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True/False Questions: Circle the correct response. (2 points each)
| 1. | T | F | In theory, if two assets have the same expected cash flows they will always have the same price. |
| 2. | T | F | Using margin to buy stocks can negate the limited liability aspect of investing in corporations. |
| 3. | T | F | Management of a company generally prefers non-cumulative to cumulative share voting. |
| 4. | T | F | Since the returns of well-diversified portfolios move very much in line with the returns for all stocks in the market, portfolio betas are equal to the beta for the market which is 1.0. |
| 5. | T | F | People who employ technical analysis when investing do not believe that markets are weak-form efficient. |
| 6. | T | F | An investor is considering adding another investment to a portfolio. To achieve the maximum diversification benefits, the investor should add an investment that has a correlation coefficient with the existing portfolio closest to 0. |
| 7. | T | F | If investors expected inflation to increase in the future, and they also became less risk averse, the SML would shift up and the slope would increase. |
| 8. | T | F | Normally, the Security Market Line has an upward slope. However, at one of those unusual times when the yield curve on bonds is downward sloping, the SML will also have a downward slope. |
| 9. | T | F | An increase in the risk-free interest rate will increase a security’s beta. |
| 10. | T | F | Combining securities that are not perfectly positively correlated helps to reduce the risk of a portfolio. |
| 11. | T | F | The addition of foreign securities to the domestic portfolio opportunity set will likely shift the efficient frontier up and to the left. |
| 12. | T | F | If markets are strong-form efficient, the expected return on each stock will be the same as the return on the market. |
| 13. | T | F | Illiquid stocks tend to have wider spreads between the bid and ask price. |
| 14. | T | F | For dividend paying stocks, prices fall in predictable ways on the ex-dividend date. |
| 15. | T | F | If a stock were to issue new stock (to raise money) this year it would be considered a secondary market transaction since the company already has stock outstanding. |
| 16. | T | F | All else equal (the expected return on the market and beta do not change), an
increase in the risk free rate will increase a stock’s expected return. |
| 17. | T | F | Empirical evidence that markets are not strong form efficient would also be |
| evidence that markets are not semi-strong form efficient. | |||
| 18. | T | F | A proxy fight typically refers to a competition to gain enough shareholder votes to determine who will serve on the board of directors. |
| 19. | T | F | A limit order to buy a security will transact at the current lowest ask price. |
| 20. | T | F | When a stock splits 2-for-1 the stock price falls and the expected return increases. |
Multiple Choice Questions: Circle the correct response. (4 points each)
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- 21. A stock currently sells for $50 and has the following potential payoffs (to be received one year from today). Each scenario is equally likely.
What is the standard deviation for the stock?
- a) 5.23% b) 14.51% c) 16.08%
- d) 19.07%
- f) 22.86%
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- 22. A company has a beta of 0.9 and the market risk premium is 5.4% percent. The risk-free rate is 3.2%. If an investor paid $26.00 for a share a year ago and they just received a dividend of $0.25 for the year, what would be a fair price for the share today?
- 23. Consider the following information:
Price E[R] Beta
$1,130.00
8.4% 0.90
Apple
Yahoo
$ 530.00
$ 38.00
7.8% 0.80
9.6% 1.10
You have a portfolio of these 3 stocks and the beta is 1.0. If your $217,307.69 portfolio includes 50 shares of Google, how many shares of Yahoo do you own?
- a) 112
- b) 238 c) 915 d) 2,313 e) 2,839 f) 3,317
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- 24. Stocks A and B are perfectly negatively correlated. The expected return on A is 8% with a standard deviation of 12%. The expected return on B is 18% with a standard deviation of 36%. You’d like to combine these two stocks into a riskless portfolio. What fraction of the portfolio should be held in A?
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- 25. You hold a diversified portfolio consisting of a $7,500 investment in each of 10 different stocks. The portfolio’s beta is 1.60. Now suppose you decide to sell one of those stocks in your portfolio for $7,500. If the sold stock had a beta of 1.80, and the proceeds are used to purchase a replacement stock, what does the beta of the replacement stock have to be for the new portfolio beta to be 1.50?
- 26. (24 points). As an analyst following WinConn, you’ve obtained the following information:
× Dividends
– You expect the company to pay its first dividend of $2.00 exactly 6 years from today.
Dividends will then grow at 13% for 4 years (until 10 years from today). After this high growth phase, dividends will grow more slowly. Dividends will grow at 11% for one year (11 years from today), and then 9% for one year (12 years from today), and then grow at
6% forever after that.
× Market Conditions
– You generally use CAPM to gage whether a stock is undervalued or overvalued. The return on 3-month Treasury securities (the risk-free rate) is 3%. The expected return on the S&P500 Index (a portfolio of 500 large stocks that you use to measure market returns) is 9%, and the standard deviation of S&P returns is 28%. You’ve estimated the standard deviation of WinConn’s returns to be 56%, and the correlation between WinConn and S&P is 0.80.
- a) What’s your estimate of the required rate of return for WinConn?
- b) What’s your estimate of the fair price today for one share of WinConn?
- c) How much would a share sell for 9 years from today?
- 27. (8 points). In your assessment, stock A has the following probability distribution of expected returns:
| Probability
0.1 |
Rate of Return
-40% |
| 0.2 | 0 |
| 0.4 | 10% |
| 0.2 | 30% |
| 0.1 | 40% |
The risk-free rate is 5.0% and the expected return on the market is 10.0%. If the standard deviation of the market is 18.0%, and the correlation of A with the market is 0.6, is the stock fairly valued?
- 28. (8 points). Complete the following table, indicating whether each of the following portfolios cannot lie on the efficient frontier:
| Standard Deviation | Cannot lie on the Efficient | ||
| Portfolio | Expected Return | Of Returns | Frontier? Yes or No |
| A | 6% | 11% | |
| B | 7% | 11% | |
| C | 5% | 10% | |
| D | 7% | 12% | |
| E | 6% | 10% |
Consider a portfolio that has five securities. The financial manager is considering adding a sixth investment to the portfolio. Which of these candidates do you recommend, and why?
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