# Chapter 7 Risk, Return, and the Capital Asset Pricing Model

 To view this video please enable JavaScript, and consider upgrading to a web browser that supports HTML5 video
Save this PDF as:

Size: px
Start display at page:

## Transcription

1 Chapter 7 Risk, Return, and the Capital Asset Pricing Model MULTIPLE CHOICE 1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios should she hold in combination with a position in the risk-free asset? a. portfolio with a standard deviation of 15% and an expected return of 12% b. portfolio with a standard deviation of 19% and an expected return of 15% c. portfolio with a standard deviation of 25% and an expected return of 18% d. portfolio with a standard deviation of 12% and an expected return of 9% To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure and choose the line with the highest slope. DIF: H 2. Suppose David can borrow and lend at the risk-free rate of 5%. Which of the following three risky portfolios should he hold in combination with a position in the risk-free asset? a. portfolio with a standard deviation of 16% and an expected return of 12% b. portfolio with a standard deviation of 20% and an expected return of 16% c. portfolio with a standard deviation of 30% and an expected return of 20% d. he should be indifferent in holding any of the three portfolios

2 To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure and choose the line with the highest slope. DIF: H 3. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 1.5, what is its expected return? a. 17% b. 12% c. 19.5% d. 24.5% E(R) = 5% + 1.5(13%-5%) = 17% DIF: E 4. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 1.0, what is its expected return? a. 8% b. 13% c. 5% d. none of the above E(R) = 5% + 1.0(13%-5%) = 13% DIF: E 5. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 0, what is its expected return? a. 0% b. 5% c. 13% d. none of the above E(R) = 5% + 0(13%-5%) = 5%

3 DIF: E 6. According to the CAPM (capital asset pricing model), the security market line is a straight line. The intercept of this line should be equal to a. zero b. the expected risk premium on the market portfolio c. the risk-free rate d. the expected return on the market portfolio ANS: C 7. According to the CAPM (capital asset pricing model), the security market line is a straight line. The slope of this line should be equal to a. zero b. the expected risk premium on the market portfolio c. the risk-free rate d. the expected return on the market portfolio 8. According to the CAPM (capital asset pricing model), what is the single factor that explains differences in returns across securities? a. the risk-free rate b. the expected risk premium on the market portfolio c. the beta of a security d. the expected return on the market portfolio e. the volatility of a security ANS: C DIF: E 9. If the market portfolio has an expected return of 0.12 and a standard deviation of 0.40, and the risk-free rate is 0.04, what is the slope of the security market line? a b c d Slope = = A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free is 5%. Which of the following statement is correct? a. This asset lies on the security market line. b. This asset lies above the security market line. c. This asset lies below the security market line. d. Cannot tell from the given information. ANS: C Equilibrium return = 5% (13%-5%) = 14.6%

4 11. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free is 5%. The stock is a. overpriced b. underpriced c. appropriately priced d. Cannot tell from the given information Equilibrium return = 5% (13%-5%) = 14.6% 12. An asset has a beta of 2.0 and an expected return of 20%. The expected risk premium on the market portfolio is 5% and the risk-free is 7%. The stock is a. overpriced b. underpriced c. appropriately priced d. Cannot tell from the given information Equilibrium return = 7% (5%) = 17% 13. A stock that pays no dividends is currently priced at \$40 and is expected to increase in price to \$45 by year end. The expected risk premium on the market portfolio is 6% and the risk-free is 5%. If the stock has a beta of 0.6, the stock is a. overpriced b. underpriced c. appropriately priced d. Cannot tell from the given information Equilibrium return = 5% (6%) = 8.6% Stock expected return = (45-40)/40 = 12.5% 14. A particular stock has a beta of 1.4 and an expected return of 13%. If the expected risk premium on the market portfolio is 6%, what s the expected return on the market portfolio? a. 10.6% b. 4.6% c. 8.4% d. 9.3% 13% = R f (6%) R f = 4.6% Expected market return = 4.6% + 6% = 10.6%

5 15. A particular stock has an expected return of 18%. If the expected return on the market portfolio is 13%, and the risk-free rate is 5%, what s the stock s CAPM beta? a b c d % = 5% + (8%) = A particular stock has an expected return of 11%. If the expected risk premium on the market portfolio is 8%, and the risk-free rate is 5%, what s the stock s CAPM beta? a b c d % = 5% + (8%) = The stock of Alpha Company has an expected return of 15.5% and a beta of 1.5, and Gamma Company stock has an expected return of 13.4% and a beta of 1.2. Assume the CAPM holds. What s the expected return on the market? a. 12% b. 7% c. 10.3% d. 11.2% Suppose the risk free rate is R f, and the expected market return is R m. 15.5% = R f +1.5(R m -R f ) 13.4% = R f +1.2(R m -R f ) R f = 5% R m = 12% 18. The stock of Alpha Company has an expected return of 18% and a beta of 1.5, and Gamma Company stock has an expected return of 15.6% and a beta of 1.2. Assume the CAPM holds. What s the risk-free rate? a. 8.0% b. 6.0% c. 0% d. 4.7% Suppose the risk free rate is R f, and the expected market return is R m.

6 18% = R f +1.5(R m -R f ) 15.6% = R f +1.2(R m -R f ) R f = 6% R m = 14% 19. The CAPM (capital asset pricing model) assumes that: a. all assets can be traded b. investors are risk-averse c. investors have homogeneous expectations d. all of the above ANS: D DIF: H 20. A portfolio has 40% invested in Asset 1 and 60% invested in Asset 2. If Asset 1 has a beta of 1.2 and Asset 2 has a beta of 1.8, what s the beta of the portfolio? a b c d e. cannot tell from the given information Suppose the expected return of Asset 1 is R 1, the expected return of Asset 2 is R 2, the risk free rate is R f, and the market return is R m. Portfolio expected return = 0.4R R 2 = 0.4[R f +1.2(R m -R f )]+ 0.6[R f +1.8(R m -R f )]= R f +1.56(R m -R f )] DIF: H REF: 7.2 Risk and Return for Portfolios 21. A portfolio has 40% invested in Asset 1, 50% invested in Asset 2 and 10% invested in Asset 3. Asset 1 has a beta of 1.2, Asset 2 has a beta of 0.8 and Asset 3 has a beta of 1.8, what s the beta of the portfolio? a b c d e. Cannot tell from given information ANS: C Suppose the expected return of Asset 1 is R 1, the expected return of Asset 2 is R 2, the expected return of Asset 3 is R 3, the risk free rate is R f, and the market return is R m. Portfolio expected return = 0.4R R R 3 = 0.4[R f +1.2(R m -R f )]+ 0.5[R f +0.8(R m -R f )]+ 0.1[R f +1.8(R m -R f )] = R f +1.06(R m -R f )] DIF: H REF: 7.2 Risk and Return for Portfolios 22. A portfolio consists 20% of a risk-free asset and 80% of a stock. The risk-free return is 4%. The stock has an expected return of 15% and a standard deviation of 30%. What s the expected return a. 12.8%

7 b. 9.5% c. 15.0% d. 4.0% Portfolio expected return = 20%(4%) + 80%(15%) = 12.8% REF: 7.2 Risk and Return for Portfolios 23. The stock of Alpha Company has an expected return of 0.10 and a standard deviation of The stock of Gamma Company has an expected return of 0.16 and a standard deviation of The correlation coefficient between the two stock s return is 0.2. If a portfolio consists of 40% of Alpha Company and 60% of Gamma Company, what s the expected return of the portfolio? a b c d Portfolio expected return =.4(0.10) +.6(0.16) = REF: 7.2 Risk and Return for Portfolios 24. Asset 1 has a beta of 1.2 and Asset 2 has a beta of 0.6. Which of the following statements is correct? a. Asset 1 is more volatile than Asset 2. b. Asset 1 has a higher expected return than Asset 2. c. In a regression with individual asset s return as the dependent variable and the market s return as the independent variable, the R-squared value is higher for Asset 1 than it is for Asset 2. d. All of the above statements are correct. 25. An investor put 40% of her money in Stock A and 60% in Stock B. Stock A has a beta of 1.2 and Stock B has a beta of 1.6. If the risk-free rate is 5% and the expected return on the market is 12%, what s the investor s expected return? a % b % c % d % ANS: C Expected return (stock A) = 5% + 1.2(12%-5%) = 13.4% Expected return (stock B) = 5% + 1.6(12%-5%) = 16.2% Portfolio expected return =.4(13.4%) +.6(16.2%) = 15.08% REF: 7.2 Risk and Return for Portfolios 26. You have the following data on the securities of three firms: Return last year Beta Firm A 10% 0.8 Firm B 11% 1.0 Firm C 12% 1.2

8 If the risk-free rate last year was 3%, and the return on the market was 11%, which firm had the best performance on a risk-adjusted basis? a. Firm A b. Firm B c. Firm C d. There is no difference in performance on a risk-adjusted basis Expected return (firm A) = 3% + 0.8(8%) = 9.4% < actual firm A return Expected return (firm B) = 3% + 1.0(8%) = 11% = actual firm B return Expected return (firm C) = 3% + 1.2(8%) = 12.6% > actual firm C return Only firm A beats the market on a risk-adjusted basis. 27. Expected returns are: a. always positive. b. always greater than the risk-free rate. c. inherently unobservable. d. usually equal to actual returns. ANS: C DIF: E REF: 7.1 Expected Returns 28. Which of the following is not a method used by analysts to estimate an asset s expected return? a. historical approach b. probabilistic approach c. risk-based approach d. estimation approach ANS: D DIF: E REF: 7.1 Expected Returns 29. A drawback to the historical approach of estimating an asset s expected return is: a. the risk of the firm may have changed over time. b. history always repeats itself. c. that the range of potential outcomes is often very broad. d. all of the above are drawbacks to the historical approach. DIF: E REF: 7.1 Expected Returns 30. An advantage of the probabilistic approach to estimating an asset s returns is: a. history always repeats itself. b. it does not require one to assume that the future will look like the past. c. recent history is more important than future risk. d. exact probabilities are easy to estimate. DIF: E REF: 7.1 Expected Returns 31. A disadvantage of the probabilistic approach to estimating an asset s returns is: a. history always repeats itself. b. it does not require one to assume that the future will look like the past. c. recent history is more important than future risk. d. that the range of possible outcomes is often broader than the scenarios used. ANS: D REF: 7.1 Expected Returns

9 32. Suppose that over the last 20 years, company XYZ has averaged a return of 13%. Over the same period, the Treasury bond rate has averaged 4%. The current estimate of the Treasury bond rate is 6.5%. Using the historical approach, what is the estimate of XYZ s expected return. a. 13.0% b. 16.5% c. 15.5% d. 19.5% ANS: C Historical Risk Premium = 13% - 4% = 9% Expected Return = 9% + 6.5% = 15.5% DIF: E REF: 7.1 Expected Returns 33. Suppose that over the last 30 years, company ABC has averaged a return of 10%. Over the same period, the Treasury bond rate has averaged 3%. The current estimate of the Treasury bond rate is 5%. Using the historical approach, what is the estimate of ABC s expected return. a. 13.0% b. 12.5% c. 12.0% d. 11.0% ANS: C Historical Risk Premium = 10% - 3% = 7% Expected Return = 7% + 5% = 12% DIF: E REF: 7.1 Expected Returns 34. Suppose that over the last 25 years, company DEF has averaged a return of 7.5%. Over the same period, the Treasury bond rate has averaged 1.5%. The current estimate of the Treasury bond rate is 4%. Using the historical approach, what is the estimate of DEF s expected return. a. 13.0% b. 12.5% c. 12.0% d. 10.0% ANS: D Historical Risk Premium = 7.5% - 1.5% = 6% Expected Return = 6% + 4% = 10% DIF: E REF: 7.1 Expected Returns NARRBEGIN: Exhibit 7-1 Exhibit 7-1 Outcome Probability Return Recession 25% -30% Expansion 40% 15% Boom 35% 55% NARREND 35. Given Exhibit 7-1, what is the expected return? a % b %

10 c % d % ANS: D 0.25* * *0.55 = DIF: E REF: 7.1 Expected Returns NAR: Exhibit Given Exhibit 7-1, what is the expected variance? a % b % c % d % Outcome Probability Return Return - E(r) (Return - (E(r))2 Recession 25% -30% % % Expansion 40% 15% -2.75% 7.56% Boom 35% 55% 37.25% % 100% Variance % REF: 7.1 Expected Returns NAR: Exhibit Given Exhibit 7-1, what is the expected standard deviation? a % b % c % d % ANS: D Outcome Probability Return Return - E(r) (Return - (E(r))2 Recession 25% -30% % % Expansion 40% 15% -2.75% 7.56% Boom 35% 55% 37.25% % 100% Variance % Std Dev 32.54% REF: 7.1 Expected Returns NAR: Exhibit 7-1 NARRBEGIN: Exhibit 7-2 Exhibit 7-2 Outcome Probability Return Recession 40% -25% Expansion 25% 20% Boom 35% 45% NARREND 38. Given Exhibit 7-2, what is the expected return? a % b %

11 c % d % 0.4* * *0.45 = DIF: E REF: 7.1 Expected Returns NAR: Exhibit Given Exhibit 7-2, what is the expected variance? a % b % c % d % Outcome Probability Return Return - E(r) (Return - (E(r))2 Recession 40% -25% % % Expansion 25% 20% 9.25% 85.56% Boom 35% 45% 34.25% % 100% Variance % REF: 7.1 Expected Returns NAR: Exhibit Given Exhibit 7-2, what is the expected standard deviation? a % b % c % d % ANS: C Outcome Probability Return Return - E(r) (Return - (E(r))2 Recession 40% -25% % % Expansion 25% 20% 9.25% 85.56% Boom 35% 45% 34.25% % 100% Variance % Std Dev 30.71% REF: 7.1 Expected Returns NAR: Exhibit The first step in the risk-based approach to estimating a security s expected return is to: a. define what is meant by risk and to measure it. b. quantify how much return we should expect on an asset with a given amount of risk. c. estimate the risk-free rate. d. define what is meant by return. DIF: E REF: 7.1 Expected Returns 42. Standard deviation measures: a. systematic risk. b. unsystematic risk. c. total risk. d. beta risk. ANS: C DIF: E REF: 7.1 Expected Returns

12 43. Investors can eliminate what type of risk by diversifying? a. systematic risk b. unsystematic risk c. beta risk d. total risk DIF: E REF: 7.1 Expected Returns 44. Which type of risk affects many different securities? a. return risk b. variance risk c. unsystematic risk d. systematic risk ANS: D DIF: E REF: 7.1 Expected Returns 45. Which type of risk affects just a few securities at a time? a. return risk b. variance risk c. unsystematic risk d. systematic risk ANS: C DIF: E REF: 7.1 Expected Returns 46. A standardized measure of risk is: a. alpha b. beta c. gamma d. omega DIF: E REF: 7.1 Expected Returns 47. Which type of firm would most likely have the greatest systematic risk? a. A grocery store chain b. A electric company c. A telephone company d. A vibrating chair manufacturer ANS: D REF: 7.1 Expected Returns 48. The beta of the risk-free asset is: a b. 0.0 c. 0.5 d. 1.0 DIF: E REF: 7.1 Expected Returns NARRBEGIN: Exhibit 7-3 Exhibit 7-3 Security Weight Expected Return 1 30% 10% 2 15% 3 10% 21%

13 NARREND 49. Given Exhibit 7-3, what is the weight of Security 2? a. 20% b. 40% c. 60% d. 80% ANS: C = 60 DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit Given Exhibit 7-3, what is the expected return on the portfolio? a. 14.1% b. 15.0% c. 16.3% d. 17.9% 0.3* * *0.21 = DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-3 NARRBEGIN: Exhibit 7-4 Exhibit 7-4 NARREND Security Weight Expected Return 1 7% 2 35% 9% 3 40% 51. Given Exhibit 7-4, what is the weight of Security 1? a. 25% b. 35% c. 45% d. 55% = 25 DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit Given Exhibit 7-4, if the expected return on the portfolio is 9.7%, what is the expected return for Security 3? a. 10% b. 11% c. 12% d. 13% ANS: C 0.25* * *X = 0.097

14 X =.12 REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-4 NARRBEGIN: Exhibit 7-5 Exhibit 7-5 NARREND Security \$ Invested Expected Return 1 \$5,000 7% 2 \$7,000 9% 3 \$9,000 12% 53. Given Exhibit 7-5, what is the weight of Security 1? a. 42.9% b. 33.3% c. 23.8% d. Cannot be determined with the data given ANS: C \$5,000/\$21,000 =.238 DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit Given Exhibit 7-5, what is the weight of Security 2? a. 42.9% b. 33.3% c. 23.8% d. Cannot be determined with the data given \$7,000/\$21,000 =.333 DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit Given Exhibit 7-5, what is the weight of Security 3? a. 42.9% b. 33.3% c. 23.8% d. Cannot be determined with the data given \$9,000/\$21,000 =.429 DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit Given Exhibit 7-5, what is the expected return on the portfolio? a. 9.81% b. 9.00% c % d. Cannot be determined with the data given

15 5000/21000* /21000* /21000*0.12 = DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit If you believed a stock was going to fall in price, a strategy to profit from the stock decline is known as: a. buying long. b. buying short. c. selling long. d. selling short. ANS: D DIF: E REF: 7.2 Risk and Return for Portfolios NARRBEGIN: Exhibit 7-6 Exhibit 7-6 NARREND Security \$ Invested Beta 1 \$9, \$5, \$8, Given Exhibit 7-6, what is the portfolio beta? a b c d /22000* /22000* /22000*1.2 = DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-6 NARRBEGIN: Exhibit 7-7 Exhibit 7-7 NARREND Security \$ Invested Beta 1 \$3, \$7, \$2, Given Exhibit 7-7, what is the portfolio beta? a b c d /12000* /12000* /12000*0.9 = DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-7

16 60. The country with the highest level of systematic risk is: a. Russia b. Poland c. Taiwan d. USA DIF: H REF: 7.2 Risk and Return for Portfolios 61. The difference between the return on the market portfolio and the risk-free rate is known as the: a. total return. b. systematic premium. c. unsystematic return. d. market risk premium. ANS: D DIF: E 62. An investor has \$10,000 invested in Treasury securities and \$15,000 invested in stock UVW. UVW has a beta of 1.2. What is the beta of the portfolio? a b c d (\$10,000/\$25,000 * 0) = (\$15,000/\$25,000 * 1.2) = The slope of the security market line is: a. E(R m ) - R f b. 1/(E(R m ) - R f ) c. R f - E(R m ) d. R f 64. The intercept of the security market line is: a. E(R m ) - R f b. 1/(E(R m ) - R f ) c. R f - E(R m ) d. R f ANS: D 65. The slope of the security market line is: a. the return on the market. b. beta. c. the market risk premium. d. the risk-free rate. ANS: C 66. The formula for the Capital Asset Pricing Model is: a. E(R i ) = R f + i(e(r m ) - R f ) b. E(R i ) = R f + ie(r m )

17 c. E(R i ) = i (E(R m ) - R f ) d. E(R i ) + R f = i(e(r m ) - R f ) DIF: E 67. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected return on the market is 11%. What is the expected return for Security I? a. 15.0% b. 18.3% c. 14.6% d. 13.1% ANS: D 4% + (11% - 4%)1.3 = 13.1% DIF: E 68. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected market risk premium is 11%. What is the expected return for Security I? a. 15.0% b. 18.3% c. 14.6% d. 13.1% 4% + (11%)1.3 = 18.3% DIF: E 69. The idea that asset prices fully reflect all available information is known as the: a. fair price hypothesis. b. efficient market hypothesis. c. full information hypothesis. d. full price hypothesis. DIF: E REF: 7.4 Are Stock Returns Predictable? 70. The hypothesis that states that it is nearly impossible to predict exactly when stocks will do well relative to bonds is known as the: a. fair price hypothesis. b. efficient market hypothesis. c. full information hypothesis. d. full price hypothesis. DIF: E REF: 7.4 Are Stock Returns Predictable? 71. A mutual fund that adopts a passive management style is called: a. an index fund. b. a research fund. c. an active fund. d. a technology fund. DIF: E REF: 7.4 Are Stock Returns Predictable? 72. What type of mutual fund managers do extensive analysis to identify mispriced stocks? a. passive

18 b. index c. active d. short ANS: C DIF: E REF: 7.4 Are Stock Returns Predictable? 73. A buy-and-hold strategy: a. typically earns higher returns, after expenses, than an active stock picking strategy. b. always earns the lowest returns. c. always have the lowest risk. d. typically outperforms most market indexes. DIF: E REF: 7.4 Are Stock Returns Predictable? 74. Active managers: a. generate lower expenses for their shareholders than passive managers. b. trade more frequently than passive managers c. always use trading rules to decide when to buy and sell stocks. d. all of the above. REF: 7.4 Are Stock Returns Predictable? 75. Modern financial markets are: a. competitive. b. transparent. c. efficient. d. all of the above. ANS: D REF: 7.4 Are Stock Returns Predictable?

Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note

Review for Exam Instructions: Please read carefully The exam will have 1 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions.

### CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM)

CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concepts Review and Critical Thinking Questions 1. Some of the risk in holding any asset is unique to the asset in question.

### Practice Questions for Midterm II

Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. -1. d. 0.5. By definition, the beta of the market portfolio is

### Portfolio Performance Measures

Portfolio Performance Measures Objective: Evaluation of active portfolio management. A performance measure is useful, for example, in ranking the performance of mutual funds. Active portfolio managers

### Chapter 6 The Tradeoff Between Risk and Return

Chapter 6 The Tradeoff Between Risk and Return MULTIPLE CHOICE 1. Which of the following is an example of systematic risk? a. IBM posts lower than expected earnings. b. Intel announces record earnings.

### SAMPLE MID-TERM QUESTIONS

SAMPLE MID-TERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID- TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,

### Solution: The optimal position for an investor with a coefficient of risk aversion A = 5 in the risky asset is y*:

Problem 1. Consider a risky asset. Suppose the expected rate of return on the risky asset is 15%, the standard deviation of the asset return is 22%, and the risk-free rate is 6%. What is your optimal position

### AFM 472. Midterm Examination. Monday Oct. 24, 2011. A. Huang

AFM 472 Midterm Examination Monday Oct. 24, 2011 A. Huang Name: Answer Key Student Number: Section (circle one): 10:00am 1:00pm 2:30pm Instructions: 1. Answer all questions in the space provided. If space

### FIN 432 Investment Analysis and Management Review Notes for Midterm Exam

FIN 432 Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation,

### Chapter 11, Risk and Return

Chapter 11, Risk and Return 1. A portfolio is. A) a group of assets, such as stocks and bonds, held as a collective unit by an investor B) the expected return on a risky asset C) the expected return on

### CHAPTER 11: ARBITRAGE PRICING THEORY

CHAPTER 11: ARBITRAGE PRICING THEORY 1. The revised estimate of the expected rate of return on the stock would be the old estimate plus the sum of the products of the unexpected change in each factor times

### FIN 3710. Final (Practice) Exam 05/23/06

FIN 3710 Investment Analysis Spring 2006 Zicklin School of Business Baruch College Professor Rui Yao FIN 3710 Final (Practice) Exam 05/23/06 NAME: (Please print your name here) PLEDGE: (Sign your name

### Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15

Test3 1. The market value of Charcoal Corporation's common stock is \$20 million, and the market value of its riskfree debt is \$5 million. The beta of the company's common stock is 1.25, and the market

### The Tangent or Efficient Portfolio

The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of reward-to-volatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r

### t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

### Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 5-1 a. Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding only one asset. Risk is

### Answers to Concepts in Review

Answers to Concepts in Review 1. A portfolio is simply a collection of investments assembled to meet a common investment goal. An efficient portfolio is a portfolio offering the highest expected return

### CHAPTER 9: THE CAPITAL ASSET PRICING MODEL

CHAPTER 9: THE CAPITAL ASSET PRICING MODEL PROBLEM SETS 1. E(r P ) = r f + β P [E(r M ) r f ] 18 = 6 + β P(14 6) β P = 12/8 = 1.5 2. If the security s correlation coefficient with the market portfolio

### Practice Set #4 and Solutions.

FIN-469 Investments Analysis Professor Michel A. Robe Practice Set #4 and Solutions. What to do with this practice set? To help students prepare for the assignment and the exams, practice sets with solutions

### 15.433 Investments. Assignment 1: Securities, Markets & Capital Market Theory. Each question is worth 0.2 points, the max points is 3 points

Assignment 1: Securities, Markets & Capital Market Theory Each question is worth 0.2 points, the max points is 3 points 1. The interest rate charged by banks with excess reserves at a Federal Reserve Bank

### Lecture 6: Arbitrage Pricing Theory

Lecture 6: Arbitrage Pricing Theory Investments FIN460-Papanikolaou APT 1/ 48 Overview 1. Introduction 2. Multi-Factor Models 3. The Arbitrage Pricing Theory FIN460-Papanikolaou APT 2/ 48 Introduction

### Lecture 15: Final Topics on CAPM

Lecture 15: Final Topics on CAPM Final topics on estimating and using beta: the market risk premium putting it all together Final topics on CAPM: Examples of firm and market risk Shorting Stocks and other

### 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises.

1. Solutions to PS 1: 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises. 7. The bill has a maturity of one-half year, and an annualized

### Chapter 5. Conditional CAPM. 5.1 Conditional CAPM: Theory. 5.1.1 Risk According to the CAPM. The CAPM is not a perfect model of expected returns.

Chapter 5 Conditional CAPM 5.1 Conditional CAPM: Theory 5.1.1 Risk According to the CAPM The CAPM is not a perfect model of expected returns. In the 40+ years of its history, many systematic deviations

### CFA Examination PORTFOLIO MANAGEMENT Page 1 of 6

PORTFOLIO MANAGEMENT A. INTRODUCTION RETURN AS A RANDOM VARIABLE E(R) = the return around which the probability distribution is centered: the expected value or mean of the probability distribution of possible

### M.I.T. Spring 1999 Sloan School of Management 15.415. First Half Summary

M.I.T. Spring 1999 Sloan School of Management 15.415 First Half Summary Present Values Basic Idea: We should discount future cash flows. The appropriate discount rate is the opportunity cost of capital.

### Chapter 13 Composition of the Market Portfolio 1. Capital markets in Flatland exhibit trade in four securities, the stocks X, Y and Z,

Chapter 13 Composition of the arket Portfolio 1. Capital markets in Flatland exhibit trade in four securities, the stocks X, Y and Z, and a riskless government security. Evaluated at current prices in

### FCS5510 Sample Homework Problems and Answer Key Unit03 CHAPTER 6. INVESTMENT COMPANIES: MUTUAL FUNDS

FCS5510 Sample Homework Problems and Answer Key Unit03 CHAPTER 6. INVESTMENT COMPANIES: MUTUAL FUNDS PROBLEMS 1. What is the net asset value of an investment company with \$10,000,000 in assets, \$500,000

### Capital Allocation Between The Risky And The Risk- Free Asset. Chapter 7

Capital Allocation Between The Risky And The Risk- Free Asset Chapter 7 Investment Decisions capital allocation decision = choice of proportion to be invested in risk-free versus risky assets asset allocation

### CHAPTER 7: OPTIMAL RISKY PORTFOLIOS

CHAPTER 7: OPTIMAL RIKY PORTFOLIO PROLEM ET 1. (a) and (e).. (a) and (c). After real estate is added to the portfolio, there are four asset classes in the portfolio: stocks, bonds, cash and real estate.

Chapter 5 Risk and Return Learning Goals 1. Understand the meaning and fundamentals of risk, return, and risk aversion. 2. Describe procedures for assessing and measuring the risk of a single asset. 3.

### 1. CFI Holdings is a conglomerate listed on the Zimbabwe Stock Exchange (ZSE) and has three operating divisions as follows:

NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY FACULTY OF COMMERCE DEPARTMENT OF FINANCE BACHELOR OF COMMERCE HONOURS DEGREE IN FINANCE PART II 2 ND SEMESTER FINAL EXAMINATION MAY 2005 CORPORATE FINANCE

### Chapter 5. Risk and Return. Learning Goals. Learning Goals (cont.)

Chapter 5 Risk and Return Learning Goals 1. Understand the meaning and fundamentals of risk, return, and risk aversion. 2. Describe procedures for assessing and measuring the risk of a single asset. 3.

### Makeup Exam MØA 155 Financial Economics February 2010 Permitted Material: Calculator, Norwegian/English Dictionary

University of Stavanger (UiS) Stavanger Masters Program Makeup Exam MØA 155 Financial Economics February 2010 Permitted Material: Calculator, Norwegian/English Dictionary The number in brackets is the

### Paper 2. Derivatives Investment Consultant Examination. Thailand Securities Institute November 2014

Derivatives Investment Consultant Examination Paper 2 Thailand Securities Institute November 2014 Copyright 2014, All right reserve Thailand Securities Institute (TSI) The Stock Exchange of Thailand Page

### Econ 422 Summer 2006 Final Exam Solutions

Econ 422 Summer 2006 Final Exam Solutions This is a closed book exam. However, you are allowed one page of notes (double-sided). Answer all questions. For the numerical problems, if you make a computational

### Journal of Exclusive Management Science May 2015 -Vol 4 Issue 5 - ISSN 2277 5684

Journal of Exclusive Management Science May 2015 Vol 4 Issue 5 ISSN 2277 5684 A Study on the Emprical Testing Of Capital Asset Pricing Model on Selected Energy Sector Companies Listed In NSE Abstract *S.A.

### 15.401 Finance Theory

Finance Theory MIT Sloan MBA Program Andrew W. Lo Harris & Harris Group Professor, MIT Sloan School Lecture 13 14 14: : Risk Analytics and Critical Concepts Motivation Measuring Risk and Reward Mean-Variance

### Chapter 11. Topics Covered. Chapter 11 Objectives. Risk, Return, and Capital Budgeting

Chapter 11 Risk, Return, and Capital Budgeting Topics Covered Measuring Market Risk Portfolio Betas Risk and Return CAPM and Expected Return Security Market Line CAPM and Stock Valuation Chapter 11 Objectives

### Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator

University of Stavanger (UiS) Stavanger Masters Program Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator The number in brackets is the weight for each problem. The weights

### Additional Practice Questions for Midterm I

1 Finance 333 Investments Additional Practice Questions for Midterm I Winter 2004 Professor Yan 1. Financial assets. A) directly contribute to the country's productive capacity *B) indirectly contribute

### 3. You have been given this probability distribution for the holding period return for XYZ stock:

Fin 85 Sample Final Solution Name: Date: Part I ultiple Choice 1. Which of the following is true of the Dow Jones Industrial Average? A) It is a value-weighted average of 30 large industrial stocks. )

### Mid-Term Spring 2003

Mid-Term Spring 2003 1. (1 point) You want to purchase XYZ stock at \$60 from your broker using as little of your own money as possible. If initial margin is 50% and you have \$3000 to invest, how many shares

### Chapter 10 Capital Markets and the Pricing of Risk

Chapter 10 Capital Markets and the Pricing of Risk 10-1. The figure below shows the one-year return distribution for RCS stock. Calculate a. The expected return. b. The standard deviation of the return.

### 1. Portfolio Returns and Portfolio Risk

Chapter 8 Risk and Return: Capital Market Theory Chapter 8 Contents Learning Objectives 1. Portfolio Returns and Portfolio Risk 1. Calculate the expected rate of return and volatility for a portfolio of

### The number of mutual funds has grown dramatically in recent

Risk-Adjusted Performance of Mutual Funds Katerina Simons Economist, Federal Reserve Bank of Boston. The author is grateful to Richard Kopcke and Peter Fortune for helpful comments and to Jay Seideman

### CHAPTER 6: RISK AVERSION AND CAPITAL ALLOCATION TO RISKY ASSETS

CHAPTER 6: RISK AVERSION AND CAPITAL ALLOCATION TO RISKY ASSETS PROBLEM SETS 1. (e). (b) A higher borrowing is a consequence of the risk of the borrowers default. In perfect markets with no additional

### Chapter 1 The Investment Setting

Chapter 1 he Investment Setting rue/false Questions F 1. In an efficient and informed capital market environment, those investments with the greatest return tend to have the greatest risk. Answer: rue

### Instructor s Manual Chapter 12 Page 144

Chapter 12 1. Suppose that your 58-year-old father works for the Ruffy Stuffed Toy Company and has contributed regularly to his company-matched savings plan for the past 15 years. Ruffy contributes \$0.50

### Actual Returns. Large Long-Term Company Government Treasury Year Stocks Bonds Bills

408 PART FIVE Risk and Return 1. Risky assets, on average, earn a risk premium. There is a reward for bearing risk. 2. The greater the potential reward from a risky investment, the greater is the risk.

### Chapter 8 Risk and Return

Chapter 8 Risk and Return LEARNING OBJECTIVES (Slides 8-2 & 8-3) 1. Calculate profits and returns on an investment and convert holding period returns to annual returns. 2. Define risk and explain how uncertainty

### Bonds, Preferred Stock, and Common Stock

Bonds, Preferred Stock, and Common Stock I. Bonds 1. An investor has a required rate of return of 4% on a 1-year discount bond with a \$100 face value. What is the most the investor would pay for 2. An

### Chapter 6 - Practice Questions

Chapter 6 - Practice Questions 1. If a T-bill pays 5 percent, which of the following investments would not be chosen by a risk-averse investor? A) An asset that pays 10 percent with a probability of 0.60

### MBA 8230 Corporation Finance (Part II) Practice Final Exam #2

MBA 8230 Corporation Finance (Part II) Practice Final Exam #2 1. Which of the following input factors, if increased, would result in a decrease in the value of a call option? a. the volatility of the company's

### A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study

A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study But I will offer a review, with a focus on issues which arise in finance 1 TYPES OF FINANCIAL

### www.optionseducation.org OIC Options on ETFs

www.optionseducation.org Options on ETFs 1 The Options Industry Council For the sake of simplicity, the examples that follow do not take into consideration commissions and other transaction fees, tax considerations,

### The problems of being passive

The problems of being passive Evaluating the merits of an index investment strategy In the investment management industry, indexing has received little attention from investors compared with active management.

### The Capital Asset Pricing Model (CAPM)

Prof. Alex Shapiro Lecture Notes 9 The Capital Asset Pricing Model (CAPM) I. Readings and Suggested Practice Problems II. III. IV. Introduction: from Assumptions to Implications The Market Portfolio Assumptions

### Holding Period Return. Return, Risk, and Risk Aversion. Percentage Return or Dollar Return? An Example. Percentage Return or Dollar Return? 10% or 10?

Return, Risk, and Risk Aversion Holding Period Return Ending Price - Beginning Price + Intermediate Income Return = Beginning Price R P t+ t+ = Pt + Dt P t An Example You bought IBM stock at \$40 last month.

### Futures Price d,f \$ 0.65 = (1.05) (1.04)

24 e. Currency Futures In a currency futures contract, you enter into a contract to buy a foreign currency at a price fixed today. To see how spot and futures currency prices are related, note that holding

### Institutional Finance 08: Dynamic Arbitrage to Replicate Non-linear Payoffs. Binomial Option Pricing: Basics (Chapter 10 of McDonald)

Copyright 2003 Pearson Education, Inc. Slide 08-1 Institutional Finance 08: Dynamic Arbitrage to Replicate Non-linear Payoffs Binomial Option Pricing: Basics (Chapter 10 of McDonald) Originally prepared

### The CAPM (Capital Asset Pricing Model) NPV Dependent on Discount Rate Schedule

The CAPM (Capital Asset Pricing Model) Massachusetts Institute of Technology CAPM Slide 1 of NPV Dependent on Discount Rate Schedule Discussed NPV and time value of money Choice of discount rate influences

### CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS

CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS PROBLEM SETS 1. The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period

### CHAPTER 10. Capital Markets and the Pricing of Risk. Chapter Synopsis

CHAPE 0 Capital Markets and the Pricing of isk Chapter Synopsis 0. A First Look at isk and eturn Historically there has been a large difference in the returns and variability from investing in different

### Lecture 1: Asset Allocation

Lecture 1: Asset Allocation Investments FIN460-Papanikolaou Asset Allocation I 1/ 62 Overview 1. Introduction 2. Investor s Risk Tolerance 3. Allocating Capital Between a Risky and riskless asset 4. Allocating

### CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS

CHAPTER 11: THE EFFICIENT MARKET HYPOTHESIS PROBLEM SETS 1. The correlation coefficient between stock returns for two non-overlapping periods should be zero. If not, one could use returns from one period

### WEB APPENDIX. Calculating Beta Coefficients. b Beta Rise Run Y 7.1 1 8.92 X 10.0 0.0 16.0 10.0 1.6

WEB APPENDIX 8A Calculating Beta Coefficients The CAPM is an ex ante model, which means that all of the variables represent before-thefact, expected values. In particular, the beta coefficient used in

### ANALYSIS AND MANAGEMENT

ANALYSIS AND MANAGEMENT T H 1RD CANADIAN EDITION W. SEAN CLEARY Queen's University CHARLES P. JONES North Carolina State University JOHN WILEY & SONS CANADA, LTD. CONTENTS PART ONE Background CHAPTER 1

### Market Efficiency and Behavioral Finance. Chapter 12

Market Efficiency and Behavioral Finance Chapter 12 Market Efficiency if stock prices reflect firm performance, should we be able to predict them? if prices were to be predictable, that would create the

### Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 39)

Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required

### Corporate Finance Sample Exam 2A Dr. A. Frank Thompson

Corporate Finance Sample Exam 2A Dr. A. Frank Thompson True/False Indicate whether the statement is true or false. 1. The market value of any real or financial asset, including stocks, bonds, CDs, coins,

### Basic Financial Tools: A Review. 3 n 1 n. PV FV 1 FV 2 FV 3 FV n 1 FV n 1 (1 i)

Chapter 28 Basic Financial Tools: A Review The building blocks of finance include the time value of money, risk and its relationship with rates of return, and stock and bond valuation models. These topics

### The Case For Passive Investing!

The Case For Passive Investing! Aswath Damodaran Aswath Damodaran! 1! The Mechanics of Indexing! Fully indexed fund: An index fund attempts to replicate a market index. It is relatively simple to create,

### Chapter 20 Understanding Options

Chapter 20 Understanding Options Multiple Choice Questions 1. Firms regularly use the following to reduce risk: (I) Currency options (II) Interest-rate options (III) Commodity options D) I, II, and III

### Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)

Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

### CHAPTER 22 Options and Corporate Finance

CHAPTER 22 Options and Corporate Finance Multiple Choice Questions: I. DEFINITIONS OPTIONS a 1. A financial contract that gives its owner the right, but not the obligation, to buy or sell a specified asset

### RISKS IN MUTUAL FUND INVESTMENTS

RISKS IN MUTUAL FUND INVESTMENTS Classification of Investors Investors can be classified based on their Risk Tolerance Levels : Low Risk Tolerance Moderate Risk Tolerance High Risk Tolerance Fund Classification

### The cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction

The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal

### Chapter 14 Capital Structure in a Perfect Market

Chapter 14 Capital Structure in a Perfect Market 14-1. Consider a project with free cash flows in one year of \$130,000 or \$180,000, with each outcome being equally likely. The initial investment required

### CHAPTER 21: OPTION VALUATION

CHAPTER 21: OPTION VALUATION 1. Put values also must increase as the volatility of the underlying stock increases. We see this from the parity relation as follows: P = C + PV(X) S 0 + PV(Dividends). Given

### Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development

Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development Equity, Portfolio Management, Real Estate Practice Exam 2 and Solutions

### Rethinking Fixed Income

Rethinking Fixed Income Challenging Conventional Wisdom May 2013 Risk. Reinsurance. Human Resources. Rethinking Fixed Income: Challenging Conventional Wisdom With US Treasury interest rates at, or near,

### GESTÃO FINANCEIRA II PROBLEM SET 3 - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE

GESTÃO FINANCEIRA II PROBLEM SET 3 - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 010-011 Chapter 10 Capital Markets and the Pricing of Risk 10-1.

### Chapter 9 Interest Rates

Chapter 9 Interest Rates Concept Questions 1. Short-term rates have ranged between zero and 14 percent. Long-term rates have fluctuated between about two and 13 percent. Long-term rates, which are less

### Finance 3130 Corporate Finiance Sample Final Exam Spring 2012

Finance 3130 Corporate Finiance Sample Final Exam Spring 2012 True/False Indicate whether the statement is true or falsewith A for true and B for false. 1. Interest paid by a corporation is a tax deduction

### FTS Real Time System Project: Portfolio Diversification Note: this project requires use of Excel s Solver

FTS Real Time System Project: Portfolio Diversification Note: this project requires use of Excel s Solver Question: How do you create a diversified stock portfolio? Advice given by most financial advisors

### NorthCoast Investment Advisory Team 203.532.7000 info@northcoastam.com

NorthCoast Investment Advisory Team 203.532.7000 info@northcoastam.com NORTHCOAST ASSET MANAGEMENT An established leader in the field of tactical investment management, specializing in quantitative research

### Concentrated Stock Diversification Analysis

Concentrated Stock Diversification Analysis Example analysis Three Harbor Drive, Suite 315 Sausalito, CA 94965 (415) 339-4300 www.aperiogroup.com Copyright 2013 Aperio Group LLC Aperio v. [Latin] to make

### BUSINESS FINANCE (FIN 312) Spring 2008

BUSINESS FINANCE (FIN 312) Spring 2008 Assignment 3 Instructions: please read carefully You can either do the assignment by yourself or work in a group of no more than two. You should show your work how

### TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II + III

TPPE17 Corporate Finance 1(5) SOLUTIONS RE-EXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder

### Key Concepts and Skills

Chapter 10 Some Lessons from Capital Market History Key Concepts and Skills Know how to calculate the return on an investment Understand the historical returns on various types of investments Understand

### BUSM 411: Derivatives and Fixed Income

BUSM 411: Derivatives and Fixed Income 2. Forwards, Options, and Hedging This lecture covers the basic derivatives contracts: forwards (and futures), and call and put options. These basic contracts are

### Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4)

Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4) Julian Vu 2-3: Given: Security A Security B r = 7% r = 12% σ (standard deviation) = 35% σ (standard deviation)

Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation

### INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK

INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK Bank of Tokyo-Mitsubishi Professor of Economics and Finance Sloan School of Management Massachusetts Institute

Madison Investment Advisors LLC Intermediate Fixed Income SELECT ROSTER Firm Information: Location: Year Founded: Total Employees: Assets (\$mil): Accounts: Key Personnel: Matt Hayner, CFA Vice President

### 1 Proactive risk management is sometimes described as fire fighting.

1 Proactive risk management is sometimes described as fire fighting. 2 Software risk always involves two characteristics A) fire fighting and crisis management B) known and unknown risks C) uncertainty