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 here) Instructions: 1. The exam is closed book and closed notes. You can bring in one page, double-sided, 8 11 formula sheet. 2. You can (and probably have to) use a calculator. 3. You have a total of 120 minutes for the exam. 4. The whole exam has a total of 45 points. It will count 45% for your final course grade. There are 30 multiple choices questions, each worth 1.5 point. 5. Do not separate the exam book. Turn in the entire exam at the end. 6. Budgeting your time efficiently. 7. Good luck. Page 1
Please use the following table for your answer to the multiple choice questions Question Your Answer Question Your Answer 1 16 2 17 3 18 4 19 5 20 6 21 7 22 8 23 9 24 10 25 11 26 12 27 13 28 14 29 15 30 Total Page 2
1. 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 2. According to the capital asset pricing model, fairly priced securities have. A) negative betas B) positive alphas C) positive betas D) zero alphas 3. The beta, of a security is equal to. A) the covariance between the security and market returns divided by the variance of the market's returns B) the covariance between the security and market returns divided by the standard deviation of the market's returns C) the variance of the security's returns divided by the covariance between the security and market returns D) the variance of the security's returns divided by the variance of the market's returns 4. is not a true statement regarding the capital market line. A) The capital market line always has a positive slope B) The capital market line is also called the security market line C) The capital market line is the best attainable capital allocation line D) The capital market line is the line from the risk-free rate through the market portfolio 5. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio and a long position in portfolio. A) A, A B) A, B C) B, A D) B, B 6. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is. Page 3
A) fairly priced B) overpriced C) underpriced D) None of the above answers are correct 7. Which one of following is NOT among the CAPM assumptions A) all investors have the same risk aversions B) all investors share the same beliefs about expected return and variance for difference securities C) no transaction costs in buying and selling stocks D) all investors have common investment horizon 8. You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of.90. The beta of this formed portfolio is. A) 1.14 B) 1.20 C) 1.26 D) 2.40 9. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of.8 to offer a rate of return of 12 percent, then you should. A) buy stock X because it is overpriced B) buy stock X because it is underpriced C) sell short stock X because it is overpriced D) sell short stock X because it is underpriced 10. The risk-free rate and the expected market rate of return are 5% and 15% respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to. A) 12% B) 17% C) 18% D) 23% 11. The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model,. A) SDA Corp. stock is underpriced B) SDA Corp. stock is fairly priced C) SDA Corp. stock's alpha is -0.75% D) SDA Corp. stock alpha is 0.75% Page 4
12. You purchase one IBM July 120 call contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a on the investment. A) $200 profit B) $200 loss C) $300 profit D) $300 loss 13. You purchase one IBM July 120 put contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a on the investment. A) $300 profit B) $200 loss C) $500 loss D) $200 profit 14. A(n) option can only be exercised on the expiration date. A) Mexican B) Asian C) American D) European 15. All else the same, an style option will be valuable than a style option. A) American, more, European B) American, less, European C) American, more, Canadian D) American, less, Canadian 16. The writer of a put option. A) agrees to sell shares at a set price B) agrees to buy shares at a set price C) acquires the opportunity to buy shares at a set price D) acquires the opportunity to sell shares at a set price 17. A put option on Snapple Beverage has an exercise price of $30. The current stock price of Snapple Beverage is $24.25. The put option is. A) at the money B) in the money C) out of the money Page 5
D) none of the above 18. A writer of a call option will want the value of the underlying asset to and a buyer of a put option will want the value of the underlying asset to. A) decrease, decrease B) decrease, increase C) increase, decrease D) increase, increase 19. You buy one Chrysler August 50 call contract and one Chrysler August 50 put contract. The call premium is $4.25 and the put premium is $4.50. Your strategy is useful if you believe that the stock price. A) will be lower than $41.25 in August B) will be between $41.25 and $58.75 in August C) will be higher than $58.75 in August D) either a or c 20. The is the stock price minus exercise price, or the profit that could be attained by immediate exercise of an in-the-money call option. A) Intrinsic value B) Time value C) State value D) None of the above 21. A call option on Juniper Corp. stock with an exercise price of $75 and an expiration date one year from now is worth $5.00 today. A put option on Juniper Corp. stock with an exercise price of $75 and an expiration date one year from now is worth $2.75 today. The risk-free rate of return is 8% and Juniper Corp. pays no dividends. The stock should be worth today. A) $66.25 B) $71.69 C) $73.12 D) $77.25 22. According to the put-call parity theorem, the payoffs associated with ownership of a call option can be replicated by. A) shorting the underlying stock, borrowing the present value of the exercise price, and writing a put on the same underlying stock and with same exercise price B) buying the underlying stock, borrowing the present value of the exercise price, and buying a put on the same underlying stock and with same exercise price C) buying the underlying stock, borrowing the present value of the exercise price, and writing a put on the same underlying stock and with same exercise price D) None of the above Page 6
23. A hedge ratio of.70 implies that a hedged portfolio should consist of. A) long.70 calls for each short stock B) long.70 shares for each long call C) long.70 shares for each short call D) short.70 calls for each long stock 24. The delta of an option is. A) the change in the value of an option for a dollar change in the price of the underlying asset B) the change in the value of the underlying asset for a dollar change in the call price C) the percentage change in the value of an option for a one percent change in the value of the underlying asset D) the percentage change in the value of the underlying asset for a one percent change in the value of the call 25. Lucy Corp. stock is current trading at $100 per share. You try to price an at-the-money call on Lucy Corp. stock with one year expiration using one-period binomial model. You believe that Lucy s stock will either double or cut by half in a year. If the borrowing rate is 5 % per year, what should be the price of the call option? A) $00.00 B) $33.33 C) $34.92 D) $66.67 26. Using the information from Q25, what will be the hedge ratio for the call option if the strike price is $125. A) 0 B) 1/3 C) 1/2 D) 1 Use the information below to answer question 27-28 Bond A is a one-year zero coupon bond selling at 900. Bond B is a two-year zero coupon bond selling at 800. Bond C is a two-year bond with annual coupon at 10% coupon rate. All three bonds have a face value of $1000. 27. To eliminate arbitrage opportunity, what should be the price of bond C based on information about bond A and bond B? A) $ 950.00 B) $ 970.00 C) $1000.00 D) $1030.00 Page 7
28. If bond C is traded at par, what can you do to make money? A) Nothing bond C is correctly priced B) Long bond A and B, and short bond C C) Short bond A and B, and long bond C D) Bond bond A and B and C. 29. Stock A has a beta of 1 and standard deviation of 50%. Market portfolio has a standard deviation of 20%. What is the correlation of stock A with the market portfolio A) 0.0 B) 0.2 C) 0.4 D) 1.0 30. How much of stock A s total risk is due to market risk? A) 0 % B) 16% C) 40% D) 100% For additional review questions from the first two midterms, please review: From first practice midterm: Question 2, 6, 14, 16-20 From second practice midterm: Question 3, 12-15, 19, 21-25 Suggested solutions: ADABC BACBB CBCDA BBADA BBCAC CBBCB Page 8
Detailed solution for selected questions: Q5. Long 2 shares in A and short 1 share of B will eliminate factor risk, yet yield an expected return of 2*13% - 15% = 11% yet according to APT it should only get riskfree rate of 10% Q6. Market has a beta of 1. So market risk premium = E(rm) rf = 15% - 5% = 10%. So security X should receive an expected return of 5% + 1.15 * 10% = 16.5% at 13% expected return, the price is too high Q8. Portfolio beta shuld be 0.6 * 1.5 + 0.4 * 0.9 = 1.26 Q9. Market risk premium is 11% - 4% = 7% so X should expect an return of 4% + 0.8 * 7% = 9.6% at 12%, X is underpriced (note: price and return move in the opposite direction). Q10. Market risk premium is 15% - 5% = 10% so X should expect an return of 5% + 1.2 * 10% = 17% Q11. Market risk premium is 15% - 8% = 7% so X should expect an return of 8% + 1.25 * 7% = 16.75% at 16%, X has a negative alpha = 16% - 16.75% = - 0.75% Q12. option payoff = 123 120 = 3; option profit = 3-5 = -2 For one contract, which is 100 call options, profit = -2 * 100 = - 200 Page 9
Q13. option will be out of money and you lost the whole 5*100 = 500 dollars. Q19. this is the case of straddle buy long call and put with the same strike prices. You profit from dramatic price movement of either direction. You need the price to move at least 4.25 + 4.50 = 8.75 either up or down to make a profit. Q21. this question is another way to use put-call parity relationship S = C P + PV(X) = 5.00 2.75 + 75 / (1+0.08) = 71.69 Q25. at-the-money call has a strike price of $100. hedge ratio is (100 0) / (200 50) = 2/3 the certain payoff with 2/3 share of stock and 1 call written is 2/3 * 50 = 2/3 * 200 100 the call should have a price of 2/3 * S0 (100/3) / (1+5%) = 34.92 Q26. Hedge ratio will be smaller (75 0) / (200 50) = ½ Q27. 0.1 of bond A and 1.1 of bond B can exactly replicate the payoff of bond C. So bond C should have a price of 0.1*900 + 1.1*800 = 970 Q28. if bond C is traded at face value of $1000, then it is too expensive. Buy 0.1 of A and 1.1 of B while short 1 share of bond C will lead to a certain cash flow today of $30, with no future liability associated with the portfolio strategy later. Q29. correlation = cov(r i, r m ) / [std(r i ) std(r m )] = cov(r i, r m ) / var(r m ) * [std(r m ) / std(r i )] = beta * [std(r m ) / std(r i )] = 1 * (0.2 / 0.5) = 40%; Q30. R2 = correlation 2 = 16% = beta 2 *var(r m ) / var(r i ) = 16% Page 10