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The rate of exchange between certain future dollars and certain current
dollars is known as the pure rate of interest.
(t)
(f)
A dollar received to day is worth less than the same dollar received in the
future.
(f)
(f)
The three components of the required rate of return are the nominal interest
rate, an inflation premium, and a risk premium.
(t)
Risk is the uncertainty that an investment will earn its expected rate of
return.
(f)
(t)
People invest with one or more of the following three basic needs in mind:
income, capital preservation, capital appreciation.
(t)
As the level of risk increases an investor will require an expected return that
will compensate for this additional risk.
(f)
10
(t)
11
The required rate of return is the minimum rate of return that will induce an
investor to invest.
(t)
12
Participants in primary capital markets that gather funds and channel them
to borrowers are called financial intermediaries.
(t)
13
305
(b)
(a)
The statement risk drives expected returns refers to the notion that
a) an investor will require a higher rate of return the higher the perceived
riskiness of an asset.
b) an investor will require a lower rate of return the higher the perceived
riskiness of an asset.
c) markets over-react to news.
d) markets under-react to news.
e) none of the above.
(a)
(e)
306
(d)
(a)
10
11
(d)
(a)
(d)
12
(b)
13
(d)
14
15
308
(a)
If the nominal risk rate is 5% per year, the risk premium is 6% per year and
the expected rate of inflation over the next year is 3%, an investment of
$1000 today worth_____ one year from today.
a)
b)
c)
d)
e)
(c)
If the nominal risk free rate is 8%, the expected rate of inflation is 2.5%,
and the risk premium is 5%, the required rate of return is
a)
b)
c)
d)
e)
(a)
$1000
$1081.50
$1091.80
$1113
$1146.39
10.5%
7.5%
13.4%
16.24%
10.7%
Assume that nominal risk free interest rate is 6%, the expected rate of
inflation is 2%, the risk premium is 3% and the required rate of return is
9.18%. What would be the value at the end of 25 years of $100 invested
today at the required rate of return?
a)
b)
c)
d)
e)
$898.62
$343.51
$1474.28
$704.13
$918
The before tax value of the tax deferred investment, assuming all savings
are removed at the end of 10 years is
a)
b)
c)
d)
e)
$4414.17
$5918.41
$2943.42
$8663.71
$4987.26
309
(c)
The after tax value of the tax deferred investment, assuming all savings are
removed at the end of 10 years is
a)
b)
c)
d)
e)
(e)
The value of the taxable investment, assuming all savings are removed at
the end of 10 years is
a)
b)
c)
d)
e)
(c)
$4987.26
$5918.41
$3846.97
$2943.42
None of the above
$8663.71
$6943.42
$3846.97
$5918.41
$5626.46
15.5%
-10.0%
8.5%
-7.75%
7.75%
c) 5.0%
d) 7.75%
e) None of the above
CHAPTER 1
ANSWERS TO PROBLEMS
1
1000(1.05)(1.06) = 1113
(1.08)(1.05) 1 = 11.34%
1.091825(100) = 898.62
1.0910(2500) = 5918.41
311
CHAPTER 2
RETURN AND RISK BASICS
TRUE/FALSE QUESTIONS
(f)
(f)
(f)
The holding period return (HPR) is equal to the return relative stated as a
percentage.
(t)
The geometric mean is the nth root of the product of the annual holding
period returns for N years minus one.
(f)
(t)
(f)
(f)
Historically return relatives are used to measure the risk for a series of
historical rates of return.
(t)
(f)
10
(b)
(b)
(1 HPR)
(1 + HPR)
(1 HPR)n
(1 + HPR)n
(1 (Income + Price Change))
312
(c)
(c)
(a)
(a)
Central tendency.
Absolute variability.
Absolute dispersion.
Relative variability.
Relative return.
c) Stability of sales.
d) The amount of debt financing.
e) Liquidity.
(b)
If U.S. firms increase their debt/total capital ratios, it will very likely cause
required returns to
a) Increase and change the slope of the capital market line (CML).
b) Increase and cause a movement up along the capital market line (CML).
c) Remain unchanged and cause a parallel shift of the capital market line
(CML).
d) Decrease and change the slope of the capital market line (CML).
e) Decrease and cause a movement down along the capital market line
(CML).
(d)
(d)
10
A parallel shift in the capital market line (CML) is caused by changes in the
following factors:
a)
b)
c)
d)
e)
(a)
(c)
314
113%
78%
65%
6.5%
1.129%
The HPR on a security is 3%. If the holding period is 4 weeks month, the
annualized HPR is
a)
b)
c)
d)
e)
(d)
(d)
1.20%
5.50%
12.00%
20.00%
30.00%
Assume that you invest $1000 for 15 years in an account that pays an
interest rate of 7% per year with annual compounding. Calculate the
proportion of the total value of the account that can be attributed to intereston-interest, at the end of 15 years.
a)
b)
c)
d)
e)
(b)
39.15%
78.87%
46.87%
158.25%
52.25%
100%
38.06%
36.24%
25.70%
0%
Given the following returns and return relatives over the past four years,
compute the arithmetic mean (AM) and geometric mean (GM) rates of
return.
Period
t1
t2
t3
t4
a)
b)
c)
d)
e)
Returns
0.05
-0.10
0.11
-0.02
Return Relative
1.05
0.90
1.11
0.98
AM = 4.000%, GM = 1.010%
AM = 1.000%, GM = 0.692%
AM = 0.692%, GM = 4.000%
AM = 1.000%, GM = 1.0692%
AM = 4.000%, GM = 0.0692%
315
(b)
(d)
$67,750
$52,791
$57,791
$40,041
$60,000
Consider a stock that has an expected return of 10% and standard deviation
of 14%. Assuming that future returns will resemble past returns, an investor
can expect 95% of actual future returns to lie between
a)
b)
c)
d)
e)
316
$67,750
$52,791
$57,791
$40,041
$60,000
(e)
$67,750
$52,791
$57,791
$40,041
$60,000
CHAPTER 2
ANSWERS TO PROBLEMS
1
HPR =
1000(1.07)15 = 2759.03
0.20 or 20%
1000
1000
Original principal
Cumulative simple interest
Cumulative interest-on-interest
= 1000
= 1050
= 709.03
Original principal
Cumulative simple interest
Total interest
Cumulative interest-on-interest
= 5000
= 30 x 0.085 x 5000 = $12,750.00
= 57,791.26 5000 = $52,791.26
= 52,791.26 12,750 = $40,041.26
Total interest
Cumulative interest-on-interest
317
CHAPTER 3
SELECTING INVESTMENTS IN A GLOBAL MARKET
TRUE/FALSE QUESTIONS
(f)
The U.S. equity and bond markets have grown in terms of their relative size
of the world equity and bond market.
(t)
(f)
The total domestic return on German bonds is the return that would be
experienced by a U.S. investor who owned German bonds.
(t)
If the exchange rate effect for Japanese bonds is negative, it means that the
domestic rate of return will be greater than the U.S. dollar return.
(t)
Investors who limit themselves to the U.S. equity market experienced rates
of return below those in many other countries.
(f)
(t)
(f)
(f)
Yields on money market funds are often lower than yields available to
individuals investing in CD's because of the fees involved.
(f)
10
Income bonds are considered as safe as debentures because they pay higher
rates of interest.
(t)
11
Warrants are options issued in connection with the sale of fixed income
securities.
(f)
12
(f)
13
For a U.K. based investor with stock investments in the U.S. a weakening
dollar will enhance returns in terms of pounds.
(t)
14
For a U.S. based investor with stock investments in the U.K. a weakening
dollar will enhance returns in dollar terms.
318
(d)
(c)
(c)
A debenture.
A warrant.
An indenture.
A rights certificate.
A trustee deed.
The correlation between U.S. equities and U.S. government bonds has been
a)
b)
c)
d)
e)
(c)
Culture.
Political systems.
International trade patterns.
Language.
None of the above.
The legal document setting forth the obligations of a bond's issuer is called
a)
b)
c)
d)
e)
(b)
The average rate of return of the portfolio when you combine U.S.
and German stocks.
The standard deviation of the German stocks.
The standard deviation of the German stocks compared to the
standard deviation of U.S. stocks.
The correlation between the rates of return for German stocks and
U.S. stocks.
The coefficient of variation (CV) of rates of return for German stocks
versus the CV of rates of return for U.S. stocks.
Strongly positive.
Weakly positive.
Strong negative.
Weakly negative.
Indeterminate.
e)
(d)
In order to diversify risk an investor must have investments that that have
correlations with other investments in the portfolio that are
a)
b)
c)
d)
e)
(a)
b)
c)
d)
e)
8
320
(a)
low positive
zero
negative
any of the above
none of the above
(c)
(b)
1.66%
12.56%
4.92%
8.80%
10.46%
(c)
3.76%
1.05%
2.71%
3.25%
4.71%
(b)
3.76%
1.05%
2.71%
3.25%
4.70%
(e)
1.32%
2.10%
2.50%
3.50%
4.90%
If the annual rate of inflation during the period was 4 percent, what was the
real rate of return on long-term corporate bonds?
321
a)
b)
c)
d)
e)
(d)
1.16%
1.85%
1.73%
3.50%
4.90%
You are trying to decide between a par value corporate bond carrying a
coupon rate of 6.25% per year and a par value municipal bond that pays an
annual coupon rate of 4.75%. Assuming all other factors are the same and
you are in the 28% tax bracket, which bond should you choose and why?
a)
b)
c)
d)
e)
Company
Ticker
Coupon
Gen Elec
GE
4.75
(b)
UST
99.544
4.808
62
10
$4.75
$47.50
$4.808
$48.08
$62
$62
$9.954
$48.08
$99.544
$995.44
322
EST
Spread
(a)
Last
Yield
(e)
Maturity
9/15/201
4
Last
Price
Est $
Vol
(000's)
158736
c) 5.371%
d) 4.132%
e) 4.753%
(c)
10
(c)
11
(d)
12
13
14
10.83%
-28.33%
5.71%
-5.71%
10.0%
(b)
-0.038%
0.456%
0.038%
-0.456%
None of the above
(a)
4.18%
5.88%
4.77%
8.125%
4.063%
10.83%
-28.33%
5.71%
-5.71%
5.0%
An investor based in the U.S. has security investments in the U.K. The
323
exchange over a one year period has gone from $1.85 per pound to $2 per
pound. During this same period the investors return in dollar terms is
calculated to be 10%. Calculate the local currency returns for the U.K.
securities ( i.e. in pound terms).
a)
b)
c)
d)
e)
(c)
15
8.11%
1.75%
-1.35%
-7.5%
10.81%
Assume the exchange rate is $1.85 per pound at the beginning of the year
and $2 per pound at the end of the year. For an investor based in the U.K.
with security investments in the U.S. the exchange rate change is
a)
b)
c)
d)
e)
8.11%
15%
-7.5%
-8.11%
-15%
(c)
16
17
Chg
-
Ask Yld
?
$9997.75
$9997.76
$9887.37
$10002.25
$10002.24
Use the information provided to calculate the ask yield (also known as the
investment rate or the bond equivalent rate.
a)
b)
c)
d)
e)
324
Asked
2.24
Use the information provided above to calculate the ask price for this
Treasury bill.
a)
b)
c)
d)
e)
(a)
Bid
2.25
2.30%
2.25%
2.24%
3.75%
4.49%
CHAPTER 3
ANSWERS TO PROBLEMS
The municipal bond has an equivalent taxable yield of 0.475/(1 0.28)= 0.066. This is
higher than the bond yield of 0.0625.
10
11
12
13
14
15
First restate exchange rates as 1/1.85 = pounds 0.5405 per $ and 1/2.0 = pounds 0.50
per dollar.
Exchange rate change = (0.50/0.5405) 1 = -0.075 or -7.5%
16
17
325
CHAPTER 5
THE ASSET ALLOCATION DECISION
TRUE/FALSE QUESTIONS
(t)
(t)
The gifting phase is similar to, and may be concurrent with, the spending phase.
(t)
(f)
(f)
(f)
An appropriate investment objective for a typical 25-year-old investor is a lowrisk strategy, such as capital preservation or current income.
(f)
Marginal tax rate is defined as a person's total tax payment divided by their total
income.
(t)
(f)
Liquidity needs, time horizon, tax concerns and risk tolerance are all investment
constraints.
(t)
10
Average tax rate is defined as a person's total tax payment divided by their total
income.
(a)
326
(a)
(e)
(e)
(c)
Discovery phase
Accumulation phase
Consolidation phase
Spending phase
Gifting phase
(d)
327
(c)
In the U.K. equity allocation in pension fund portfolios stands around 78%. This
high level of allocation to equities can be explained by
a)
b)
c)
d)
e)
(e)
(a)
10
11
90 and 100.
100 and 40.
90 and 40.
40 and 100.
40 and 90.
Investors can manage risk confronting their wealth using the following
a)
b)
c)
d)
e)
(d)
(d)
risk avoidance
risk anticipation
risk transfer
all of the above
none of the above
328
329
(d)
The nominal rate of return for a security is 12.5% per year. If the relevant tax rate
is 35% and the rate of inflation is 3.75% per year, calculate the after tax real rate
of return for the security.
a)
b)
c)
d)
e)
8.75%
5.69%
8.43%
3.06%
2.95%
Calculate the tax savings generated by the regular IRA at the time of investment.
a)
b)
c)
d)
e)
(c)
Calculate the future value, at the end of 25 years, of the tax savings.
a)
b)
c)
d)
e)
(c)
$2,900.51
$3,867.35
$2,496.70
$1,248.35
$4,369.23
Calculate the total after tax future value, at the end of 25 years, of the regular IRA
contribution and the tax savings.
a)
b)
c)
d)
e)
330
$300
$400
$700
$100
$200
$19,336.73
$21,833.43
$18,932.92
$16,840.03
$16,436.23
(a)
Calculate the total after tax future value, at the end of 25 years, of the Roth IRA
contribution.
a)
b)
c)
d)
e)
(e)
Your portfolio currently has an asset allocation that is 15% cash, 35% bonds, and
50% stocks. The returns over the past years for cash was 3.5%, bonds
5.75%, and stocks 8.5%. The return on your portfolio for the past year was
a)
b)
c)
d)
e)
(a)
$233,976
$220,515
$250,515
$500,673
$213,321
Assume that you invest $1000 at the end of each quarter for the next 15 years in a
mutual fund. The annual rate of interest that you expect to earn in
the this account is 8.75%. The amount in the account at the end of 15 years
a)
b)
c)
d)
e)
(d)
-5.04%
5.47%
0.25%
5.91%
-1.71%
The future value of $25,000 invested today, at the end of 20 years assuming an
interest rate of 11.5% per year, with semiannual compounding, is
a)
b)
c)
d)
e)
(b)
$19,336.73
$21,833.43
$18,932.92
$16,840.03
$16,436.23
$28,790
$121,749
$60,000
$315,000
$115,637
d) 9.72%
e) 9.80%
(d)
10
(d)
11
Calculate the balance in the investment account at the end of the second year
(prior to any withdrawals)
a)
b)
c)
d)
e)
(b)
12
13
$750,000
$618,750
$825,000
$680,625
$510,468
Someone in the 15 percent tax bracket can earn 8% on his investments in a taxexempt IRA account. What will be the value of a $10,000 investment after 5
years (assuming annual compounding)?
a)
b)
c)
d)
e)
(c)
$148,739
$250,000
$170,156
$206,250
$186,320
$ 6,805
$14,693
$15,528
$20,114
$50,000
Suppose you invest money in a taxable account earning 8% per year. What will be
the after-tax value of a $10,000 investment after 5 years if you are in the 15% tax
bracket (assuming annual compounding)?
a) $10,680
b) $11,765
332
c) $13,895
d) $14,693
e) $15,528
CHAPTER 5
ANSWERS TO MULTIPLE CHOICE PROBLEMS
1.
2.
3.
4.
5.
6.
7.
8.
(1 .021875 60 ) 1
=$121,749
FV = 1000
.021875
9.
333
10.
Interest rate
Withdrawal rate
Year
Principal
10%
25%
outflow
Balance
$1,000,000.00
$250,000.00
$750,000.00
$ 825,000.00
$206,250.00
$618,750.00
$ 680,625.00
$170,156.25
$510,468.75
The remaining balance at the end of the first year = 825,000 206,250 = $618,750
This earns interest of 10% and at the end of year 2 is worth = 618,750(1.1) = $680,625
12.
13.
After-tax yield = Before-tax yield (1 - Tax rate) = 0.08(1 - 0.15) = 0.068 or 6.8%
$10,000(1 + 0.068)5 = $13,895
334
CHAPTER 5 APPENDIX
MULTIPLE CHOICE QUESTIONS
(a)
(b)
Cash flows for nonlife insurance companies, such as property and casualty, are
similar to cash flows of life insurance companies.
a) True
b) False
(b)
The portfolio mixes of institutional investors around the world are approximately
the same.
a) True
b) False
(e)
(d)
335
CHAPTER 6
ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS
TRUE/FALSE QUESTIONS
(t)
A continuous market that has price continuity requires depth of buyers and
sellers.
(f)
(f)
(f)
The primary market is where existing issues are traded between current and
potential owners.
(t)
A general obligation (GO) bond is backed by the full taxing power of the
municipality.
(t)
(t)
(f)
In a call market, trades occur at any time while the market is open.
(t)
(f)
10
The third market describes direct trading of securities between parties with
no broker intermediary.
(f)
11
(t)
12
A short seller can only trade on an uptick (or zero uptick) and must pay any
dividends to the lender of the stock.
(t)
13
(t)
14
(t)
15
In the United States commons stocks are quoted in decimals not fractions.
336
(f)
16
(b)
(b)
(e)
(a)
(d)
b)
c)
d)
e)
(d)
(b)
(b)
Negotiated sale
Private placement
All of the above
None of the above
The impact of changing the system for quoting share prices from fractions
to decimals has been to
a) Increase spread size, increase transaction costs, and increase the number
of transactions.
b) Decrease spread size, decrease transaction costs, and increase the
number of transactions.
c) Decrease spread size, decrease transaction costs, and decrease the
number of transactions.
d) Decrease spread size, increase transaction costs, and increase the
number of transactions.
e) Decrease spread size, decrease transaction costs and decrease the
number of transactions..
(d)
(b)
338
10
Marketability
Price continuity
Low transaction costs
Few buyers and sellers
Informational efficiency
11
(d)
12
(c)
13
Origination.
Risk-bearing and origination.
Distribution and origination.
Risk bearing and distribution.
Origination, risk bearing and distribution.
(a)
14
(c)
15
a)
b)
c)
d)
e)
(a)
16
(e)
17
The term third market describes the market where dealers and brokers:
a)
b)
c)
d)
e)
(e)
18
(e)
19
20
The member of the New York Stock Exchange who acts as a dealer on
assigned stocks is known as a
a)
b)
c)
d)
e)
(c)
Registered trader.
Commission broker.
Registered dealer.
Floor dealer.
Specialist.
340
b) Are employees of a member firm and buy and sell for customers of the
firm.
c) Act as brokers for other members.
d) Handle limit and other special orders placed by other brokers on the
floor.
e) Maintain a fair and orderly market.
(a)
21
(c)
22
(e)
23
Limit order.
Short sale.
Market order.
Priced order.
Stop loss.
A short sale.
A fill or kill order.
A margin transaction.
A limit order.
A credit order.
(c)
24
341
342
(c)
(c)
$51.25
$43.25
$53.33
$45.33
$83.33
Calculate your percentage rate of return if the shares of Sisco Corp falls to
$65.
a)
b)
c)
d)
e)
(b)
$50,000
$12,500
$25,000
$100,000
$120,000
If the maintenance margin is 25 percent, to what price can Sisco Corp fall
before you receive a margin call?
a)
b)
c)
d)
e)
(d)
$100,000
$200,000
$175,000
$150,000
$300,000
-15.00%
-25.00%
-23.07%
-37.50%
-30.50%
a)
b)
c)
d)
e)
-29.38%
-28.00%
-26.23%
-25.00%
-35.00%
(d)
$121.89
$315.05
$425.50
$637.73
$950.45
0.87%
3.87%
5.08%
9.53%
11.87%
344
$15,000
$5,250.75
$9,750.25
$9,937.50
$15,187.50
(a)
At the end of one year you close out your short position by purchasing
shares of XCorp at $45 per share. The commission is 1.25%. Calculate your
dollar profit.
a)
b)
c)
d)
e)
(c)
10
If at the end of one year you close out your short position by purchasing
share of XCorp at $45 per share with commission of 1.25%, what is your
rate of return on the investment?
a)
b)
c)
d)
e)
(b)
11
12
-55.92%
10.31%
51.06%
23.1%
-33.05%
Suppose at the end of one year XCorp is selling at $90 per share and you
cover your short position at this price. What is your dollar profit on the
investment? (Assume a 1.25% commission on the purchase)
a)
b)
c)
d)
e)
(a)
$5,074.38
-$4,038.13
$5250.00
-$5074.38
$4,038.13
$5,074.38
-$4,038.13
$5250.00
-$5074.38
$4,038.13
If you cover your short position at $90 per share. What is your rate of return
on the investment? (Assume a 1.25% commission on the purchase)
a)
b)
c)
d)
e)
-40.64%
-25.53%
5.21%
72.7%
71.2%
13
At the end of one year shares of RossCorp stock are selling for $55 per
share and the company paid dividends of $0.85 per share. Assuming that
345
you paid the full cost of the purchase, what is your rate of return if you sell
RossCorp stock?
a)
b)
c)
d)
e)
(b)
14
At the end of one year shares of RossCorp stock are selling for $35 per
share and the company paid dividends of $0.85 per share. Assuming that
you paid the full cost of the purchase, what is your rate of return if you sell
RossCorp stock?
a)
b)
c)
d)
e)
(c)
15
16
17
33.05%
-33.05%
-23.51%
-25.35%
40.64%
346
-23.51%
29.35%
23.51%
5.21%
10.06%
At the end of one year shares of RossCorp stock are selling for $35 per
share and the company paid dividends of $0.85 per share. Assuming that
you borrowed 25% of cost of the purchase, what is your rate of return?
a)
b)
c)
d)
e)
(d)
-33.05%
-23.42%
23.42%
33.05%
25.35%
At the end of one year shares of RossCorp stock are selling for $55 per
share and the company paid dividends of $0.85 per share. Assuming that
you borrowed 25% of cost of the purchase, what is your rate of return?
a)
b)
c)
d)
e)
(b)
18.08%
23.51%
22.32%
14.96%
19.28%
$29.39
$26.48
$50.39
$16.07
e) $50.10
CHAPTER 6
ANSWERS TO MULTIPLE CHOICE PROBLEMS
1.
2.
3.
4.
5.
347
7.
8.
9.
10.
11.
12.
13.
14.
348
15.
16.
17.
CHAPTER 7
349
(t)
(f)
(f)
(f)
The DJIA has been criticized because when a stock in the index splits there
are more shares outstanding and the importance of the stock in the
index increases.
(t)
Security market indexes have been used to create index funds and exchange
traded funds.
(f)
(t)
(f)
(t)
(t)
10
The low correlations between the U.S. and the U.K., and the U.S. and
Japan, confirm the benefit of global diversification.
(t)
11
350
(c)
(c)
(a)
(d)
Value.
Average beta.
Breadth.
Variability.
Dividend record.
(d)
351
(c)
(e)
An arithmetic mean.
A harmonic average.
A geometric mean.
An expected average.
A logarithmic average.
Which of the following are factors that make it difficult to create and
maintain a bond index?
a) The universe of bonds is broader than stocks.
b) The universe of bonds is constantly changing due to new issues, bond
maturities, calls, and bond sinking funds.
c) There can be difficulties in correctly pricing bond issues.
d) Choices a and c.
e) Choices a, b and c.
(a)
Low correlations between the S&P 500 stock index and the MSCI EAFE
suggest
a)
b)
c)
d)
e)
(d)
(a)
10
Correlations between U.S. investment grade bonds and high yield bonds are
a) Low because of the equity characteristics of high yield bonds.
b) Low because yields on investment grade bonds are determined by
systematic interest rate variables.
c) High because of the equity characteristics of high yield bonds.
d) High because yields on investment grade bonds are determined by
systematic interest rate variables.
e) None of the above.
352
Stock
W
X
Y
Z
31-Dec-03 31-Dec-0331-Dec-0431-Dec-04
Price
Shares
Price
Shares
$ 75.00 10000 $ 50.00 30000
$ 150.00 5000
$ 65.00 15000
$ 25.00 20000 $ 35.00 20000
$ 40.00 25000 $ 50.00 25000
Stocks W and X had 3 for 1 splits on December 31, 2003 at the end of trading.
(c)
Calculate the price weighted series for Dec 31, 2003, prior to the splits.
a)
b)
c)
d)
e)
(a)
Calculate the price weighted series for December 31, 2003 after the splits.
a)
b)
c)
d)
e)
(e)
72.5
100.0
119.25
121.25
103.57
(a)
103.57
100.0
72.5
121.25
119.25
121.25
119.25
100.0
72.5
103.57
Calculate the percentage return in the price weighted series for the period
Dec 31, 2003 to Dec 31, 2004.
a)
b)
c)
d)
e)
42.86%
20.00%
21.76%
33.33%
40.00%
353
(d)
Calculate the value weighted index for Dec 31, 2003, prior to the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
(c)
Calculate the value weighted index for Dec 31, 2003, after the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
(e)
12.68%
47.50%
21.76%
33.33%
40.00%
Calculate the unweighted index for Dec 31, 2003, prior to the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
354
121.25
100.0
81.69
72.5
147.5
Calculate the percentage return in the value weighted index for the period
Dec 31, 2003 to Dec 31, 2004.
a)
b)
c)
d)
e)
(a)
72.5
81.69
100.0
147.5
121.25
Calculate the value weighted index for Dec 31, 2004. Assume a base index
value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
(b)
147.5
81.69
72.5
100.0
121.25
100.0
200.0
150.0
120.0
175.0
(c)
10
Calculate the unweighted index for Dec 31, 2003, after the splits. Assume a
base index value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
(a)
11
Calculate the unweighted index (geometric mean) for Dec 31, 2004.
Assume a base index value of 100. The base year is Dec 31, 2003.
a)
b)
c)
d)
e)
(a)
12
110.0
200.0
100.0
120.0
150.0
146.05
121.25
151.25
148.75
100.25
46.05%
21.25%
51.25%
48.75%
100.25%
Stock
A
B
C
(b)
Number of Shares
1,000,000
10,000,000
25,000,000
13
PriceT
50
30
20
PriceT+1
60
35
25
b)
c)
d)
e)
(d)
14
(c)
20.00%
21.76%
33.33%
40.00%
15
1.22%
20.00%
20.55%
21.76%
33.33%
1.21%
20.00%
20.56%
21.76%
33.33%
Shares
A
12
10
8
9
B
23
22
26
25
16
17
B
350
350
350
350
C
250
250
250**
750
13.000
19.000
29.000
87.000
100.000
356
A
500
500*
1000
1000
(c)
C
52
55
51
19
b)
c)
d)
e)
(e)
18
21.3343
31.2389
41.6890
None of the above
Calculate a Standard & Poor's Index for Day 3 if the base period is Day 1
with an initial index value is 100.
a)
b)
c)
d)
e)
90.351
91.035
95.234
101.628
110.351
CHAPTER 7
ANSWERS TO MULTIPLE CHOICE PROBLEMS
x100 100
750000 750000 500000 1000000
x100 147.5
750000 750000 500000 1000000
8
9
SINCE THE BASE VALUE IS 100 AND THE CURRENT INDEX VALUE IS
147.5, the percentage return is 47.5%.
The index value Dec 2003 is 100
357
10
11
12
13
Given a three security series and a price change from period T to T+1, the percentage
change in the price weighted series would be
A
B
C
Sum
Divisor
Average
Period T
$50
30
20
$100
3
33.33
Period T+1
$60
35
25
$120
3
40.00
Period T
Stock
Price/Share
A
$50
B
30
C
20
Total
# of Shares
1,000,000
10,000,000
25,000,000
Market Value
$50,000,000
300,000,000
500,000,000
$850,000,000
Period T+1
Stock Price/Share
A
$60
B
35
C
25
Total
# of Shares
1,000,000
10,000,000
25,000,000
Market Value
$60,000,000
350,000,000
625,000,000
$1,035,000,000
Period T
Stock Price/Share
A
$50
B
30
C
20
Total
Period T+1
Stock Price/Share
A
$ 60
B
35
C
25
358
Market Value
$1,200.00
1,166.55
1,250.00
Total
$3,616.55
16
17
18
CHAPTER 8
359
(t)
(t)
A basic assumption of the Markowitz model is that investors base decisions solely
on expected return and risk.
(t)
The yield spread between yields on AAA bonds and BAA bonds is evidence that
investors are risk averse.
(t)
(t)
The covariance is a measure of the degree to which two variables (e.g., rates of
return) move together over time relative to their means.
(f)
For a two stock portfolio containing Stocks i and j, the correlation coefficient of
returns (ri,j) is equal to the square root of the covariance (covi,j).
(f)
(t)
(f)
(t)
10
(f)
11
other.
360
Most assets of the same type have negative covariances of returns with each
(a)
(d)
(c)
(b)
As the correlation coefficient between two assets decreases, the shape of the
efficient frontier
a)
b)
c)
d)
e)
(d)
0.0
0.25
-0.25
-0.75
1.0
A positive covariance between two variables indicates that
a)
b)
c)
d)
(d)
What information must you input to a computer program in order to derive the
portfolios that make up the efficient frontier
a)
b)
c)
d)
e)
(d)
(a)
As the correlation coefficient between two assets increases, the shape of the
efficient frontier
a)
b)
c)
d)
e)
(d)
10
362
Statistics.
Variance.
Random.
Risk.
definition of:
e) Semivariance.
(c)
11
(b)
12
(a)
13
14
With low, zero or negative correlations it is possible to derive portfolios that have
a)
b)
c)
d)
e)
(d)
(a)
15
In a two stock portfolio, if the correlation coefficient between two stocks were to
decrease over time everything else remaining constant the portfolio's risk would
a)
b)
c)
d)
e)
Decrease.
Remain constant.
Increase.
Fluctuate positively and negatively.
Be a negative value.
363
(d)
16
(c)
17
Given a portfolio of stocks the envelope curve containing the set of best possible
combinations is known as the
a)
b)
c)
d)
e)
(d)
18
19
364
Efficient portfolio.
Utility curve.
Efficient frontier.
Last frontier.
Capital asset pricing model.
(a)
Pair A,B
Pair C,D
Pair E,F
Pair G,H
Pair I,J
No other portfolio offers higher expected returns with the same risk.
No other portfolio offers lower risk with lower expected return.
There is no portfolio with a higher return.
There is no portfolio with lower risk.
None of the above
a)
b)
c)
d)
e)
(a)
300
461.54
261.54
195
200
Calculate the expected return for a three asset portfolio with the following
Asset
A
B
C
a)
b)
c)
d)
e)
(c)
Exp. Ret.
0.0675
0.1235
0.1425
Given the following weights and expected security returns, calculate the expected
return for the portfolio.
a)
b)
c)
d)
e)
4
Weight
0.25
0.35
0.40
11.71%
11.12%
15.70%
14.25%
6.75%.
Weight
.20
.25
.30
.25
(d)
Std. Dev
0.12
0.1675
0.1835
Expected Return
.06
.08
.10
.12
.085
.090
.092
.097
None of the above
the standard deviation for stock A is 0.15 and for stock B, it is 0.20. The
covariance between returns for these stocks is 0.01. The correlation coefficient
between these two stocks is:
a) -0.125
b) 0.195
c) -0.285
365
d) 0.333
e) 0.405
USE THE FOLLOWING INFORMATION FOR THE NEXT TWO PROBLEMS
Given: E(R1) = .10
E(SD1) = .03
W1 = .30
(d)
W2 = .70
(c)
E(R2) = .15
E(SD2) = .05
.105
.115
.125
.135
None of the above
Calculate the expected standard deviation of the two stock portfolio when the
correlation is 0.40.
a)
b)
c)
d)
e)
.0016
.0160
.0395
.1558
.3950
(d)
366
E(R2) = 0.16
E(SD2) = 0.15
0.13
0.136
0.14
0.125
0.16
a)
b)
c)
d)
e)
(b)
(c)
10
0.1025
0.0705
0.0906
0.0404
0.0623
0.13
0.136
0.14
0.125
0.16
0.1025
0.0705
0.0906
0.0404
0.0623
CHAPTER 8
ANSWERS TO MULTIPLE CHOICE PROBLEMS
1.
3.
4.
5.
6.
7.
8.
9.
10.
367
CHAPTER 9
AN INTRODUCTION TO ASSET PRICING MODELS
TRUE/FALSE QUESTIONS
(t)
One of the assumptions of Capital Market Theory is that investors can borrow or
lend at the risk-free rate.
(f)
(t)
A risky asset is an asset with uncertain future returns, and uncertainty (or risk) is
measured by the variance or standard deviation of returns.
(t)
The standard deviation of a portfolio that combines the risk-free asset with risky
assets is the linear proportion of the standard deviation of the risky asset portfolio.
(t)
The Capital Market Line (CML) is the line from the intercept point that represents
the risk-free rate tangent to the original efficient frontier.
(t)
(f)
All portfolios on the CML are perfectly negatively correlated, which means that
all portfolios on the CML are perfectly negatively correlated with the
completely diversified market portfolio since it lies on the CML.
(t)
(f)
The Capital Asset Pricing Model (CAPM) is a technique for determining the
expected risk on an asset.
(t)
10
(t)
11
Multifactor models of risk and return can be broadly grouped into models that use
macroeconomic factors and models that use microeconomic factors.
(f)
12
Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and
their identity
368
(d)
(e)
(c)
(d)
from decisions on
Lending, borrowing
Risk, return
Investing, financing
Risky assets, risk free assets
Buying stocks, buying bonds
(b)
its
its
its
its
Utilizing the security market line an investor owning a stock with a beta of (-2)
would expect the stock's return to
in a market that
was expected to decline 10 percent.
a) Rise or fall an indeterminate amount
b) Rise by 20.0%
369
c) Fall by 20.0%
d) Rise by 10.2%
e) Fall by 10.2%
(d)
The Capital Market Line (CML) refers to the efficient formed by creating
portfolios that
a)
b)
c)
d)
e)
(e)
(a)
10
risk
risk
Confidence risk.
Maturity risk.
Expected inflation risk.
Call risk.
Return difference between small capitalization and large capitalization stocks.
370
risk
In a macro-economic based risk factor model the following factor would be one
of many appropriate factors
a)
b)
c)
d)
e)
(d)
risk
(a)
risk
11
(e)
12
In a micro-economic based risk factor model the following factor would be one
of many appropriate factors
a)
b)
c)
d)
e)
Confidence risk.
Maturity risk.
Expected inflation risk.
Call risk.
Return difference between small capitalization and large capitalization stocks.
MULTIPLE CHOICE PROBLEMS
(b)
Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5%
and the expected return on the stock index is 15%. The estimated return on the
asset is 20%. Calculate the alpha for the asset.
a)
b)
c)
d)
e)
(b)
19.25%
0.75%
0.75%
9.75%
9.0%
The table below provides factor risk sensitivities and factor risk premia for
a three factor model for a particular asset where factor 1 is MP the growth
rate in U.S. industrial production, factor 2 is UI the difference between
actual and expected inflation, and factor 3 is UPR the unanticipated change
in bond credit spread.
Risk Factor
Factor
Sensitivity()
Risk
Premium()
371
MP
UI
UPR
1.76
-0.8
0.87
0.0259
-0.0432
0.0149
The variance of returns for a risky asset is 25%. The variance of the error
term, Var(e) is 8%. What portion of the total risk of the asset, as measured
by variance, is unsystematic?
a)
b)
c)
d)
e)
(c)
5.2%
8.0%
3.2%
4.0%
1.2%
An investor wishes to construct a portfolio by borrowing 35% of his
original wealth and investing all the money in a stock index. The return on
the risk-free asset is 4.0% and the expected return on the stock index is
15%. Calculate the expected return on the portfolio.
a)
b)
c)
d)
e)
372
32%
8%
68%
25%
75%
An investor wishes to construct a portfolio consisting of a 40% allocation to
a stock index and a 60% allocation to a risk free asset. The return on the
risk-free asset is 2% and the expected return on the stock index is 10%. The
standard deviation of returns on the stock index 8%. Calculate the expected
standard deviation of the portfolio.
a)
b)
c)
d)
e)
(b)
12.32%
9.32%
4.56%
6.32%
8.02%
18.25%
18.85%
9.50%
15.00%
11.15%
(d)
(d)
A stock has a beta of the stock is 1.1. The risk free rate is 2.5% and the return on
the market is 12%. The estimated return for the stock is 14%. According to the
CAPM you should
a)
b)
c)
d)
e)
(b)
10
1.0
0.0
-1.0
0.5
-0.5
The expected return for a stock, calculated using the CAPM, is 10.5%. The
market return is 9.5% and the beta of the stock is 1.50. Calculate the
implied risk-free rate.
a)
b)
c)
d)
e)
(d)
a)
b)
c)
d)
e)
(a)
8.25%
16.50%
17.50%
9.75%
14.38%
7.50%
13.91%
17.50%
21.88%
14.38%
The expected return for a stock, calculated using the CAPM, is 25%. The
risk free rate is 7.5% and the beta of the stock is 0.80. Calculate the implied
return on the market.
a) 7.50%
b) 13.91%
c) 17.50%
373
d) 21.88%
e) 14.38%
(c)
11
The expected return for Zbrite stock calculated using the CAPM is 15.5%.
The risk free rate is 3.5% and the beta of the stock is 1.2. Calculate the
implied market risk premium.
a)
b)
c)
d)
e)
(d)
12
5.5%
6.5%
10.0%
15.5%
12.0%
Calculate the expected return for Express Inc. which has a beta of .69 when
the risk free rate is.09 and you expect the market return to be .14.
a)
b)
c)
d)
e)
0.05%
13.91%
10.92%
12.45%
14.25%
STOCK
X
Y
Z
(b)
13
BETA
1.50
0.50
2.00
CURRENT
PRICE
$ 22
$ 40
$ 45
EXPECTED
PRICE
$ 23
$ 43
$ 49
EXPECTED
DIVIDEND
$ 0.75
$ 1.50
$ 1.00
What are the expected (required) rates of return for the three stocks (in the order
X, Y, Z)?
a)
b)
c)
d)
e)
(a)
374
14
What are the estimated rates of return for the three stocks (in the order X, Y, Z)?
a)
b)
c)
d)
e)
(e) 15
a)
b)
c)
d)
e)
(a)
16
17
18
0.4255
0.5929
5.6825
9.4163
0.3333
Compute the correlation coefficient between GBC and the Market Index.
a)
b)
c)
d)
e)
(b)
Return for
Market
12
13
17
-15
-8
9
Compute the beta for GBC Company using the historic returns presented above.
a)
b)
c)
d)
e)
(e)
Return for
GBC
25
10
5
-13
11
-20
0.4255
0.5929
5.6825
9.4163
0.3333
375
a)
b)
c)
d)
e)
(d)
19
0.4255
1.013
1.4385
0.5875
0.5219
ANSWERS TO PROBLEMS
1
Risk
Premium()
0.0259
-0.0432
0.0149
()x()
0.0456
0.0346
0.013
0.1232
376
10
11
12
For problems 13 - 15
STOCK
REQUIRED
ESTIMATED
EVALUATION
Overvalued
Undervalued
Overvalued
For problems 16 19
The table below shows the relevant calculations.
16
(1)
(2)
(3)
Year
1
2
3
4
5
6
Total
Average
Variance
Std. Dev.
Covariance
Correlation
Beta
GBC
25
10
5
-13
11
-20
18
3.0000
Market
12
13
17
-15
-8
9
28
4.67
(4)
GBC
(R-E(R ))2
484.00
49.00
4.00
256.00
64.00
529.00
1386.00
(5)
Market
(R-E(R ))2
53.73
69.39
152.03
386.91
160.53
18.75
841.33
277.20
16.65
168.27
12.97
(6)
GBC
R-E(R )
22.00
7.00
2.00
-16.00
8.00
-23.00
(7)
Market
R-E(R )
7.33
8.33
12.33
-19.67
-12.67
4.33
(8)
(6) x (7)
161.26
58.31
24.66
314.72
-101.36
-99.59
358.00
71.60
0.33
0.4255
17
377
19
378