EC3333 Midterm Fall 2014.Questions

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1 EC3333 Financial Economics I Name: ________________________ Seat No: _____ i. Use the bubble form to answer the following multiple-choice questions. Only the correctly shaded bubble form will be graded. ii. On the bubble form, write down your student card number (including the letters) and shade it. iii. Choose the most appropriate answer. Shade only one option for each question. Each correct answer is worth 1 point. There is no deduction for incorrect answer. iv. You must submit both question paper and bubble form at the end of the midterm. You are not allowed to bring the question paper out of the exam venue. START OF PAPER 1. 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 A. 15.5%. B. 10.0%. C. 5.0%. D. 4.8%. E. 15.0%. 2. The ______ is a measure of the average rate of return an investor will earn if the investor buys the bond now and holds until maturity. A. current yield B. dividend yield C. P/E ratio D. yield to maturity E. discount yield 3. 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? A. 12.5% B. 14.0% C. 13.6% D. 11.8% E. 4.4% 4. You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9. The beta of the resulting portfolio is A. 1.466. B. 1.157. C. 0.968. D. 1.082. E. 1.175. 2 5. According to CAPM, The security market line (SML) is A. the line that describes the expected return-beta relationship for well-diversified portfolios only. B. also called the capital allocation line. C. the line that is tangent to the efficient frontier of all risky assets. D. the line that represents the expected return-beta relationship. E. All of the above. 6. According to the Capital Asset Pricing Model (CAPM), a security with a A. positive alpha is considered overpriced. B. zero alpha is considered to be a good buy. C. negative alpha is considered to be a good buy. D. positive alpha is considered to be underpriced. E. None of the above. 7. An investment provides a 2% return semi-annually, its effective annual rate is A. 2%. B. 4%. C. 4.02%. D. 4.04%. E. 8.24%. 8. The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. nonsystematic risk. D. market risk. E. None of the above. 9. Other things equal, diversification is most effective when A. securities' returns are uncorrelated. B. securities' returns are positively correlated. C. securities' returns are high. D. securities' returns are negatively correlated. E. securities' returns are positively correlated and high. 10. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a T-bill with a rate of return of 0.03. What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a portfolio with a standard deviation of 0.08? A. 30% and 70% B. 50% and 50% C. 60% and 40% D. 40% and 60% E. Cannot be determined 11. Which statement is not true regarding the market portfolio? A. It includes all publicly traded financial assets. B. It lies on the efficient frontier. C. All securities in the market portfolio are held in proportion to their market values. D. It is the tangency point between the capital market line and the indifference curve. E. All of the options are true. 3 12. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. 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 A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided. 13. Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the capital allocation line? I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. III) Investors choose the portfolio that maximizes their expected utility. A. I only B. II only C. III only D. I and III E. II and III 14. Consider the following probability distribution for stocks A and B: 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? A. 9.9%; 3% B. 9.9%; 1.1% C. 11%; 1.1% D. 11%; 3% E. None of the above 15. Consider again the probability distribution for stocks A and B in question 14. Let G be the global minimum variance portfolio. The weights of A and B in G are __________ and __________, respectively. A. 0.40; 0.60 B. 0.66; 0.34 C. 0.34; 0.66 D. 0.77; 0.23 E. 0.23; 0.77 4 16. 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. A. 12%; 20% B. 10%; 15% C. 10%; 10% D. 8%; 10% E. All of the options yield the same utility. 17. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist. A. 13.5% B. 15.0% C. 16.5% D. 23.0% E. None of the above 18. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.43; 0.57 E. 0.76; 0.24 19. Which of the following investments offered the lowest overall return over the past eighty years? A. Treasury Bills B. Small stocks C. S&P 500 D. Corporate bonds E. All investments have the same return. 20. A coupon bond pays annual interest, has a par value of $1,000, matures in 12 years, has a coupon rate of 8.7%, and has a yield to maturity of 7.9%. Its current price is $1,060.60. The current yield on this bond is A. 7.90 %. B. 8.30%. C. 8.70%. D. 8.83 %. E. None of the above. 21. The individual investor's optimal portfolio is designated by: A. The point of tangency with the indifference curve and the capital allocation line. B. The point of highest reward to variability ratio in the opportunity set. C. The point of tangency with the opportunity set and the capital allocation line. D. The point of the highest reward to variability ratio in the indifference curve. E. Two of the above. 5 22. If a stock pays dividends at the end of each quarter, with realized returns of R1, R2, R3, and R4 each quarter, then the annual realized return is calculated as: A. Rannual = (R1 + R2 + R3 + R4 ) / 4 B. Rannual = (1 + R1)(1 + R2)(1 + R3)(1 + R4) C. Rannual = (1 + R1)(1 + R2)(1 + R3)(1 + R4) - 1 D. Rannual = R1 + R2 + R3 + R4 E. None of the above. 23. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio, A. the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations. B. the portfolio standard deviation will be less than the weighted average of the individual security standard deviations. C. the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. D. the portfolio standard deviation will always be equal to the securities' covariance. E. None of the above. 24. Which of the following statements is(are) true? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. II, III, and IV only 25. Which of the following statements regarding the capital allocation line (CAL) is false? A. The CAL shows risk-return combinations. B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation. C. The slope of the CAL is also called the reward-to-volatility ratio. D. The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset. E. All of the above statements are correct. 26. Standard deviation and beta both measure risk, but they are different in that beta measures A. both systematic and unsystematic risk. B. only systematic risk while standard deviation is a measure of total risk. C. only unsystematic risk while standard deviation is a measure of total risk. D. both systematic and unsystematic risk while standard deviation measures only systematic risk. E. only systematic risk while standard deviation measures only nonsystematic risk. 6 27. An investor invests 70% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 30% in a T-bill that pays 5%. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.120; 0.14 B. 0.087; 0.06 C. 0.295; 0.12 D. 0.087; 0.12 E. 0.087; 0.14 28. 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. A portfolio that has an expected outcome of $115 is formed by A. investing $100 in the risky asset. B. investing $80 in the risky asset and $20 in the risk-free asset. C. borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset. D. investing $43 in the risky asset and $57 in the riskless asset. E. Such a portfolio cannot be formed. 29. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. If you want to form a portfolio with an expected rate of return of 0.11, what percentages of your money must you invest in the T-bill and P, respectively? A. 0.25; 0.75 B. 0.19; 0.81 C. 0.65; 0.35 D. 0.50; 0.50 E. Cannot be determined 30. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081. What would be the dollar value of your positions in X, Y, and the T-bills, respectively, if you decide to hold a portfolio that has an expected outcome of $1,120? A. Cannot be determined B. $568; $378; $54 C. $568; $54; $378 D. $378; $54; $568 E. $108; $514; $378 31. Which of the following must be true? A. For premium bonds, current yield > coupon rate > yield to maturity. B. For premium bonds, current yield > yield to maturity > coupon rate. C. For discount bonds, coupon rate > current yield > yield to maturity. D. For discount bonds, yield to maturity > coupon rate > current yield. E. None of the options 7 32. Which alternative offers you the highest effective rate of return? Investment Rate Compounding A 6.25% Annual B 6.10% Daily C 6.125 Quarterly D 6.120 Monthly A. Investment A. B. Investment B. C. Investment C. D. Investment D. E. Two of the above. 33. Which of the following statements is FALSE? A. Firm specific news is good or bad news about the company itself. B. Firms are affected by both systematic and firm-specific risk. C. When firms carry both types of risk, only the firm-specific risk will be diversified when we combine many firms stocks into a portfolio. D. The risk premium for a stock is unaffected by its idiosyncratic risk. E. All of the statements are correct. 34. Which of the following statements is FALSE? A. A stock's return is perfectly positively correlated with itself. B. When the covariance equals 0, the stocks have no tendency to move either together or in opposition of one another. C. The closer the correlation is to -1, the more the returns tend to move in opposite directions. D. The variance of a portfolio depends only on the variance of the individual stocks. E. All of the statements are correct. 35. A group of portfolios from which we can form an efficient portfolio are called: A. factor portfolios. B. semi-efficient portfolios. C. partially efficient portfolios. D. characteristic portfolios. E. None of the above. END OF PAPER