FIN4504 Spring 2011 Problem set 1
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Student Name ________________________________ Date ____________________Instructions:
1. There are 25 questions in this problem set. The questions are drawn from Portfolio Theory, Asset Pricing Models, Efficient Markets and Equity Valuation.
2. The purpose of the problem set is to help you prepare for the exam. The problem set is one of the study aids at your disposal (in addition to the slides, BKM, etc.). The layout of the problem set is similar to that of the exam. HOWEVER, you should not expect the exact same questions to appear in the exam.
3. You do not have to turn in the problem set. You only need to attempt the questions.
4. Choose the best answer to each question and write in your answer choice (A, B, C, D or E) on the answer sheet.
Answer Sheet. Write your answer choices here.
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FIN4504 Spring 2011 Problem set 1
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7. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of 0.03 and 70 percent in a T-bill that pays 6 percent. His portfolio's expected return and standard deviation are __________ and __________, respectively.A. 0.114; 0.128 B. 0.087; 0.063 C. 0.295; 0.125 D. 0.081; 0.052 E. none of the above
8. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. 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 0.09?
A. 85% and 15% B. 75% and 25% C. 67% and 33% D. 57% and 43% E. cannot be determined
9. A reward-to-volatility ratio is useful in: A. measuring the standard deviation of returns.
B. understanding how returns increase relative to risk increases. C. analyzing returns on variable rate bonds.
D. assessing the effects of inflation. E. none of the above.
10. Systematic risk is also referred to as A. market risk, nondiversifiable risk. B. market risk, diversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. none of the above.
11. The variance of a portfolio of risky securities A. is a weighted sum of the securities' variances. B. is the sum of the securities' variances.
C. is the weighted sum of the securities' variances and covariances. D. is the sum of the securities' covariances.
E. none of the above.
12. The efficient frontier of risky assets is
A. the portion of the investment opportunity set that lies above the global minimum variance portfolio. B. the portion of the investment opportunity set that represents the highest standard deviations.
C. the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation. D. the set of portfolios that have zero standard deviation.
E. both A and B are true.
13. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return.
A. 9.5% B. 10.4% C. 10.9% D. 9.9%
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14. In the context of the Capital Asset Pricing Model (CAPM) the relevant risk isA. unique risk. B. systematic risk.
C. standard deviation of returns. D. variance of returns.
E. none of the above.
15. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should
A. buy the stock because it is overpriced. B. sell short the stock because it is overpriced. C. sell the stock short because it is underpriced. D. buy the stock because it is underpriced. E. none of the above, as the stock is fairly priced.
16. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent. Your company has a beta of 1.4 and the project that you are evaluating is
considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%.
A. 13.8 B. 7 C. 15 D. 4 E. 1.4
17. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is A. 1.40 B. 1.00 C. 0.36 D. 1.08 E. 0.80
18. 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 ___.
A. 1.25. B. 1.7. C. 1. D. 0.95.s.
E. none of the above.
19. The weak form of the efficient market hypothesis contradicts A. technical analysis, but supports fundamental analysis as valid. B. fundamental analysis, but supports technical analysis as valid. C. both fundamental analysis and technical analysis.
FIN4504 Spring 2011 Problem set 1
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20. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests thatA. bad news about Music Doctors was announced yesterday. B. good news about Music Doctors was announced yesterday. C. no news about Music Doctors was announced yesterday. D. interest rates rose yesterday.
E. interest rates fell yesterday.
21. Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. You observe that Nicholas had an abnormal return of -1.2% yesterday. This suggests that A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced. D. investors expected the earnings increase to be smaller than what was actually announced. E. earnings are expected to decrease next quarter.
22. A preferred stock will pay a dividend of $3.00 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.
A. $33.33 B. $0.27 C. $31.82 D. $56.25
E. none of the above
23. Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is _______.
A. $10.71 B. $15.00 C. $17.75 D. $25.00
E. none of the above
24. The market capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13% and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be _________.
A. 7.69 B. 8.33 C. 9.09 D. 11.11
E. none of the above
25. Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today.
