Exam 1 Prep FIN 4350

An investor invests 35% of his wealth in a risky asset with an expected rate of return of 0.18 and a variance of 0.10 and 65% in a T-bill that pays 4%. His portfolio's expected return and standard deviation are __________ and __________, respectively.

0.089; 0.111

The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to

0.132

If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's excess returns was 20%, the Sharpe measure would be

0.25

Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL?

0.27

Given an optimal risky portfolio with expected return of 13%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL?

0.31

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

The index model for stock A has been estimated with the following result: RA = 0.01 + 0.9RM + eA. If σM = 0.25 and R2A = 0.25, the standard deviation of return of stock A is

0.4500

Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%.The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively.

0.46; 0.54

Consider the following probability distribution for stocks A and B: (State, Probability, Return on Stock A, Return on Stock B) 1 0.15 8% 8% 2 0.20 13% 7% 3 0.15 12% 6% 4 0.30 14% 9% 5 0.20 16% 11% The coefficient of correlation between A and B is

0.474

You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the resulting portfolio is

0.52

The index model for stock A has been estimated with the following result: RA = 0.01 + 0.94RM + eA If σM= 0.30 andR2A= 0.28, the standard deviation of return of stock A is

0.5329

Given an optimal risky portfolio with expected return of 20%, standard deviation of 24%, and a risk free rate of 7%, what is the slope of the best feasible CAL?

0.54

Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.14 and σM was 0.19, the β of the portfolio would be approximately

0.74

Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of

0.75

Suppose the following equation best describes the evolution of β over time: t = 0.18 + 0.63βt - 1. If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming year.

0.87

The beta of a stock has been estimated as 0.85 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of

0.90

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

Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%, respectively. The risk-free rate of return is 4%. Stock A has an expected return of 16% and a beta on factor-1 of 1.3. Stock A has a beta on factor-2 of

1.05

You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is

1.15

Suppose on August 27, there were 1,455 stocks that advanced on the NYSE and 1,553 that declined. The volume in advancing issues was 852,581, and the volume in declining issues was 1,058,312. The trin ratio for that day was ________, and technical analysts were likely to be ________.

1.15; bearish.

The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of

1.40

The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of

1.53

Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is 3%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock performance. The β of the stock is

1.57

Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of

1.67

Assume an investor with the following utility function: U = E(r) - 3/2(s2).To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a standard deviation of ________, respectively.

10%; 10%

Consider the following probability distribution for stocks C and D: (State, Probability, Return on Stock C, Return on Stock D) 1 0.30 7%-9% 2 0.50 11% 14% 3 0.20 -16% 26% The standard deviations of stocks C and D are _____ and _____, respectively.

10.35%; 12.93%

Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate _____________ expected returns and ___________ variances of returns.

100; 100

If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio's excess returns was 34%, the risk premium would be

13%

Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk premium on the first factor portfolio is 4%, and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8 on the second factor, what is its expected return?

13.2%

You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a T-bill with a rate of return of 0.045.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 0.13?

130.77% and -30.77%

You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return?

14.0%

Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios have expected returns of 15% and 6%, respectively. Based on this information, what would be the expected return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.

14.1%

Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk premium on the first-factor portfolio is 4%, and the risk premium on the second-factor portfolio is 6%. If portfolio A has a beta of 0.6 on the first factor and 1.8 on the second factor, what is its expected return?

18.2%

There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: (Stock, State of Nature Strong Growth, Moderate Growth, Weak Growth) A 39% 17% -5% B 30% 15% 0% C 6% 14% 22% If you invested in an equally-weighted portfolio of stocks A and C, your portfolio return would be ____________ if economic growth was strong.

22.5%

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei) equal to 20% and 40 securities with zero correlations?

3.16%

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei) equal to 25% and 50 securities?

3.54%

A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?

4%

Over the past year, you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over the same period. The exact actual growth rate of your purchasing power was

4.8%

You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return?

5.56%

You have been given this probability distribution for the holding-period return for Cheese, Inc. stock: (Stock of the Economy, Probability, HPR) Boom 0.20 24% Normal Growth 0.45 15% Recession 0.35 8% Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these returns?

5.74%

If an investment provides a 3% return semi-annually, its effective annual rate is

6.09%

If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately

6.2%

Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters.

60

Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1, and a beta of .8 on factor 2. The risk premium on the factor-1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?

7.75%

Over the past year, you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6% over the same period. The exact actual growth rate of your purchasing power was

9.65%

Consider the following probability distribution for stocks A and B: (State, Probability, Return on Stock A, Return on Stock B) 1 0.10 10% 8% 2 0.20 13% 7% 3 0.20 12% 6% 4 0.30 14% 9% 5 0.20 15% 8% If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and standard deviation?

9.9%; 1.1%

Studies of negative earnings surprises have shown that there is

A negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the days following the earnings surprise announcement.

Proponents of the EMH typically advocate

A passive investment strategy.

Studies of positive earnings surprises have shown that there is

A positive abnormal return on the day positive earnings surprises are announced and a positive drift in the stock price on the days following the earning surprise announcement.

_________ below which it is difficult for the market to fall.

A support level is a value.

Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________.

A; B

The capital asset pricing model assumes

All investors are price takers, have the same holding period, and have homogenous expectations.

Which of the following factors did Chen, Roll, and Ross not include in their multifactor model?

All of the factors are included in the Chen, Roll, and Ross multifactor model.

Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________.

B; A

The risk premium for common stokcs

Cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory.

A statistic that measures how the returns of two risky assets move together is:

Covariance and correlation.

A support level is the price range at which a technical analyst would expect the

Demand for a stock to increase substantially.

The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus harvest. In an efficient market, one would expect the price of Florida Orange's stock to

Drop immediately.

When comparing investments with different horizons, the ____________ provides the more accurate comparison.

Effective annual rate.

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 zero.

A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor.

Factor.

Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is 0.04, and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is

Fairly priced.

Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is

Fairly priced.

An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses.

Framing.

The weak form of the efficient-market hypothesis asserts that

Future changes in stock prices cannot be predicted from past prices, and technicians cannot expect to outperform the market.

Efficient portfolios of N risky securities are portfolios that

Have the highest rates of return for a given level of risk.

Which of the following statement(s) is(are) true? I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation.

I and III only.

Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I) Steve and Edie's indifference curves might intersect. II) Steve's indifference curves will have flatter slopes than Edie's. III) Steve's indifference curves will have steeper slopes than Edie's. IV) Steve and Edie's indifference curves will not intersect. V) Steve's indifference curves will be downward sloping, and Edie's will be upward sloping.

I and III.

To take advantage of an arbitrage opportunity, an investor would I) construct a zero-investment portfolio that will yield a sure profit. II) construct a zero-beta-investment portfolio that will yield a sure profit. III) make simultaneous trades in two markets without any net investment. IV) short sell the asset in the low-priced market and buy it in the high-priced market.

I and III.

Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.

Increased.

__________ can lead investors to misestimate the true probabilities of possible events or associated rates of return.

Informing processing errors.

According to the mean-variance criterion, which of the statements below is correct? (Investment, E(r), Standard Deviation) A 10% 5% B 21% 11% C 18% 23% D 24% 16%

Investment B dominates investment C.

QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's fourth quarter. You observe that QQAG had an abnormal return of -1.7% yesterday. This suggests that

Investors expected the earning to increase to be larger than what was actually announced.

Given the capital allocation line, an investor's optimal portfolio is the portfolio that

Maximized her expected utility.

Barber and Odean (2001) report that men trade __________ frequently than women and the frequent trading leads to __________ returns.

More; inferior.

When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the

Most optimistic, as it takes the highest return (smallest loss) of all the cases.

You have been given this probability distribution for the holding-period return for a stock: (Stock of the Economy, Probability, HPR) Boom 0.40 22% Normal growth 0.35 11% Recession 0.25 -9% What is the expected holding-period return for the stock?

None of the options are correct. (12.4%, 9.56%, 11.67%, 8.33%)

You have been given this probability distribution for the holding-period return for a stock: (Stock of the Economy, Probability, HPR) Boom 0.40 22% Normal growth 0.35 11% Recession 0.25 -9% What is the expected standard deviation for the stock?

None of the options are correct. (7.04%, 9.96%, 2.07%, 1.44%)

The APT differs from the CAPM because the APT

Recognizes multiple systematic risk factors.

The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should

Sell short CAT because it is overpriced.

If you believe in the reversal effect, you should

Sell stocks this period that performed well last period.

When a distribution is positively skewed,

Standard deviation overestimates risk.

If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including information that is available only to insiders.

Strong.

The APT requires a benchmark portfolio

That is well-diversified and lies on the SML.

Advantage(s) of the APT is(are)

That the model does not require a specific benchmark market portfolio.

Which of the following is false about the security market line (SML) derived from the APT?

The SML has a downward slope, shows expected return in relation to portfolio standard deviation, and has an intercept equal to the expected return on the market portfolio.

In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called

The capital allocation line.

Which of the following factors would not be expected to affect the nominal interest rate?

The coupon rate on previously issued government bonds.

The market risk, beta, of a security is equal to

The covariance between the security's return and the market return divided by the variance of the market's returns.

The factor F in the APT model represents

The deviation from its expected value of a factor that affects all security returns.

At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads). This is most closely associated with

The lucky event issue.

In words, the real rate of interest is approximately equal to

The nominal rate minus the inflation rate.

The certainty equivalent rate of a portfolio is

The rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio.

Treasury bills are commonly viewed as risk-free assets because

Their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty over their time to maturity is negligible.

If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by examining market trading data, such as the history of past stock prices, trading volume or short interest.

Weak.

Banz (1981) found that, on average, the risk-adjusted returns of small firms

Were higher than the risk-adjusted returns of large firms.

The utility score an investor assigns to a particular portfolio, other things equal,

Will increase as the rate of return increases.

A common strategy for passive management is

creating an index fund.

Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when making forecasts. This is referred to as ____________.

too much; memory bias.

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to

​rf + β [E(rM) - rf].