Additional Practice Questions for Midterm I

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1 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 to the country's productive capacity C) contribute to the country's productive capacity both directly and indirectly D) do not contribute to the country's productive capacity either directly or indirectly E) are of no value to anyone 2. T-bills are financial instruments initially sold by to raise funds. A) commercial banks *B) the U. S. government C) state and local governments D) agencies of the federal government E) b and d 4. The price quotations of Treasury bonds in the Wall Street Journal show an ask price of 104:08 and a bid price of 104:04. As a buyer of the bond what is the dollar price you expect to pay? A) $10, *B) $10, C) $10, D) $10, E) $10, A 20-year municipal bond is currently priced to yield 7.2%. For a taxpayer in the 33% marginal tax bracket, this bond would offer an equivalent taxable yield of: A) 8.20%. *B) 10.75%. C) 11.40%. D) 4.82%. E) none of the above. 6. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin. A) 0.33 B) 0.55 C) 0.43 D) 0.23

2 2 *E) An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding period return on his investment? A) 1.52% B) 0.50% *C) 1.02% D) 0.01% E) 0.01% 12. Given the capital allocation line, an investor's optimal portfolio is the portfolio that A) maximizes her expected profit. B) maximizes her risk. C) minimizes both her risk and return. *D) maximizes her expected utility. E) none of the above. 13. are financial assets. a. Bonds b. Machines c. Stocks *d. a and c e. a and b Machines are real assets; stocks and bonds are financial assets. Consider the following three stocks: Price Number of shares outstanding Stock A $ Stock B $ Stock C $ The price-weighted index constructed with the three stocks is a. 30 *b. 40 c. 50 d. 60 e. 70 ($40 + $70 + $10)/3 = $ The asked discount yield on a T-bill is 5 percent. What is the asked price of the bill if it matures in 60 days and has a face value of $10,000? a. $9,500. *b. $9,

3 3 c. $9, d. none of the above. e. cannot be determined. $10,000 ( x 60/360) = $9, A T-bill has a face value of $10,000 and is selling for $9,800. If the T-bill matures in 90 days, what is its effective annual yield? a. 8.16%. b. 2.04%. *c. 8.53%. d. 6.12%. e. 8.42% ($10,000 - $9,800) ) $9,800 = ; ( ) 365/90-1 = 8.53%. 17. An investor purchases one municipal and one corporate bond that pay rates of return of 8% and 10%, respectively. If the investor is in the 20% marginal tax bracket, his or her after tax rates of return on the municipal and corporate bonds would be and, respectively. a. 8% and 10% *b. 8% and 8% c. 6.4% and 8% d. 6.4% and 10% e. 10% and 10% r c = 0.10(1-0.20) = 0.08, or 8% r m = 0.08(1-0) = 8%. 18. You purchased XYZ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a. a. stop-loss order b. limit-buy order c. market order *d. limit-sell order. With a limit-sell order, your stock will be sold only at a specified price, or better. Thus, such an order would protect your gains. None of the other orders are applicable to this situation. 19. You sold ABC stock short at $80 per share. Your losses could be minimized by placing a a. limit-sell order b. limit-buy order *c. stop-loss order d. day-order

4 4. With a stop-loss order, the stock would be purchased if the price increased to a specified level, thus limiting your loss. None of the other orders are applicable to this situation. 20. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was a. $4,800. b. $12,000. c. $5,600. *d. $7, shares X $60/share = $12,000 X 0.6 = $7, You purchased 100 shares of ABC common stock on margin at $70 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore interest on margin. a. $21 *b. $50 c. $49 d. $ shares X $70 = $7,000 X 0.5 = $3,500 (loan amount); 0.30 = (100P - $3,500)/100P; 30P = 100P - $3,500; -70P = -$3,500; P = $ You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60% and the stock pays no dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin. a. 25% b. -33% c. 44% *d. -42% e. cannot be determined 300($60)(0.60) = $10,800 investment; 300($60) = $18,000 X (0.40) = $7,200 loan; Proceeds after selling stock and repaying loan: $13,500 - $7,200 = $6,300; Return = ($6,300 - $10,800)/$10,800 = - 42%. 23. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a margin call if the maintenance margin is 35%? a. $51

5 5 *b. $65 c. $35 d. $40 Equity = 300($55) X 1.6 = $26,400; 0.35 = ($26, P) ) 300P; 105P = 26, P 405P = 26,400 P = $ You wish 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 can you buy? *a. 100 shares b. 200 shares c. 50 shares d. 500 shares e. 25 shares.5 = [(Q X 60)-3000] / (Q X 60) 30Q = 60Q Q = 3000 Q= You sell short 100 shares of Loser Co. at a market price of $45 per share. Your maximum possible loss is a. $4500 *b. unlimited c. zero d. $9000 e. cannot tell from the information given A short seller loses money when the stock price rises. Since there is no upper limit on the stock price, the maximum theoretical 26. You purchase a share of Yestel stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding period return? *a. 5.56% b. 2.22% c. 3.33% d. 1.11% e. 40% HPR = ( ) / 90 = 5.56%

6 6 Assume an investor with the following utility function: U = E(r) - 3/2(σ 2 ). 27. To maximize her expected utility, she would choose the asset with an expected rate of return of and a standard deviation of, respectively a. 12%; 20% b. 10%; 15% *c. 10%; 10% d. 8%; 10% U = /2(0.10) 2 = 8.5%; highest utility of choices. 28. A portfolio has an expected rate of return of 0.15 and a standard deviation of The riskfree rate is 6 percent. An investor has the following utility function: U = E(r) - (A/2)σ 2. Which value of A makes this investor indifferent between the risky portfolio and the riskfree asset? a. 5 b. 6 c. 7 *d = A/2(0.15) 2 ; = -A/2(0.0225); = A; A = 8; U = /2(0.15) 2 = 6%; U(R f ) = 6%. 29. The variable (A) in the utility function represents the: a. investor's return requirement. *b. investor's aversion to risk. c. certainty-equivalent rate of the portfolio. d. minimum required utility of the portfolio. A is an arbitrary scale factor used to measure investor risk tolerance. The higher the value of A, the more risk averse the investor. 30. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. Her portfolio's expected return and standard deviation are and, respectively. a ; 0.12 *b ;0.06 c ; 0.12 d ; 0.12

7 7 E(r P ) = 0.3(15%) + 0.7(6%) = 8.7%; σ P = 0.3(0.04) 1/2 = 6%.

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