Download Junior Sophisters Monetary and Welfare Economics

XEC30503
UNIVERSITY OF DUBLIN
TRINITY COLLEGE
FACULTY OF ARTS, HUMANITIES AND SOCIAL SCIENCES
DEPARTMENT OF ECONOMICS
Junior Sophister
Hilary Term 2008
BESS, TSM, BBS, MSISS,
One Year Student
INVESTMENT ANALYSIS
Tuesday 11th March 2008
LUCE HALL
14:00-16:00
Professor Patrick Honohan
Exam Instructions
Answer ALL questions
Materials Permitted for this Examination
Calculators
Log Tables
You may not start this examination until you are instructed to do so by the
Invigilator.
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XEC30503
1. (i) Which of the following statements is true: “beta and standard
deviation differ as risk measures in that beta measures:
(a) Only unsystematic risk, while standard deviation measures total
risk
(b) Only systematic risk, while standard deviation measures total risk
(c) Both systematic and unsystematic risk, while standard deviation
measures only unsystematic risk
(d) Both systematic and unsystematic risk, while standard deviation
measures only systematic risk
(ii) Based on current dividend yields and expected growth rates, the
expected rates of return on stocks A and B are 11% and 14%
respectively. The beta of stock A is 0.8, while the beta of stock B is 1.5.
The risk-free rate is currently 6% while the expected return on the
market index is 12%. The standard deviation of stock A is 10% annually,
while than of stock B is 11%.
(e) If you currently hold a well-diversified portfolio, would you choose
to add either of these stocks to your portfolio?
(f) If instead you could invest only in risk free Government bills and
one of these stocks, which stock would you choose? Explain your
answer using either a graph or a quantitative measure of the
attractiveness of the stocks.
2. Suppose asset returns are influenced by two independent economic
factors F1 and F2. The following are well-diversified portfolios:
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Expected
on F1
on F2
return
A
1.5
2.0
29%
B
2.0
-0.5
24%
C
1.0
0.5
14%
Portfolio
Write down the relationship between factor loadings (sensitivities) and
factor rewards (risk premia) consistent with this data.
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XEC30503
3. (i) For each of the following three statements, indicate whether it is true
or false:
(a) Stocks with a beta of zero offer an expected rate of return of zero
(b) The CAPM implies that investors require a higher return to hold
highly volatile securities
(c) You can construct a portfolio with a beta of 0.75 by investing
three-quarters of the investment budget in T-bills and the
remainder in the market portfolio.
(ii) Assuming that expected returns follow the basic CAPM model,
consider the following table, which gives the expected return on two
stocks for two particular market returns:
Market
Aggressive
Defensive
return
stock
stock
5%
-2%
6%
25%
38%
12%
(a) What are the betas of the two stocks?
(b) What is the expected return on each stock if the market return is
equally likely to be 5% or 25%
(c) If the Treasury Bill rate is 6% and the market return in equally
likely to be 5% or 25%, draw the Security Market Line (SML) for
this economy
(d) Plot two securities on the SML graph. What are the alphas of
each?
(e) What hurdle rate (minimum required rate) of return should be used by
the management of the aggressive firm for a project with the risk
characteristics of the defensive firm’s stock
© UNIVERSITY OF DUBLIN 2008
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