Download Fin 331, Exam 2, Spring 2009

Fin 331, Exam 2, Spring 2009
Name___________________________________
1. Rank the following from highest average historical return to lowest average historical return from
1926-2006.
I. Small stocks
II. Long term bonds
III. Large stocks
IV. T-bills
a. I, II, III, IV
b. III, IV, II, I
c. I, III, II, IV
d. III, I, II, IV
2. Rank the following from highest average historical standard deviation to lowest average historical
standard deviation from 1926-2006.
I. Small stocks
II. Long term bonds
III. Large stocks
IV. T-bills
a. I, II, III, IV
b. III, IV, II, I
c. I, III, II, IV
d. III, I, II, IV
3. You have calculated the historical dollar weighted return, annual geometric average return and annual
arithmetic average return. If you desire to forecast performance for next year, the best forecast will be
given by the
a. dollar weighted return
b. geometric average return
c. arithmetic average return
d. index return
4. According to CAPM, an investor's degree of risk aversion will determine his _______.
A)
B)
C)
D)
optimal risky portfolio
risk-free rate
mix of risk-free asset and optimal risky asset
choice of risk free asset
5. Asset A has an expected return of 12% and a standard deviation of 20%. The risk free rate is 4%.
What is the reward-to-variability ratio?
A)
.20
B)
.40
C)
.60
D)
It cannot be determined from the information provided.
6. Diversification is most effective when security returns are __________.
A)
high
B)
negatively correlated
C)
positively correlated
D)
uncorrelated
7. Beta is a measure of __________.
A)
firm specific risk
B)
diversifiable risk
C)
market risk
D)
unique risk
8. The risk that can be diversified away is ___________.
A)
beta
B)
firm specific risk
C)
market risk
D)
systematic risk
9. The term efficient frontier refers to the set of portfolios that _________________.
A)
yield the greatest return for a given level of risk
B)
involve the least risk for a given level of return
C)
Both a and b above
D)
None of the above answers are correct
10. Harry Markowitz is best known for his Nobel prize winning work on ______________.
A)
strategies for active securities trading
B)
techniques used to identify efficient portfolios of risky assets
C)
techniques used to measure the systematic risk of securities
D)
techniques used in valuing securities options
11. In a well diversified portfolio, __________ risk is negligible.
A)
nondiversifiable
B)
market
C)
systematic
D)
unsystematic
12. According to the capital asset pricing model, a well-diversified portfolio's rate of return is a function
of __________.
A)
market risk
B)
unsystematic risk
C)
unique risk
D)
reinvestment risk
13. According to the capital asset pricing model, a security with a __________.
A)
negative alpha is considered a good buy
B)
positive alpha is considered overpriced
C)
positive alpha is considered underpriced
D)
zero alpha is considered a good buy
14. Random price movements indicate
A)
Irrational markets
B)
That prices cannot equal fundamental values
C)
That technical analysis to uncover trends can be quite useful
D)
That markets are functioning efficiently
15. Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock
price behavior.
A)
Short-run, short-run
B)
Long-run, long-run
C)
Long-run, short-run
D)
Short-run, long run
16. The weak form of the EMH states that ________ must be reflected in the current stock price.
A)
All security price and volume data
B)
All publicly available information
C)
All information including inside information
D)
All costless information
17. If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant
information including information that is available only to insiders.
A)
Semi-strong
B)
Strong
C)
Weak
D)
Perfect
18. The term random walk is used in investments to refer to ______________.
A)
Stock price changes that are random but predictable
B)
Stock prices that respond slowly to both old and new information
C)
Stock price changes that are random and unpredictable
D)
Stock prices changes that follow the pattern of past price changes
19. Most evidence indicates that U.S. stock markets are _______________________,
A)
Reasonably weak form and semi-strong form efficient
B)
Strong form efficient
C)
Reasonably weak form but not semi- or strong form efficient
D)
Neither weak form, semi- or strong form efficient
20. Which of the following statements is/are correct?
A)
If a market is weak form efficient it is also semi- and strong form efficient
B)
If a market is semi-strong efficient it is also strong form efficient
C)
If a market is strong form efficient it is also semi-strong but not weak form efficient
D)
If a market is strong form efficient it is also semi- and weak form efficient
1. (9 points) Returns for the past five years for common stock in Flagstaff, Inc. are shown below:
Year
2004
2005
2006
2007
2008
% Return
10
2
14
20
-31
a. Calculate the arithmetic average return.
b. Calculate the standard deviation of returns.
c. Calculate the geometric mean return.
2. (8 points) The risk-free rate is 2%, the expected return on the market is 12% and the standard
deviation of market returns is 20%.
a. Stock i has a standard deviation of returns of 50% and a correlation with the market of 0.5.
Calculate stock i’s beta.
b. Stock j has a beta of 1.40. Calculate the required return on stock j.
3. (12 points) The risk-free rate is 2%, the expected return on the market is 12% and the
standard deviation of market returns is 20%.
Stock
Expected Return*
Standard Deviation
Beta
X
8%
30%
.60
Y
14%
50%
1.20
*The expected returns are based on the market prices of the stocks and your assessment of
each firm’s future potential. They could also be called “predicted returns.”
The correlation between returns on X and Y is 0.4. A portfolio has 40 percent invested in X and
60 percent invested in Y.
a. Calculate the expected return of the portfolio.
b. Calculate the portfolio’s beta.
c. Calculate the standard deviation of the portfolio’s returns.
4. (14 points) The risk-free rate is 2%, the expected return on the market is 12% and the
standard deviation of market returns is 20%.
An investor has $80,000 to invest. She invests $20,000 at the risk-free rate and $60,000 in the
market.
a. Calculate the expected return (in percent) on the portfolio.
b. Calculate the standard deviation of the portfolio’s returns.
c. Use the information provided in problem 5 to draw and label two graphs below, one
depicting the capital market line and one depicting the security market line. On each graph, plot
the portfolio described in problem 5.
5. (6 points) Prof. Siegel states that stocks can be classified as either value or growth on the
basis of P-E ratios. According to Siegal, are high P-E ratios associated with value stocks, or with
growth stocks? Briefly explain why high P-E stocks are so considered.