that are risk-free to all other asset choices

N/A

1. The GE example on the text book. This is a typical example of two stage DDM model and the explanation from the text book is very detailed. This kind of question will be definitely shown on the exam!

B. investment bankers

1. Underwriting is one of the services provided by _____. A. the SEC B. investment bankers C. publicly traded companies D. FDIC

D. Political risk

1. Which one of the following country risks refers to the possibility of expropriation of assets, changes in tax policy and the possibility of restrictions on foreign exchange transactions? ______ A. Default risk B. Foreign exchange risk C. Market risk D. Political risk

D. Unit investment trust

1. Which one of the following invests in a portfolio that is fixed for the life of the fund? _____ A. Mutual fund B. Money market fund C. Managed investment company D. Unit investment trust

A. $300 profit Answer: 1 contract=100 shares of options. For the call option writer, the payoff is (120-121)*100=-100. So the profit=payoff+premium=-100+4*100=300.

1. 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 $121 per share. You will realize a ______ on the investment. A. $300 profit B. $200 loss C. $600 loss D. $200 profit

D) A and C

1. _______ are financial assets. A) Bonds B) Machines C) Stocks D) A and C E) A, B and C

B. in the money Answer: Since the current stock price is smaller than the strike price, the put option is in the money.

10. A put option on Snapple Beverage has an exercise price of $30. The current stock price of Snapple Beverage is $24.25. The put option is _________. A. at the money B. in the money C. out of the money D. knocked out

C. $8,000 Answer: The IMR is 60% and that is to say you can borrow (1 - 60% = 40%) of your purchase from the broker, i.e. 500*40*0.40 = $8,000.

10. Assume you purchased 500 shares of XYZ common stock on margin at $40 per share from your broker. If the initial margin is 60%, the amount you borrowed from the broker is _________. A. $20,000 B. $12,000 C. $8,000 D. $15,000

B. $70

10. Grott and Perrin, Inc. has expected earnings of $3 per share for next year. The firm's ROE is 20% and its earnings retention ratio is 70%. If the firm's market capitalization rate is 15%, what is the present value of its growth opportunities? _________. A. $20 B. $70 C. $90 D. $115

B. techniques used to identify efficient portfolios of risky assets

10. Harry Markowitz is best known for his Nobel prize winning work on ________. A. strategies for active securities trading B. techniques used to identify efficient portfolios of risky assets C. techniques used to measure the systematic risk of securities D. techniques used in valuing securities options

A. the NAV calculated at the market close at 4:00 pm New York time.

10. If you place an order to buy or sell a share of a mutual fund during the trading day the order will be executed at _________. A. the NAV calculated at the market close at 4:00 pm New York time. B. the real time NAV. C. the NAV delayed 15 minutes. D. the NAV calculated at the open of the next day's trading.

B) investor's aversion to risk.

10. The variable A in the utility function, U = E(r) - 0.5Aσ^2, represents the: ______. A) investor's return requirement. B) investor's aversion to risk. C) certainty-equivalent rate of the portfolio. D) minimum required utility of the portfolio. E) none of the above.

A. 1.048 =0.4*1.3+0.24*1.0+0.36*0.8=1.048

10. You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta? A. 1.048 B. 1.033 C. 1.000 D. 1.037 Remember: the portfolio β is the weighted average of the β of individual asset included in the portfolio.

B. The capital market line is also called the security market line

11. In a world where the CAPM holds which one of the following is not a true statement regarding the capital market line? A. The capital market line always has a positive slope B. The capital market line is also called the security market line C. The capital market line is the best attainable capital allocation line D. The capital market line is the line from the risk-free rate through the market portfolio

A. left and above

11. On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the ____________ of the current investment opportunity set. A. left and above B. left and below C. right and above D. right and below

D. money spread

11. You buy a call option on Merritt Corp. with an exercise price of $50 and an expiration date in July and write a call option on Merritt Corp. with an exercise price of $55 with an expiration date in July. This is called a ________. A. time spread B. long straddle C. short straddle D. money spread

A. $4,500 Answer: Your Equity (or Investment) = 300*30*50% = $4,500.

11. You sold short 300 shares of common stock at $30 per share. The initial margin is 50%. You must put up _________. A. $4,500 B. $6,000 C. $9,000 D. $10,000

C). Real, financial

11. __________ assets generate net income to the economy and __________ assets define allocation of income among investors. A). Financial, financial B). Financial, real C). Real, financial D). Real, real

A. 0.583

12. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________. A. 0.583 B. 0.225 C. 0.327 D. 0.128

D) 0.08 (8%)

12. An investment has a 10% probability of earning a 20% rate of return, a 60% probability of earning a 10% rate of return and a 30% probability of losing 5%. What is the standard deviation of the rate of return for this investment? _____. A) 0.05 (5%) B) 0.06 (6%) C) 0.07 (7%) D) 0.08 (8%) E) 0.09 (9%)

C. 10.75% E[rm]= 0.04+3*0.0225=10.75%

12. Consider the capital asset pricing model. The average degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is _________. A. 6.75% B. 9.0% C. 10.75% D. 12.0%

A. $10.00 3/(0.4-0.1)=10.

12. Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 10% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 13%. The stock of Interior Airline has a beta of 4.00. Using the constant growth DDM, the intrinsic value of the stock is _________. A. $10.00 B. $22.73 C. $27.78 D. $41.67

C. I, II and III only Answer: When the strike price is higher, the call option is less likely to result in positive payoff so the call price is lower. When time approaches to maturity, there is less chance for a stock to have a large movement so the call price is lower. When the stock price decreases, the call option is less likely to result in positive payoff so the call price is lower. However, the option price doesn't depend on the split of the stock.

12. The value of a listed call option on a stock is lower when _______________. I. the exercise price is higher II. the contract approaches maturity III. the stock decreases in value IV. a stock split occurs A. II, III and IV only B. I, III and IV only C. I, II and III only D. I, II, III and IV

D. unlimited Answer: There is no upper limit to the price of a share of stock; therefore no upper limit the price you will have to pay to replace the 200 shares of Tuckerton.

12. You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible loss? _________. A. $50 B. $150 C. $10,000 D. unlimited

C. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion

13. According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return tradeoffs B. identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion D. choosing which risky assets an investor prefers according to their risk aversion level; minimizing the CAL by lending at the risk-free rate

A). commits to delivering the underlying commodity at contract maturity

13. An individual who goes short in a futures position _____ A). commits to delivering the underlying commodity at contract maturity B). commits to purchasing the underlying commodity at contract maturity C). has the right to deliver the underlying commodity at contract maturity D). has the right to purchase the underlying commodity at contract maturity

B. 3.7% E[ri]= 0.05+1.1*(0.08-0.05)= 0.083. Then α=0.12-0.083=0.037

13. Security A has an expected rate of return of 12% and a beta of 1.10. The market expected rate of return is 8% and the risk-free rate is 5%. The alpha of the stock is _________. A. -1.7% B. 3.7% C. 5.5% D. 8.7%

D. unlimited Answer: Since the stock price can be any value larger or equal to 0, the loss of the naked (uncovered) call is unlimited.

13. The potential loss for a writer of a naked call option on a stock is _________. A. equal to the call premium B. larger the lower the stock price C. limited D. unlimited

C. $10,000 Answer: Tuckerton could go bankrupt with a share price of $0. You could keep the entire proceeds from the short sale. So Maximum Gain = 200*50 - 200*0 = $10,000.

13. You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible gain ignoring transactions cost? _________. A. $50 B. $150 C. $10,000 D. unlimited

C). the firm and its real assets

14. The success of common stock investments depends on the success of _________. A). derivative securities B). fixed income securities C). the firm and its real assets D). government methods of allocating capital

B. 10.8%

14. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A and the correlation coefficient between the two stocks is -1.0. __________ A. 0.0% B. 10.8% C. 18.0% D. 24.0%

C. 43% Answer: Initial Equity (or Investment) = 250*25*65% = $4,062.5. Borrowing = 250*25*35% = $2,187.5. Equity left for you after sale at $32 = 250*32 - 2187.5 = $5,812.5. Return = (5812.5 - 4062.5)/4062.5 = 43%.

14. You purchased 250 shares of common stock on margin for $25 per share. The initial margin is 65% and the stock pays no dividend. Your rate of return would be _________ if you sell the stock at $32 per share. Ignore interest on margin. A. 35% B. 39% C. 43% D. 28%

C. $475 Answer: Since the put is at the money right now, then the strike price X=50. In addition, the payoff of writing a naked put is: state 1: 0 since the stock price increases by 10%; state 2: (ST-X)*100=[50*(1-5%)-50]*100=-250; state 3: (ST-X)*100 [50*(1-20%)-50]*100=-1000; So the expected profit=expected payoff+premium= [0.6*0+0.3*(-250)+0.1*(-1000)]+650=475.

15. A stock is trading at $50. You believe there is a 60% chance the price of the stock will increase by 10% over the next three months. You believe there is a 30% chance the stock will drop by 5% and you think there is only a 10% chance of a major drop in price of 20%. At the money 3 month puts are available at a cost of $650 per contract. What is the expected dollar profit for a writer of a naked put at the end of three months? _________. A. $300 B. $200 C. $475 D. $0

D). Allow most participants to routinely earn high returns with low risk

15. Financial markets allow for all but which one of the following? _______ A). Shift consumption through time from higher income periods to lower B). Price securities according to their riskiness C). Channel funds from lenders of funds to borrowers of funds D). Allow most participants to routinely earn high returns with low risk

D. both well diversified portfolios and individual assets; well diversified portfolios only

15. The SML is valid for _______________ and the CML is valid for ______________. A. only individual assets; well diversified portfolios only B. only well diversified portfolios; only individual assets C. both well diversified portfolios and individual assets; both well diversified portfolios and individual assets D. both well diversified portfolios and individual assets; well diversified portfolios only

D) 14

16. Assume there are 4 risky assets traded in the market. In order to generate the minimum variance frontier, how many inputs (in terms of expected return, variance, and covariance) do you need? _____. A) 10 B) 12 C) 13 D) 14 E) 15

D. systematic risk

17. Investors require a risk premium as compensation for bearing ______________. A. unsystematic risk B. alpha risk C. residual risk D. systematic risk

B. along the security market line

18. According to the capital asset pricing model, a fairly priced security will plot _________. A. above the security market line B. along the security market line C. below the security market line D. at no relation to the security market line

C. hedge fund

2. A _________ is a private investment pool open only to wealthy or institutional investors that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds. A. commingled pool B. unit trust C. hedge fund D. money market fund

B. earnings retention ratio will increase Answer: When the firm cuts its dividend ratio, its plowback ratio or retention ratio b increases.

2. A firm cuts its dividend payout ratio. As a result you know that the firm's _______. A. return on assets will increase B. earnings retention ratio will increase C. earnings growth rate will fall D. stock price will fall

A. American, more, European Answer: The American option gives the option holder more flexibility than the European option since it can be exercised on or before the expiration date. So it is more valuable.

2. All else the same, an ______ style option will be ______ valuable than a ______ style option. A. American, more, European B. American, less, European C. American, more, Canadian D. American, less, Canadian

A. asset A

2. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and _____. A. asset A B. asset B C. no risky asset D. can't tell from the data given Answer: A has a higher Sharpe ratio.

D. $1,690,000 Answer: Total Cost = Direct Cost + Indirect Cost = 90,000 + (43 - 35)*200,000 = $1,690,000.

2. Barnegat Light sold 200,000 shares in an initial public offering. The underwriter's explicit fees were $90,000. The offering price for the shares was $35, but immediately upon issue, the share price jumped to $43. What is the best estimate of the total cost to Barnegat Light of the equity issue? ________. A. $90,000 B. $1,290,000 C. $2,390,000 D. $1,690,000

B. mostly diversifiable

2. It appears from empirical work that exchange rate risk is _______. A. declining for individual investments in recent years B. mostly diversifiable C. mostly systematic risk D. unimportant for an investment in a single foreign country

B. 8.00%

2. The arithmetic average of -11%, 15% and 20% is _______. A. 15.67% B. 8.00% C. 11.22% D. 6.45%

C. III and IV only

2. The optimal risky portfolio can be identified by finding ____________. I. the minimum variance point on the efficient frontier II. the maximum return point on the efficient frontier III. the tangency point of the capital market line and the efficient frontier IV. the line with the steepest slope that connects the risk free rate to the efficient frontier A. I and II only B. II and III only C. III and IV only D. I and IV only

A) depends on the value of the related underlying asset

2. The value of a derivative security _______. A) depends on the value of the related underlying asset B) can only cause increased risk. C) is unrelated to the value of the related underlying asset D) has been enhanced due the recent misuse and negative publicity regarding these instruments E) is worthless today

A. semi-strong

3. If you believe in the __________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders. A. semi-strong B. strong C. weak D. perfect

B. in the primary market

3. Purchases of new issues of stock take place _________. A. at the desk of the Fed B. in the primary market C. in the secondary market D. in the money markets

A. in proportion to the market value weight of the firm's equity in the S&P500

3. The Vanguard 500 Index Fund tracks the performance of the S&P 500. To do so the fund buys shares in each S&P 500 company _________. A. in proportion to the market value weight of the firm's equity in the S&P500 B. in proportion to the price weight of the stock in the S&P500 C. by purchasing an equal number of shares of each stock in the S&P 500 D. by purchasing an equal dollar amount of shares of each stock in the S&P500

C. growth rate is less than the required return Answer: Since the stock price is a finite number (assumption), we must have g<k, i.e. growth rate is smaller than the required rate of return.

3. The constant growth dividend discount model (DDM) can be used only when the ___________. A. growth rate is less than or equal to the required return B. growth rate is greater than or equal to the required return C. growth rate is less than the required return D. growth rate is greater than the required return

B. rate of return in excess of the Treasury bill rate

3. The excess return is the _________. A. rate of return that can be earned with certainty B. rate of return in excess of the Treasury bill rate C. rate of return to risk aversion D. index return

A. call premium Answer: For call option buyer, the maximum loss is the price you paid for the call when entering the contract, which is the call premium.

3. The maximum loss a buyer of a stock call option can suffer is the _________. A. call premium B. stock price C. stock price minus the value of the call D. strike price minus the stock price

D. usually positive, but are not restricted in any particular way

3. The values of beta coefficients of securities are __________. A. always positive B. always negative C. always between positive 1 and negative 1 D. usually positive, but are not restricted in any particular way

B. 19.76%

4. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________. A. 23.00% B. 19.76% C. 18.45% D. 17.67%

C. sell their shares on the open market

4. Investors who wish to liquidate their holdings in a closed-end fund may ___________________. A. sell their shares back to the fund at a discount if they wish B. sell their shares back to the fund at net asset value C. sell their shares on the open market D. sell their shares at a premium to net asset value if they wish

B) it promises to pay to its holder a fixed stream of income each year

4. Preferred stock is like long-term debt in that _____. A) it gives the holder voting power regarding the firm's management B) it promises to pay to its holder a fixed stream of income each year C) the dividend is a tax-deductible expense for the firm D) the stock-holder can force the firm into bankruptcy if the dividends are not paid in a timely manner E) more than one of the above apply

D. -33% Answer: According to constant growth DDM, when growth rate is smaller than the discount rate, the price is: P_0=D_1/(k-g). The original value is: P_0=D_1/(k-g)=240/(0.08-0.06)=12,000. The new value is: P_0=D_1/(k-g)=240/(0.09-0.06)=8,000. So the percentage change is (8,000-12,000)/12,000= -33%.

4. Suppose that in 2009 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%. Using the constant growth formula for valuation, if the discount rate increases to 9% the value of the market will change by _____. A. -10% B. -20% C. -25% D. -33%

A. $150 Answer: 1 contract=100 shares of options. For holding the option, the payoff is (79-75)*100=400. So the profit=payoff-premium=400-8.5*100=-450. For writing the option, the payoff is 0 since the stock price is smaller than the exercise price. So the profit=payoff+premium=0+6*100=600. Total profit=-450+600=150.

4. Suppose you purchase one Texas Instruments August 75 call contract quoted at $8.50 and write one Texas Instruments August 80 call contract quoted at $6. If, at expiration, the price of a share of Texas Instruments stock is $79, your profit would be ______. A. $150 B. $400 C. $600 D. $1,850

B. 10% Answer: ₤55 × 100 = ₤5,500 ₤50 × 100 = ₤5,000 (5500/5000) - 1 = 1.10 -1 = 10%

5. After one year, the exchange rate is unchanged and the share price is ₤55. What is the POUND-denominated return? _______ A. 14% B. 10% C. 9.3% D. 7.1%

C. $37.50 Answer: The "break even" means that the profit=0, i.e. payoff=premium for the option holder. In this case, payoff=premium=2.5. Since the investor is a call holder, the stock price must be 35+2.5=37.5 for him to be break even.

5. An investor purchases a call at a price of $2.50. The expiration price is $35.00. If the current stock price is $35.10, what is the break even point for the investor? _________. A. $32.50 B. $35.00 C. $37.50 D. $37.60

A. 15.64%

5. Consider a mutual fund with $300 million in assets at the start of the year, and 12 million shares outstanding. If the gross return on assets is 18% and the total expense ratio is 2% of the year end value, what is the rate of return on the fund? __________ A. 15.64% B. 16.00% C. 17.25% D. 17.50%

C. 40%

5. Consider two perfectly negatively correlated risky securities, 1 and 2. Security 1 has an expected rate of return of 16% and a standard deviation of return of 20%. 2 has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security 2 in the minimum variance portfolio is _________. A. 10% B. 20% C. 40% D. 60%

D. I, II, and III

5. Restrictions on trading involving insider information apply to _________. I. corporate officers and directors II. major stockholders III. relatives of corporate directors and officers A. I only B. I and II only C. II and III only D. I, II, and III

C. neither Asset A nor Asset B is acceptable

5. Two assets have the following expected returns and standard deviations when the risk-free rate is 5%: Asset A E(Ra) = 10% std dev = 20% Asset B E(Ra) = 15% std dev = 27% An investor with a risk aversion of A = 3 would find that _________________ on a risk return basis. A. only Asset A is acceptable B. only Asset B is acceptable C. neither Asset A nor Asset B is acceptable D. both Asset A and Asset B are acceptable

A. positive; positive

5. When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns. A. positive; positive B. positive; negative C. negative; positive D. positive; zero

B. I, II and III only

5. 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 A. I, II and IV only B. I, II and III only C. II, III and IV only D. I, II, III and IV

A. will be higher than the intrinsic value of stock B Answer: According to constant growth DDM, when growth rate is smaller than the discount rate, the price is: P_0=D_1/(k-g). So price increases with the expected dividend growth rate.

5. You wish to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5% for stock B. Using the constant growth DDM, the intrinsic value of stock A _________. A. will be higher than the intrinsic value of stock B B. will be the same as the intrinsic value of stock B C. will be less than the intrinsic value of stock B D. more information is necessary to answer this question Answer:

C. 0.42 (15-4.5)/25 = .42

6. A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. This portfolio had a Sharpe measure of _____. A. 0.22 B. 0.60 C. 0.42 D. 0.25

D. Ability to handle very large orders

6. Advantages of ECNs over traditional markets include all but which one of the following? _________. A. Lower transactions costs B. Anonymity of the participants C. Small amount of time needed to execute and order D. Ability to handle very large orders

A. 25.7% Answer: ₤55 × 100 × 1.60 = $8,800 (8800/7000) - 1 = 1.257 -1 = 25.7%

6. After one year, the exchange rate is $1.60/₤ and the share price is ₤55. What is the dollar-denominated return? _______ A. 25.7% B. 16% C. 14.3% D. 9.3%

D. 21.6% E[ri] = 6% + [18% - 6%](1.3) = 21.6%

6. Consider the CAPM. The risk-free rate is 6% and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3? A. 6% B. 15.6% C. 18% D. 21.6%

B. I and II only

6. Even if the markets are efficient, professional portfolio management is still important because it provides investors with _________. I. low cost diversification II. provides a portfolio with a specified risk level III. provides better risk adjusted returns than an index A. I only B. I and II only C. II and III only D. I, II and III

B. It is a price-weighted average of 30 large industrial stocks

6. Which one of the following is a true statement regarding the Dow Jones Industrial Average? _____. A. It is a value-weighted average of 30 large industrial stocks B. It is a price-weighted average of 30 large industrial stocks C. It is a price-weighted average of 100 large stocks traded on the New York Stock Exchange D. It is a value-weighted average of all stocks traded on the New York Stock Exchange

B. $32.37 Answer: The maximum price you want to pay is the intrinsic value, which is given by: ((D_1 )+(P_1 ))/(1+k)=(1.25+35)/(1+0.12)=32.37

6. You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for one year. You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return. A. $31.25 B. $32.37 C. $38.47 D. $41.32

A. security A

7. 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 his complete portfolio to achieve the best CAL would be _________. A. security A B. security B C. security C D. security D

B. highest outstanding bid price and highest outstanding ask price

7. When matching orders from the public a specialist is required to use the _______. A. lowest outstanding bid price and highest outstanding ask price B. highest outstanding bid price and highest outstanding ask price C. lowest outstanding bid price and lowest outstanding ask price D. highest outstanding bid price and lowest outstanding ask price

C. $19.24 Answer: This is an easy two-stage DDM problem. First, you need to calculate the expected price of a share at the end of year 2: P_2=D_3/(k-g)=2/(0.14-0.06)=25. Then calculate the present price. Since in the first two years, the firm doesn't pay out any dividend, the price is just given by: P_0=P_2/〖(1+k)〗^2 =25/〖(1+0.14)〗^2 =19.24

8. A firm is planning on paying its first dividend of $2 after two years (at the end of the 3rd year). Then dividends are expected to grow at 6% per year indefinitely. The stock's required return is 14%. What is the intrinsic value of a share today? _________. A. $25.00 B. $16.87 C. $19.24 D. $20.99

D. securities issued by firms in a particular industry

8. Specialized sector funds concentrate their investments in _________________. A. bonds of a particular maturity B. geographical segments of the real estate market C. government securities D. securities issued by firms in a particular industry

D. 1.0

8. The market portfolio has a beta of ________. A. -1.0 B. 0 C. 0.5 D. 1.0

C. positive alpha is considered underpriced

9. According to the capital asset pricing model, a security with a _________. A. negative alpha is considered a good buy B. positive alpha is considered overpriced C. positive alpha is considered underpriced D. zero alpha is considered a good buy

B. 12% 3.36/84+0.08=0.12

9. Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year. Dividends are expected to grow at 8% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate, and the constant growth DDM to determine the value of the stock. The stock's current price is $84.00. Using the constant growth DDM, the market capitalization rate is _________. A. 9% B. 12% C. 14% D. 18%

C. equal to 0

9. 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 _________. A. equal to the sum of the securities standard deviations B. equal to -1 C. equal to 0 D. greater than 0

B. long straddle

9. You buy a call option and a put option on General Electric. Both the call option and the put option have the same exercise price and expiration date. This strategy is called a ________. A. time spread B. long straddle C. short straddle D. money spread

D. $55 Answer: Total Cost = Commission + Bid-Ask Spread = 25*2 + (10.30 - 10.25)*100 = $55. Note that here you make a Round Trip transaction.

9. You find that the bid and ask prices for a stock are $10.25 and $10.30 respectively. If you purchase or sell the stock you must pay a flat commission of $25. If you buy 100 shares of the stock and immediately sell them, what is your total implied and actual transaction cost in dollars? ________. A. $50 B. $25 C. $30 D. $55

A. They offer investors a guaranteed rate of return

9. __________ is a false statement regarding open-end mutual funds. A. They offer investors a guaranteed rate of return B. They offer investors a well diversified portfolio C. They redeem shares at their net asset value D. They offer low cost diversification

B. 100 Answer: $7,000 = 7,000/1.40 = ₤5,000 ₤5,000/50 = 100 shares

Q3-Q7: Suppose a U.S. investor wishes to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest and the current exchange rate is $1.40/₤. 3. How many shares can the investor purchase? ______ A. 140 B. 100 C. 71.43 D. none of the above

C) $391, $174, $435

The following three questions (8-10) refer to the table below. Consider the three stocks A, B, and C. Pt represents price at time t, and Vt represents shares outstanding at day t. P0 V0 P1 V1 A 90 10 88 10 B 20 20 21 20 C 10 100 11 100 10. At time t=0 you have $1000 dollars. You want to invest them all and have the return of the value-weighted index. This means that you have to invest the following amounts in the stocks A, B, and C correspondingly (rounded to the nearest dollar). _____. A) $500, $300, $200 B) $560, $310, $130 C) $391, $174, $435 D) $360, $220, $420 E) $700, $200, $100

B) 4.35% Answer: value-weighted index is the sum of the market capital of the stock included in the index. The market capital=price*shares outstanding. Index level on day1=88*10+21*20+11*100=2400; Index level on day0=90*10+20*20+10*100=2300; return=( level on day1- level on day0)/ level on day0=(2400-2300)/2300=4.35%

The following three questions (8-10) refer to the table below. Consider the three stocks A, B, and C. Pt represents price at time t, and Vt represents shares outstanding at day t. P0 V0 P1 V1 A 90 10 88 10 B 20 20 21 20 C 10 100 11 100 9. What is the return of the value-weighted index of the three stocks for the period from t=0 to t=1. _____. A) 3.15% B) 4.35% C) 5.60% D) 7.25% E) 8.50%