MIDTERM IM
Question 1. Discuss the relationships between interest rates (both real and nominal), expected
inflation rates, and tax rates on investment returns.
Question 2. Discuss the differences between investors who are risk averse, risk neutral, and risk
loving by using a utility function: U = E(r) - 0.5A0?
Question 3. Theoretically, the standard deviation of a 2-asset portfolio can be reduced to zero?
Explain. Realistically, is it possible to reduce the standard deviation to this level? Explain.
Question 4. You purchase one put option for a premium of $6. The exercise price is $100.
What is the maximum profit that you could gain from this strategy?
What is the maximum loss that you could suffer from this strategy?
Question 5. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of
0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. Using the Capital
Asset Pricing Model, what is your investment decision?
11.2% - [4% + 0.92(10% - 4%)] = 1.68%; therefore, the security is underpriced.
Question 6. The growth in dividend of Vega Corp. is expected to be 10%/year for the next two
years, followed by a growth rate of 5%/year for three years; after this five year period, the
growth in dividend is expected to be 2%/year, indefinitely. The required rate of return on Vega
Corp. Is 12%. Current year's dividend is $2.00. What should the stock sell for today?
Question 7. Use the following information to calculate expected returns and standard
deviations.
Based on mean-variance criteria, which stock should you choose?
Return of Stock A Return of Stock B
2013 -0.3505 -0.1154
2014 0.7083 0.2472
2015 0.7329 0.3665
2016 -0.2034 -0.4271
Ouestion 8. You have the following information on 4 different securities:
Stock Expected return E(r) Standard deviation
A 0.12 0.3
B 0.15 0.3
C 0.21 0.16
D 0.24 0.21
Utility function U = E(r) - 0.005A0?. With A = 3.0, based on the utility function, which stock (only
one stock) would you select?
Question 9. A coupon bond that pays interest annually has a par value of $1,000, matures in 5
years, and has a yield to maturity of 10%. Calculate the intrinsic value of the bond today if the
coupon rate is 7%.
Question 10. The following data are available relating to the performance of Sooner Stock Fund
and the market portfolio:
Sooner Market portfolio
Average return 20% 11%
Standard deviation of returns 44% 19%
Beta 1.8 1
Residual standard deviation 2% 0%
Risk-free rate 3%
What is the Sharpe measure of performance evaluation for Sooner Stock Fund?
What is the Treynor measure of performance evaluation for Sooner Stock Fund?
Calculate the Jensen measure of performance evaluation for Sooner Stock Fund.
Question 11. Discuss the differences between the capital market line (ML) and the security
market line (SML).
Question 12. Discuss the theories of the term structure of interest rates. Include in your
discussion the differences in the theories, and the advantages/disadvantages of each.
MCQ:
1. Suppose a two-year 9% p.a. bond with a face value of $100 000 has a yield of 8% p.a.
What is the price of this bond provided it pays semi-annual coupons?
a. $98 206.24
b. $100 719.11
c. $101 814.95
d. $101 937 34
2. The broadest index in the Australian equity market is the:
a. S&P/ASX 200
b. S&P/ASX 50
c. AX All-Ordinaries
d. Consumer Price Index
3. An investor wants to calculate the continuously compounded return for month t for a
company. If the share price of the company was $4.50 at the start of month t and $7.25
at the end of month t, then the month t continuously compounded return is:
a. 30.50%
b. 33.65%
c. 40.00%
d. 47.69%
4. The market capitalisation rate on the stock of Aberdeen Wholesale Company is 10%. Its
expected ROE is 12%, and its expected EPS is $5. If the firm's plowback ratio is 50%, its
P/E ratio will be
a. 8.33
b. 12.5
c. 19.23
d. 24.15
5. Consider the CAPM. The expected return on the market is 18%. The expected return on
a stock with a beta of 1.2 is 20%. What is the risk-free rate?
a. 2%
b. 6%
c. 8%
d. 12%
6. Calculate the duration (measured in six-monthly periods) of a bond with a price of $100,
two years to maturity, and yield and coupon rates of 5% and 10% p.a. respectively,
a. 3.65
b. 3.74
c. 3.79
d. 3.82
7. Musters Ltd currently pays a dividend of $0.76. One share in Musters Ltd currently costs
$14.25. Given a cost of equity capital of 9%, what is the implied constant growth rate?
a. 1.9891%
b. 0.0134%
c. 0.0666%
d. 10.4978%
8. Emerging markets are typically characterized as:
a. high return
b. high risk
c. low liquidity
d. all of these answers
9. Which of the following is typically used as a proxy for a risk-free asset?
a. Corporate Bond
b. Consumer Price Index
c. All-Ordinaries
d. None of these choices
10. In mid-1997, which part of the world struggled in financial crisis?
a. South-east Asian market
b. New Zealand market
c. Asian market
d. USA market
11. The constant-growth dividend discount model (DDM) can be used only when the
a. growth rate is less than or equal to the required return
b. growth rate is greater than or equal to the required return
c. growth rate is less than the required return
d. growth rate is greater than the required return
12. Bond A has a price of $97 635 and a duration of 1.93. Bond B has a price of $54,696 and
has a duration of 3.46. Calculate the duration of a portfolio comprised of one of Bond A
and one of Bond B.
a. 2.4794
b. 2.5511
c. 2.6638
d. 2.6842
13. A bank-accepted bill with a face value of $100 000 currently has 30 days to expiry. If the
current price of the bank-accepted bill is $93 809, what is the implied annual yield?
a. 6.8%
b. 7.0%
c. 7.5%
d. 8.0%
14. A risk-averse investor will, all other things being equal, prefer investing in which of the
following asset classes?
a. equity
b. property
c. fixed interest
d. shares
15. An abnormal return is calculated as:
a. expected return less risk-free rate
b. expected return less market return
c. actual return less market return
d. actual return less expected return
16. Securities traded on the money market include
a. Commercial bills
b. Promissory notes
c. Treasury notes
d. All of these answers
17. CBA has a beta of 1.6 and WPL has a beta of 1.8. Given this, calculate the beta for a
portfolio consisting of 65% in CBA and 35% in WPL.
a. 0.65
b. 1.10
c. 1.30
d. 1.67
18. Which theory is consistent with an observed concentration of investors in particular
segments of the term structure?
a. segmented market
b. liquidity premium
c. expectations
d. preferred habitat
19. A portfolio comprising two assets can be formed with zero variance, provided the
correlation between the securities is:
a. 0
b. 0.5
c. 1
d. -1
20. The correct price of a share with a cost of capital of 25% p.a. that pays $0.28 p.a.
dividends in perpetuity is:
a. $1.12
b. $1.20
c. $0.89
d. $0.07
21. All other things equal, a bond's duration is
a. higher when the coupon rate is higher
b. lower when the coupon rate is higher
c. the same when the coupon rate is higher
d. indeterminable when the coupon rate is high
22. An investor expects Chewy Lewy Ltd to pay a dividend of $0.95 next year, after which
the investor expects to sell the share for $12.80. The cost of equity capital is estimated
to be 12% p.a. What is the present value of one share in Chewy Lewy Ltd?
a. $11.05
b. $12.28
c. $12.59
d. $13.10
23. The standard deviation of returns of an inefficient portfolio is the standard deviation of
an efficient portfolio, provided both portfolios have equal expected returns.
a. lower than
b. higher than
c. the same as
24. Calculate the beta for an asset with a variance of 10%, where the market has a variance
of 15% and a covariance with the asset of 20%.
a. 0.15
b. 1.33
c. 0.75
d. 1.50
25. A firm has a dividend payout ratio of 20%, annual profit of $20 000 and a market value
of equity equal to $150 000. Given a corporate tax rate of 30%, estimate the growth rate
in dividends.
a. 8.89%
b. 9.56%
c. 10.26%
d. 10.67%
