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NAME: SECTION _________________________ STUDENT NUMBER: TEST-LOCATION: _________________

COMMERCE 2FA3 – Mid-term Test 1: February 6, 2010 Dr. Richard Deaves

Duration: 2 hours INSTRUCTIONS:

1. This paper comprises 8 pages (including this page). There are 14 TRUE/FALSE questions each worth 1 mark; 14 MULTIPLE CHOICE questions each worth two marks; and 6 more MULTIPLE CHOICE questions, each worth 3 marks. For all questions, there is only one best answer.

2. You are responsible for ensuring that your copy of the question paper is complete. Bring any discrepancy to the attention of the invigilator.

3. On the question paper, fill in your name, student number and section number. The full question paper (intact) must be returned to have any credit. All answers however must be written on a scan sheet (see below).

4. The use of a standard McMaster calculator (Casio fx-991) is permitted. In addition, a double-sided (8 1/2 by 11 inches) formula sheet prepared by the student, and which must be handed in with the test, may be used. If you do not have a formula sheet please point this out to an invigilator.

5. Instructions for use of the computer scan sheets:

The special scanner which scans the answer sheet senses the shaded areas by their non-flection of light. A heavy mark must be made, completely filling the circular bubble, with an HB pencil. Marks made with a pen or felt tip marker will NOT be sensed. Erasures must be thorough or the scanner may still sense a mark. Do NOT use correction fluid on the sheets. Do NOT put any unnecessary marks or writing on the sheet.

i. Print your name, student number, course name, section number and the date of the test in the space provided at the top of side 1 of the sheet. The sheet MUST be signed in the space marked SIGNATURE.

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True/False (14 questions - 1 mark each):

1 Restrictive covenants protect the positions of shareholders. A) True

B) False

2 A home mortgage loan problem often requires use of the perpetuity formula. A) True

B) False

3 The ex post return is the actual return earned for a given security or portfolio. A) True

B) False

4 In a standard amortized loan, the first few payments contain the largest percentage of interest.

A) True B) False

5 Real interest rates tend to be low when a country has a saving mentality. A) True

B) False

6 Through careful diversification an investor can usually eliminate all systematic risk from her stock portfolio.

A) True B) False

7 The efficient set is made up of those portfolios having the lowest level of risk for a given expected return.

A) True B) False

8 In calculating the present value of an annuity, a 10% decrease in the cashflow leads to a 10% decrease in the value of the annuity.

A) True B) False

9 You have just won a lottery prize. You can choose to receive $750,000 today or an annual payment of $50,000 at the end of each of the next 20 years. If the appropriate discount rate is 7% you are better off taking the lump sum.

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10 The variance of a portfolio is more than the weighted average of the variance of the individual securities.

A) True B) False

11 Heuristics are decision-making shortcuts. A) True

B) False

12 When two securities have a correlation of -1, the variance of a portfolio made up of these two securities can be pushed to zero if the right weights are chosen.

A) True B) False

13 Historically Canadian stock returns have been less volatile than Canadian bond returns.

A) True B) False

14 Securities which were issued some time ago are sold in primary markets. A) True

B) False

Multiple Choice (14 questions - 2 marks each):

15 What is the future value of $1,000 received at the end of each year for the next 20 years? Assume an annual interest rate of 8% compounded semi annually.

A) $25,000 B) $44,943 C) $45,762 D) $46,581 E) $47,311

16 If you borrow $25,000 for two years and must make monthly level payments to pay off the loan, given a 6% interest rate based on monthly compounding, what is the payment that you have to make?

A) $1,106.23 B) $1,108.02 C) $1,110.49 D) $1,991.98

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17 You can hold only two stocks in your portfolio, A and B. Given that A and B both have an expected return of 12% and a standard deviation of 17.5%. The correlation between the two stocks is 0.33. What percentage of your portfolio should be invested in B to achieve maximum diversification?

A) 0% B) 33% C) 50% D) 67% E) 100%

18 If the interest rate is 10% based on monthly compounding, the effective monthly interest rate is:

A) 0.805% B) 0.826% C) 0.833% D) 2.5%

E) None of the other answers

19 Which of the following statements is/are correct? All else being equal: I. Future values increase as the interest rate increases.

II. Present values are always smaller than future values when both the interest rate and the number of time periods in an annuity are positive.

III.Present values increase the farther away in time payments are received.

A) I only.

B) I and II only. C) I and III only. D) III only.

E) I, II and III only.

20 If you are given $1,000 and invest it in an asset which earns an interest rate of 9% per year with quarterly compounding, how much will you have at the end of 15 years?

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21 In return for a $10,000 investment today, you will receive $2,500 in one year, $3,000 in two years and $9,000 in six years. What is the net present value of this opportunity if the discount rate is 8%?

A) $558 B) $954 C) $1,012 D) $2,031

22 How long does it take to double your money given a 10% continuously compounded interest rate?

A) 6.93 years B) 6.96 years C) 7.20 years D) 7.27 years

23 If the nominal interest rate is 9% and inflation is 2%, the real interest rate is equal to: A) 2%

B) 7% C) 15%

D) It is impossible to say E) None of the other answers

24 If the effective monthly rate is 2%, what is the continuously compounded rate? A) 21.51%

B) 23.76% C) 24.00% D) 24.65% E) 27.12%

25 How much should you be willing to pay today for a perpetuity if the first payment of $2,500 occurs five years from now and the payment grows by 3% per year from that point on? The appropriate discount rate is 8%.

A) $21,268 B) $22,970 C) $34,029 D) $36,751

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26 If there is a 30% chance of an 6% return and a 70% chance of a 16% return, what is the expected return?

A) 9.0% B) 11.0% C) 13.0% D) 17.2%

27 Based on the following historical data for a Canadian security, what are the average return and standard deviation of returns?

Year Return

2001 16%

2002 7%

2003 -7%

2004 13%

A) Average return = 10.75%, Standard Deviation = 2.25% B) Average return = 10.75%, Standard Deviation = 4.50% C) Average return = 7.25%, Standard Deviation = 2.25% D) Average return = 7.25%, Standard Deviation = 6.88% E) Average return = 7.25%, Standard Deviation = 10.21%

28 As you increase the numbers of securities in your portfolio: A) Total risk falls

B) Diversifiable risk rises C) Non-diversifiable risk falls D) All security weights must fall E) None of the other answers

Multiple Choice (6 questions - 3 marks each):

29 An investor has allocated 20% of her portfolio to each of Stocks A, B, C, D and E. All correlations between pairs of securities are 0.6. All stock expected returns are 17.5% and all stock standard deviations are 20%. What is the standard deviation of the portfolio return?

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Use the following information to answer questions 30 and 31:

You are saving for the college education of your two children. They are one year apart in age. One will begin college in 15 years; the other will begin in 16 years. (They are three and two years old at present.) You estimate each child's college expenses to be $35,000/year for four years (payable at the beginning of each school year). The interest rate is 6%, and you expect it to remain at 6% indefinitely.

30 At the point each child is about to start college, what is the present value (as of these relevant future dates) of each child’s education?

A) $121,279 B) $128,555 C) $138,313 D) $138,986

31 How much money must you place in an account each month to fund your children's educations? You will begin payments one month from today. Your last payment will be when your oldest child enters college.

A) $842 B) $859 C) $871 D) $894

32 Returns on Rollins stock are shown below for the five possible states of the economy that might prevail next year.

Economic Condition Probability Rollins return

Rapid expansion 0.10 35%

Moderate expansion 0.40 20%

No growth 0.20 10%

Moderate contraction 0.18 -10%

Serious contraction 0.12 -20%

What is the variance of Rollins returns? A) 0.0401

B) 0.0089 C) 0.0128 D) 0.0282

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Use the following information to answer questions 30 and 31:

You recently purchased a house. The purchase price was $300,000 and you paid $75,000 immediately and obtained a 20-year mortgage at 8% compounded semi-annually for the remainder. Your payments are monthly.

33 How much is each monthly payment? A) $1,864

B) $1,931 C) $1,947 D) $1,983 E) $2,084

34 After you have made half your payments, what percent of the next payment is the interest?

A) 33% B) 46% C) 50% D) 54% E) 119%

Solutions: 1B 2B 3A 4A 5A 6B 7A 8A 9A 10B 11A 12A