Finc4340 Midterm 1 2 and Final

8/3/2019 Finc4340 Midterm 1 2 and Final

1/64

1.

If a bond is callable, this means:

Student

Response

Value Correct Answer Feedback

1. the issuingcompany canrequire thebondholder tosell the bondsback to thecompany priorto maturity.

100%

2. the bondholdermay sell thebond back to thecompany prior

to maturity ather option.

3. the issuingcompany mayextend thematurity date.

4. the bondholdercan convert thebond into theissuing

company'sstock at any timeat any time priorto maturity.

Score: 1/1

2.

One of the advantages of a convertible is downside protection. This means that the:

StudentResponse


1. bond price willbe fairly stableirrespective ofchanges in theinterest rate.

0%

2. price of the bondwill always be at


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least 90 per centof its marketprice.

3. convertiblebond'sprice will notfall below the

bond'sinvestmentvalue.

4. price of the bondwill not declinebelow its parvalue.

Score: 0/1

3.

Treasury bills and bonds are both typically used as a proxy for the short-term riskless rate.

Student

Response


1. True 0%

2. False

Score: 0/1

4.

Which of the following bonds would you expect to have the lowest price volatility?

Student

Response


1. 4%, 10 yearbond

2. 8%, 20 year

bond

3. 4%, 20 yearbond

4. 8%, 10 yearbond

100%

Score: 1/1

5.


3/64

When interest rates decrease:

Student

Response


1. bond prices fall.

2. interest rates of

existing bondsare raised.

3. prices of newlyissued bonds arelowered.

4. bond prices rise. 100%

Score: 1/1

6.

The lower the discount rate used in bond valuation, the higher the bond's intrinsic value.

Student

Response


1. True 100%

2. False

Score: 1/1

7.

If bond investors do not reinvest the coupons received during the life of the bond, then the:

Student

Response


1. the calculatedYTM willexceed therealized yield.

100%

2. the calculatedYTM will beless than therealized yield.

3. current yieldwill equal thecalculated YTM.

4. nominal yieldwill be greater


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than thecalculated YTM.

Score: 1/1

8.

In order to have a yield to maturity less than the coupon rate, the bond must be:

Student

Response


1. selling at par.

2. selling at apremium.

100%

3. selling at adiscount.

4. a zero couponbond.

Score: 1/1

9.

The par value of a convertible security divided by the conversion ratio is known as the conversion:

Student

Response


1. premium.

2. price.

3. ratio.

4. value. 0%

Score: 0/1

1

0.

If a convertible bond is quoted at 90 (par value = $1000) and has a conversion rate of 30, then theunderlying stock should be trading at:

Student

Response


1. $3

2. $30 100% Current price = conversion value / con= $900 / 30 = $30


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3. $90

4. $27

GeneralFeedback:

Current price = conversion value / conversion ratio= $900 / 30 = $30

Score: 1/1

1

1.

The arbitrage pricing theory (APT) and the CAPM both assume all exceptwhich of the following?

Student

Response


1. Investors havehomogeneousbeliefs.

2. Borrowing andlending can bedone at the rateRF.

100%

3. Markets areperfect.

4. Investors arerisk-averseutility

maximizers.

Score: 1/1

1

2.

Are betas useful in analyzing required rates of return?

Student

Response


1. Yes, becauseindividualsecurity betasare relativelystable over time.

0%

2. No, becauseindividualsecurity betasare unstable over


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time.

3. No, becauseportfolio betasare unstable overtime.

4. Yes, because

portfolio betasare relativelystable over time.

Score: 0/1

1

3.

A security that plots above the SML would be a good security to sell short because it is overvalued.

Student

Response


1. True

2. False 100%

Score: 1/1

1

4.

Select the correct statement regarding the market portfolio. It:

Student

Response


1. should becomposed ofstocks or bonds.

2. is the lowestpoint oftangency

between therisk-free rate andthe efficientfrontier.

3. is readily andpreciselyobservable.

4. should includeall risky assets.

100%


7/64

Score: 1/1

1

5.

Select the true statement regarding the results of CAPM tests.

Student

Response


1. Investors arerewarded forassumingsystematic andunsystematicrisk.

2. The SMLappears not to be

linear.3. The intercept

term is agenerally foundto be higher thanthe risk-free rate.

100%

4. The slope of theCAPM is steeperthan posited bythe theory.

Score: 1/1

1

6.

The systematic risk level of a security:

Student

Response


1. is best

approximated bythe slope of theSML.

2. is measured bythesecurity'sbeta.

3. does not takeinto account the


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variance of theoverall marketportfolio.

4. is measured bythe standarddeviation of themarket and the

standarddeviation of anyindividualsecurity.

0%

Score: 0/1

1

7.

The most important role of the capital asset pricing model (CAPM) is to determine:

Student

Response


1. the beta for anindividualsecurity orportfolio.

2. the systematicrisk of a securityor a portfolio.

3. the total risk of asecurity orportfolio.

4. the requiredreturn on asecurity orportfolio.

100%

Score: 1/1

1

8.

The Capital Asset Pricing Model (CAPM) prices:

Student

Response


1. all the risk of asecurity.


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2. the unsystematicrisk of asecurity.

3. the diversifiablerisk of asecurity.

4. the systematicrisk of asecurity.

100%

Score: 1/1

1

9.

In equilibrium, all risky assets must have betas equal to 0.

StudentResponse


1. True

2. False 100%

Score: 1/1

2

0.

Which statement is incorrect?

Student

Response


1. In equilibriumthe correctlypriced assetswill lie on theSML.

2. The SML prices

the relationshipbetweenexpected returnand risk forindividualsecurities onlyand cannot priceefficientportfolios.

100%

3. The beta for a


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stock is theindependentvariable for theSML and not itsslope.

4. The RF is theintercept for the

SML.

Score: 1/1

2

1.

Which of the following is not one of the assumptions of the CAPM?

Student

Response


1. There are nopersonal incometaxes.

2. There are notransactioncosts.

0%

3. All investorshave the sameone-period time

horizon.4. There is no

interest ratecharged onborrowing.

Score: 0/1

2

2.

Which of the following statements about the difference between the SML and the CML isfalse?

Student

Response


1. The intercept ofboth the CMLand the SML isRF.

2. The CML and


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the SML areboth assumed tobe upwardsloping.

3. The CML andthe SMLmeasure

everything thesame exceptthey werederived bydifferenttheorists.

4. The CML pricesefficientportfolios, whilethe SML prices

both portfoliosand individualsecurities.

0%

Score: 0/1

2

3.

The Security Market Line is the graphical depiction of the Capital Asset Pricing Model.

Student

Response


1. True 100%

2. False

Score: 1/1

2

4.

The returns, variances, and covariances of annual returns for XYZ Corp. and AST Inc. have been calculated

for the period 19992008 (n = 10). The values are:Corporation Return Variance Covariance

XYZ 31.4% 194.4 173.8

AST 23.0% 354.5 173.8

Reference: Ref 9-1

If the mean return and variance for the market (S&P/TSX Composite Index) for the period were 18.2percent and 161.1 respectively, and the covariance between AST and S&P/TSX Composite Index was159.4, the beta for AST would have been:


12/64

Student

Response


1. greater than1.00.

2. between .50 and1.00.

100% AST = i,M/2

M = 159.4/161.1 = 0.989

3. less than zero,negative.

4. between zeroand .50.

GeneralFeedback:

AST = i,M/2

M = 159.4/161.1 = 0.989448

Score: 1/1

25.

Like the CAPM, the APT assumes borrowing and lending can be done at the risk-free rate.

Student

Response


1. True 0%

2. False

Score: 0/1

2

6.

Market equilibrium exists:

Student

Response


1. when the partiesinvolved in

trading haveheterogeneousexpectationswhich providethe incentive totrade.

2. when assets areunderpricedallowing forspeculation.


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3. when assets arepriced correctlyto allow themarkets to clear.

100%

4. when assets areoverpricedallowing forshort selling.

Score: 1/1

2

7.

Which of the following statements regarding beta is true?

Student

Response


1. Beta is anabsolutemeasure of risk.

2. Beta is ageometricmeasure of risk.

3. Beta is a relativemeasure of risk.

100%

4. Beta is a abstractmeasure of risk.

Score: 1/1

2

8.

The size of yield spreads tends to remain constant over time.

Student

Response


1. True

2. False 100%

Score: 1/1

2

9.

Bond investors can avoid the risk that interest rates will rise and drive bond prices down by:


14/64

Student

Response


1. holding the bonduntil maturity.

100%

2. buyingGovernment of

Canada bonds.

3. buying strippedbonds.

4. holdingintermediateterm bonds.

Score: 1/1

3

0.

A major difference between the liquidity preference theory and the expectations theory is that the liquiditypreference theory:

Student

Response


1. only deals inlong-termsecurities.

2. assumesinvestors are riskaverse and theexpectationstheory does not.

0%

3. only deals inshort-termsecurities.

4. recognizes thatinterest rateexpectations areuncertain.

Score: 0/1

3

1.

The intrinsic value of common stock is calculated by:


15/64

Student

Response


1. present value ofall capital gains.

2. present value ofall expected cash

flows.

100%

3. present value ofall dividendpayments.

4. future value ofall dividendpayments.

Score: 1/1

3

2.

What is the estimated value of a stock with a required rate of return of 10 percent, a projected constantgrowth rate of dividends of 5 percent and expected dividend of $2.00?

Student

Response


1. $44

2. $4

3. $20

4. $40 100% P0 = D1 / (k g) = 2 / (.10 .05) = $40

General Feedback: P0 = D1 / (k g) = 2 / (.10 .05) = $40

Score: 1/1

3

3.

Which of the following statements regarding dividend discount models is not true?

Student

Response


1. Differentinvestors oftenuse differentdiscount rates intheir calculation.


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2. Few moneymanagers usethe model toestimate intrinsicvalue.

100%

3. Future benefitsare uncertainand must beestimated.

4. The models arebased onestimates.

Score: 1/1

3

4.

EVA analysis reflects an emphasis on return on capital.

Student

Response


1. True 100%

2. False

Score: 1/1

3

5.

If interest rates rise and other factors remain constant, the P/E ratio of a company will:

Student

Response


1. increase.

2. decrease. 0%

3. becomenegative.

4. become morevolatile.

Score: 0/1

3

6.

The P/E model can value common stocks when a firm does not pay dividends.


17/64

Student

Response


1. True 100%

2. False

Score: 1/1

3

7.

A company has a price to sales ratio of 1.10, annual sales of $2 billion and 100 million shares of commonstock outstanding. Its stock price is:

Student

Response


1. $17.52

2. $20.00

3. $18.18

4. $22.00 100% 2 billion 100 million = $20 Sales per$20 1.10 PSR = $22 MPS

GeneralFeedback:

2 billion 100 million = $20 Sales per share$20 1.10 PSR = $22 MPS

Score: 1/1

3

8.

The intrinsic value of any stock is its:

Student

Response


1. current dividendyield.

2. future value of

expecteddividends.

3. present value offuture dividends.

100%

4. current marketprice.

Score: 1/1


18/64

3

9.

An investor planning to sell stock at the end of two years can still use the DDM to value the stock becausethe anticipated selling price is:

Student

Response


1. too risky to beconsidered avariable withinthe model.

0%

2. irrelevant to theanalysis since itdoes notconsider futuredividends.

3. built into themodel as theselling price intwo years wouldbe simply thepresent value ofanticipateddividends.

4. worth little asthe present valueof the price in

two years wouldbe close to zero.

Score: 0/1

4

0.

Which of the following is a problem in using the dividend discount model (DDM) to value common stock?

Student

Response


1. The model doesnot consider theriskiness of thestock.

2. The model doesnot consider thepresent value ofthe dividends.


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3. The model doesnot value firmswhich do notpay dividends.

100%

4. The model doesnot account forsmall dividends.

Score: 1/1

4

1.

Compare the security market line model and the arbitrage pricing theory.

Student Response Value Correct Answer

1. Please see email 0%

Score: 0/15

Newscore:

15/15 This score has been adjusted by the grader.

Comments:

Very good.

4

2.

At a given point the SML requires that a security with a beta of 1.10 should have a return of 18 percent.

Analysts calculate that a particular stock with an observed beta of 1.10 actually produces a return of 20percent. Outline the scenario that will restore the security's return to equilibrium.


1. Please see email 0%

Score: 0/15

Newscore:

15/15 This score has been adjusted by the grader.

Comments

:

Welldone.

4

3.

A 10-year, $1000 corporate bond paying $100 in interest annually is currently selling for $950.(a) Calculate its current yield.(b) Calculate the coupon rate.(c) Calculate the Total Return for this bond if it is sold one year later for $800.


20/64


1. a) 100/950 = 10.53%, b) 100/1000 = 10% c) TR= (CF+(Ending Price -Beginning Price)) /Beginning Price = -5.26%

0%

Score: 0/15

Newscore: 15/15 This score has been adjusted by the grader.

Comments:

Welldone!

4

4.

Contemporary Casuals, Inc., (CCI) has a beta of 1.15, an expected dividend of $2.30, and an expecteddividend growth rate of 5 per cent for the foreseeable future. The S&P/TSX Composite Index expectedreturn is 18 per cent, and the Treasury bill rate is 6 per cent.(a) Calculate the required return on Contemporary stock.(b) Calculate the price of Contemporary stock.


1. a) RF+Beta(E(R)M - RF) = 6%+1.15(18%-6%)=19.80% b)Expected Dividend/(E(R)M-Expected Dividend Growth Rate) = $2.3/(.18-.05)=17.6923 or $17.23

0%

Score: 0/15

New

score: 11/15 This score has been adjusted by the grader.

Comments:

a) correct b) P0 = D1/(Kcs-g) => P0= 2.30/(19.8%-5%) = $ 15.54

1.

Dividends on common stock are typically declared and paid:

Student

Response


1. quarterly. 100%

2. semi-annually.

3. monthly.

4. yearly.

Score: 1/1


21/64

2.

Which of the following statements regarding dividend dates is true?

Student

Response


1. The ex-dividenddate is prior tothe date ofrecord.

2. The date ofrecord is prior tothe ex-dividenddate.

100%

3. The ex-dividenddate is prior to

the declarationdate.

4. The date ofrecord is prior tothe declarationdate.

Score: 1/1

3.

Which of the following is notan institutional investor?

Student

Response


1. pension funds

2. chartered banks

3. high net worthinvestors

100%

4. insurancecompanies

Score: 1/1

4.

In order to become licensed to sell securities in Canada, individuals must pass the following courses:

1. CSC 3. IFIC

2. CPH 4. CFA


22/64

Student

Response


1. 1, 2, and 3

2. 1 only 0%

3. 1 and 4

4. 1 and 2

Score: 0/1

5.

Which of the following is nota usual characteristic of money market securities?

Student

Response


1. They are issuedby large creditworthycorporations inlargedenominations.

2. They are veryliquid instrumentthat trade

without asignificantliquiditypremium.

3. They include T-bills,commercialpaper, andbankers'acceptances.

4. They are of anintermediate tolong termmaturity.

100%

Score: 1/1

6.

The ex ante risk-return trade-off as its basic principle suggests:


23/64

Student

Response


1. the amount ofexpected returnfor investors isnot directlyrelated to theamount ofexpected risk.

2. a lower expectedreturn forinvestors whotake on higherexpected risk.

3. a higherexpected return

for investorswho take onhigher expectedrisk.

100%

4. the sameexpected returnfor investorswho take onhigher expectedrisk.

Score: 1/1

7.

A major difference between a warrant and a call option is that:

Student

Response


1. warrantsgenerally have a

longer term.

100%

2. options have agreater leverageeffect.

3. warrants haveless value.

4. warrants allowinvestors to buy


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bonds; callsallow investorsto buy stock.

Score: 1/1

8.

A three-for-one stock split results in which of the following, compared to before the split?

Student

Response


1. One-third asmany shares; thesame total bookvalue of equity;one-third themarket price per

share.

2. Three times asmany shares; thesame total bookvalue of equity;one-third themarket price pershare.

100%

3. Three times asmany shares;

three times thetotal book valueof equity; threetimes the marketprice per share.

4. One-third asmany shares;one-third thetotal book valueof equity; one-

third the marketprice per share.

Score: 1/1

9.

The discipline of security analysis concerns as its primary criterion to provide a(n):

Student

Response



25/64

1. purchasingsecurities at thebest price.

2. analysis of theoverall securitiesmarket and itsdirection.

3. determination oftheinvestor'srequired return.

4. valuation andanalysis ofindividualsecurities.

100%

Score: 1/1

1

0.

An unsecured bond that has a claim that is after all other debt holders is known as a(an):

Student

Response


1. debenture.

2. indenture.3. subordinated

debenture100%

4. mortgage bond.

Score: 1/1

1

1.

The Dow Jones Industrial Average is composed of:

Student

Response


1. 500 OTC stocks.

2. 100 defensivestocks.

3. 100 cyclicalstocks.


26/64

4. 30 blue chipstocks.

100%

Score: 1/1

1

2.

A criticism of the Dow Jones Industrial Average is:

Student

Response


1. it adjusts foreven small stockdividends.

2. it is a valueweighted

method.

3. it includes toomany riskystocks.

4. it has too fewstocks in theaverage.

100%

Score: 1/1

1

3.

All public offerings regulated by the Canadian Business Corporations Act require that a(n) _____ beprepared to outline full, true, and plain disclosure of material facts relating to the securities offered.

Student

Response


1. MOU

2. prospectus 100%

3. indenture

4. debenture

Score: 1/1

1

4.

A listed company can be cancelled or delisted for the following reasons except:


27/64

Student

Response


1. the company cutits dividend intwo successivequarters.

100%

2. it no longerexists.

3. the company hasno assets or isbankrupt.

4. publicdistribution ofthe security is nolonger sufficient.

Score: 1/1

1

5.

A major difference between the Standard & Poor's 500 Index and the Dow Jones Industrial Average is that:

Student

Response


1. the S&P 500 is

more difficult tocalculate thanthe Dow JonesIndustrialAverage.

2. the S&P 500 ismore stable thanthe Dow JonesIndustrialAverage.

3. the S&P 500 ismore dominatedby OTC stocksthan the DowJones IndustrialAverage.

4. the S&P 500 is amarket valueindex and theDow Jones

100%


28/64

IndustrialAverage is not.

Score: 1/1

1

6.

The index currently used in Canada as the basis for derivative products trading is the:

Student

Response


1. the S&P/TSXCompositeIndex.

2. TSE 100 Index.

3. the S&P/TSX 60

Index.

100%

4. TSE 35 Index.

Score: 1/1

1

7.

The TSX is:

Student

Response


1. smaller thanboth the NYSEand Nasdaq.

100%

2. smaller than theNYSE but largerthan Nasdaq.

3. smaller than theNYSE and the

TSX VentureExchange.

4. bigger than bothNYSE and theTSX VentureExchange.

Score: 1/1


29/64

1

8.

The fourth market refers to:

Student

Response


1. transactions that

are low involume anddollar amount.

2. transactionsmade betweentwo brokerswithout a clientinvolved.

3. transactionswhere the brokeris both the buyerand seller in thesametransaction.

4. transactionsmade betweenlarge institutionsand wealthyindividualsbypassing

brokers anddealers.

100%

Score: 1/1

1

9.

Investment dealers operate in the:

Student

Response


1. secondarymarket.

2. fourth market.

3. third market.

4. primary market. 100%

Score: 1/1


30/64

2

0.

Which of the following is not a primary market transaction?

Student

Response


1. All of the aboveare primarymarkettransactions.

100%

2. an IPO

3. treasury billsauctioned by theBank of Canada

4. a new bondissued by theBank of Canada

Score: 1/1

2

1.

The measure that best shows returns over time in relation to the initial investment is the:

Student

Response


1. return relative.

2. cumulativewealth index.

0%

3. total return.

4. total yield.

Score: 0/1

2

2.

Which of the following statements regarding returns from 1938 to 2007 is true?

Student

Response


1. Canadiancommon stocks


31/64

returns weregreater than thestandarddeviation.

2. Mostinvestmentsunderperformed

inflation overthat time period.

0%

3. Bondsoutperformedstocks duringthis period.

4. Treasury billsoutperformedthe CPI by lessthan 1%.

Score: 0/1

2

3.

Liquidity risk is associated with:

Student

Response


1. the use of equityfinancing bycorporations.

2. the use of debtfinancing bycorporations.

3. debt investmentsheld bycorporations.

4.the priceconcession in asecondarymarkettransaction.

100%

Score: 1/1

2

4.


32/64

According to the text, total return is:

Student

Response


1. measured bydividing all cashflows received

by its sellingprice.

2. the reciprocal ofa return relative.

3. measured bydividing the sumof all cash flowsby the amountinvested.

100%

4. the differencebetween the saleprice and thepurchase priceof aninvestment.

Score: 1/1

2

5.

The cumulative wealth index is composed of the:

Student

Response


1. yield componentand the pricechangecomponent.

0%

2. price change

component andthe inflation rate.

3. total return andreturn relative.

4. yield componentand the risk-freerate.

Score: 0/1


33/64

2

6.

On average which of the following is false concerning total returns for major financial assets, 1938 to 2007?

Student

Response


1. Long-termGovernment ofCanada bondshave higher ratesthan short-termissues.

2. The return on91-DayGovernment ofCanada T-bills

has consistentlybeen less thaninflation.

3. US commonStocks havehigher returnsthan Canadianstocks.

4. Canadiancommon stockshave higherreturns thanlong-termGovernment ofCanada bonds.

0%

Score: 0/1

2

7.

Which of the following statements regarding risk is false?

Student

Response


1. Nonsystematicrisk is alsoknown asspecific risk orissuer risk


34/64

2. Nonsystematicrisk refers to theamount ofinterest rate riskthat will affectthe market.

100%

3. Systematic riskis also referredto as market riskor general risk.

4. Systematic riskis attributable tobroad macrofactors affectingall securities

Score: 1/1

2

8.

The bond default premium is measured by the difference between the:

Student

Response


1. return on long-term corporatebonds and short-

term corporatebonds.

2. return on long-term corporatebonds and long-term governmentbonds.

100%

3. return on short-term corporatebonds and short-term governmentbonds.

4. return on long-term governmentbonds and short-term governmentbonds.

Score: 1/1


35/64

2

9.

The total risk of an asset or a portfolio is measured by:

Student

Response


1. its covariancewith the marketportfolio.

2. its standarddeviation.

3. its geometricreturn.

4. its correlation

with the marketportfolio.

0%

Score: 0/1

3

0.

The equity risk premium is the difference between:

Student

Response


1. high-gradestocks and low-grade stocks.

2. a stock marketindex and theinflation rate.

3. stocks and therisk-free rate.

100%

4. stocks andbonds.

Score: 1/1

3

1.

In the top-down approach to fundamental analysis, industry analysis should:


36/64

Student

Response


1. come aftercompanyanalysis.

2. precede

economic/marketanalysis.

0%

3. In the top-downapproach theorder of analysisdoes not matter.

4. come aftereconomic/marketanalysis butbefore companyanalysis.

Score: 0/1

3

2.

Generally, when interest rates fall, stock prices:

Student

Response


1. fall.

2. remainunchanged.

3. rise. 100%

4. rise or falldepending onthe expectedinflation

premium.Score: 1/1

3

3.

In order to value the market with the P/E model, it is necessary to analyze:

Student

Response



37/64

1. earningsforecasts andP/E ratios.

2. earningsforecasts.

3. earnings

forecasts, P/Eratios, and therequired rate ofreturns.

0%

4. P/E ratios.

Score: 0/1

3

4.

The beginning and ending of a business cycle is considered to occur during a:

Student

Response


1. cycle. 0%

2. contraction.

3. trough.

4. peak.

Score: 0/1

3

5.

Assume that the P/E ratio of the S&P/TSX Composite Index is moving quickly above 22 times, and theassociated dividend yield has fallen below 2 per cent. Investors attempting market timing should invest in:

Student

Response


1. high-P/E stocksto buy intostocks at thecurrent marketvaluation.

2. interest-sensitivestocks to takeadvantage of theincrease in


38/64

interest rates thatwill followshortly.

3. aggressivestocks to takeadvantage of thequickly rising

market market.

4. defensive stocksto prepare forthe pendingmarket slide.

100%

Score: 1/1

3

6.

Which of the following is notamong the qualitative factors that should be analyzed to assess an industry'sfuture?

Student

Response


1. Growth rate ofsales

2. Structuralchanges

3. Competition

4. Historicalperformance

0%

Score: 0/1

3

7.

Assume that the dividend payout ratio on the S&P/TSX Composite Index will be 40 per cent when the rateon long-term government bonds falls to 9 per cent. Investors being more risk averse demand an equity risk

premium of eight per cent. If the growth rate of dividends is expected to be 10 per cent, what will be theprice of the market index if the earnings expectation is $30?

Student

Response


1. $266.56 0% D1 = 0.40($30) = $12k = 0.09 + 0.08 = 0.17P0 = D1 / (k g) = 12 / (0.17 0.10) =


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2. $171.43

3. $384.00

4. $213.44

GeneralFeedback:

D1 = 0.40($30) = $12k = 0.09 + 0.08 = 0.17

P0 = D1 / (k g) = 12 / (0.17 0.10) = $171.43Score: 0/1

3

8.

The most basic industry rotation strategy involves shifting back and forth between what two industries?

Student

Response


1. energy andcapital goodsindustries

0%

2. cyclical anddefensiveindustries

3. bank andconsumerindustries

4. consumer anddurable goodsindustries

Score: 0/1

3

9.

All of the following are lead economic indicators except:

Student

Response


1. real moneysupply (M1).

2. new orders forconsumerdurables.

3. average workweek.

0%


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4. unemploymentrate.

Score: 0/1

4

0.

Which of the following statements regarding the uses of market indicators is false?

Student

Response


1. The historicalreturns onmarket indicesare used incomputing betas.

2. Historicalrecords ofmarketindicators areused todetermineunsystematicrisk.

3. Market averagesand indices areuseful to

investors inevaluatingportfolioperformance.

0%

4. Historicalrecords ofmarket averagesare used forgauging markettrends.

Score: 0/1

4

1.

a) What is total risk? How can we measure it?b) The total risk can be separated into two parts. Explain:b1. which types of risk are these,b2. which one is possible to eliminate through diversification.c) Provide the explanation/rationale for the elimination of part of the total risk via diversification.


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StudentResponse:

Total Risk is the systematic (Market) risk and the non-systematic (Specific) risk of aparticular security. Total risk can be measured by measuring the standard deviation of thereturn on the particular asset or security. Systematic (Market) risk is the risk that cannot beeliminated no matter how much hedging or diversification is done to a portfolio. Systematicrisk is the risk that every investor must pay. Non-systematic (Specific) risk is the risk that canbe reduced or eliminated through hedging and diversification. b1 is systematic (market) riskb2 is the non-systematic risk, which can be reduced or eliminated through diversification orhedging. The rationale for the elimination of part of the total risk via diversification is that the

more stocks you add to your portfolio at a certain point you can no longer reduce your riskany further. Diversification works by reducing your specific risk by adding uncorrelatedstocks to the portfolio that combine to offset the uncontrollable factors within the market.This is because the more and more of the stocks that are added to the portfolio, the more theyare correlated. The optimum amount of stocks is 20-30, and for Canada it is about 70 stocks.Each additional stock at a certain point only reduces your risk a small amount. This isbecause each additional stock adds more work to follow and analyse that stock than it isworth for its added benefit to the portfolio. There is a certain amount of market risk(systematic risk) that everyone pays and it cannot be eliminated. To analyse stocks it is betterto use correlation coefficient rather than correlation covariance. Covariance is the amount ordegree that two stocks move returns move together. The problem with covariance is that just

looking at the number you dont know. A better way to determine a portfolio is throughcorrelation coefficient, which is a way of determining the direction and strength of therelationship between two variables. A +1 is a perfect positive correlation means that the twovariables move in the same direction together A 0 means there is zero correlation between thetwo variables. A -1 correlation (inverse relationship) means that there is a perfect negativecorrelation where the two variables move the opposite direction. Example of negativelycorrelated industries: Heating company vs a air conditioning company. It is a bad thing to beperfectly positively correlated because the securities move up and down together and as suchprovides no risk reduction. Securities with zero correlation reduce the risk of the portfolio.Negative correlation is best to minimize your overall non-systematic risk. In addition it isbetter to have zero correlation than a positive correlation. To reduce your overall portfolio

risk it is best to choose different industries and select negative correlation coefficients.Foreign stocks are a good addition to a portfolio because they are less correlated withdomestic stocks because they are generally in a different sector and likely not affected by thesame factors.

Score: 15/15

Comments: Very goodanswer!

4

2.

Why is the introduction of risk-free borrowing and lending such an important change relative to theMarkowitz analysis?

StudentResponse:

Markowitz portfolio selection is a form of non-random diversification. The Markowitz modelrequires active measurement and management of the securities to determine best possibleportfolio. Each relationship between the securities must be analyzed before deciding whetheror not to add it to the portfolio. This requires a lot of time and energy analysing each securityespecially as the number of securities within the portfolio increases. Markowitz model assesseach security for how their returns move together by taking advantage of the expected returnand risk for each of the individual securities.With the the introduction of risk-free borrowing


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and lending is such an important change relative to the Markowitz analysis because themarkowitz model is built on the best combination of risk versus return.With the introductionof risk free investments such as T-bill and risk free lending the efficient frontier model isused. The efficient frontier graph demonstrates the risk versus return for investors. It is usedto acquire the optimal portfolio of risk versus return with is determined by the investors risklevel. The option that investors have to own not only risky investments but also risk freeinvestments changes the efficient set to a straight line that now intersects the efficient frontiercurve at a single point. This intersection point is determined to be the best possible risk

versus return choice for a specifically selected group of securities within a portfolio.

Score: 12/15

Comments:

Very goodanswer! You could only have emphasized that considering riskfree lendingand

borrowinginvestors expand their possibilities,and become with more options (andwithbetter optionssince they were able to get higher returnsat the same levelofriskcompared tothe previous model).

4

3.

Using the stock prices of Tim Hortons and Rogers Communications available on Google Finance (andalso on the links below), prepare an Excel spreadsheet providing the following information: * total return(in %) for each day per company; * (arithmetic) return average per company: * total risk (standarddeviation) per company; * covariance between the two companies; * correlation between the twocompanies; * total return (in %) of a portfolio formed by the companies (weight= 20% for Tim Hortonsand 80% for Rogers), considering the data found previously. * total risk (standard deviation) of a portfolioformed by the two companies (weight= 20% for Tim Hortons and 80% for Rogers), considering the datafound previously. Instructions: * You can use formulas created by yourself in Excel; not the functions,though. * Tim Hortons link: http://www.google.com/finance/historical?q=TSE:THI * RogersCommunications link: http://www.google.com/finance/historical?q=TSE:RCI.A * send the spreadsheet as

an attached file to the email [email protected] with your name and ID. * the number of daysshould be the same as the 2 last digits of your ID. For instance: ID = 300167998, you should consider tohave 98 days or 98 stock prices to make all your calculations asked above.

StudentResponse:

not answered

Score: 30/30

Comments: Welldone!

1.

A bond's intrinsic value is:

Student

Response


1. another name for


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par value.

2. the amount bywhich themarket valueexceeds the parvalue of thebond.

3. the value that thebond will pay tothe bondholderat maturity.

4. the present valueof the expectedcash flows to bereceived fromthe bond.

100%

Score: 1/1

2.

One of the advantages of a convertible is downside protection. This means that the:

Student

Response


1. price of the bondwill always be at

least 90 per centof its marketprice.

2. price of the bondwill not declinebelow its parvalue.

3. bond price willbe fairly stableirrespective of

changes in theinterest rate.

4. convertiblebond'sprice will notfall below thebond'sinvestmentvalue.

100%


44/64

Score: 1/1

3.

A disadvantage of a convertible bond is:

Student

Response


1. that convertiblesare not callable,and must be heldto maturity.

2. its exposure toupsidemovements inthe stock price.

3. a yield less thanstraight bonds ofsimilar risk andmaturity.

100%

4. the lack ofdownsideprotection forthe investor.

Score: 1/1

4.

Which of the following statements about the risk premium affecting market interest rates isfalse? The riskpremium:

Student

Response


1. is not reflectedin the price ofthe security.

0%

2. results in a yielddifferential.

3. is additionalcompensationdemanded byinvestors for therisk involved.

4. is by definition anegative


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amount.

Score: 0/1

5.

The real rate of interest is almost always:

StudentResponse


1. equal to thenominal rate ofinterest.

2. easily affectedby risk factors.

3. the opportunitycost of foregoing

consumption.

100%

4. greater than thenominal rate ofinterest.

Score: 1/1

6.

Find the price of a 10 percent coupon bond with three years to maturity if the yield to maturity is now 12 percent. Use semi-annual discounting.

Student

Response


1. $1196.70

2. $999.80

3. $952.20 0% Use 6 percent and 6 periods.Price = 50(4.917) + 1000(0.705) = $95

4. $950.85

GeneralFeedback:

Use 6 percent and 6 periods.Price = 50(4.917) + 1000(0.705) = $950.85

Score: 0/1

7.

Which of the following regarding the current yield on a bond is nottrue?


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Student

Response


1. The currentyield shows thebond'sexpected rate ofreturn if held tomaturity.

100%

2. The currentyield is superiorto the couponrate because ituses marketprice instead offace value.

3. The current

yield does notaccount fordifferencebetweenpurchase priceand redemptionvalue.

4. The currentyield is equal tothe coupon rateif the bond is

trading at par. .

Score: 1/1

8.

In the equation for the Security Market Line (SML), the slope is represented by:

Student

Response


1. RF.2. i.

3. i,Mi/M

4. [E(RM) RF] 100%

Score: 1/1

9.


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Like the CAPM, the APT assumes borrowing and lending can be done at the risk-free rate.

Student

Response


1. True

2. False 100%

Score: 1/1

1

0.

Choose the statement below that is notcorrect.

Student

Response


1. With the

introduction ofrisk-freeborrowing andlending, theefficient frontierwill be an arcthat is higherthan theMarkowitz arcwhich had beenthe efficient

frontier.

100%

2. With theaddition of risk-free borrowingand lending, theMarkowitzefficient frontieris dominated bya new efficientfrontier.

3. With theintroduction ofrisk-freeborrowing andlending, theefficient frontierwill become astraight line.

4. In equilibrium,


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all risky assetsmust still be inthe marketportfolio.

Score: 1/1

11.

If markets are efficient and in equilibrium:

Student

Response


1. any assets thatlie above theSML would beconsidered

overvalued.

2. no assets wouldlie on the SML.

3. all assets wouldlie on the SML.

100%

4. any assets thatplot below theSML would beconsidered

undervalued.Score: 1/1

1

2.

What does it mean when the CAPM is called robust?

Student

Response


1. No other modelcan representstock returnsbetter than theCAPM.

2. The CAPMrequires noassumptions.

3. Even if most of 100%


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the assumptionsof the CAPM arerelaxed, most ofthe conclusionswill still hold.

4. The CAPM isbased on

realisticassumptions.

Score: 1/1

1

3.

Are betas useful in analyzing required rates of return?

Student

Response


1. No, becauseindividualsecurity betasare unstable overtime.

2. Yes, becauseindividualsecurity betasare relatively

stable over time.

3. No, becauseportfolio betasare unstable overtime.

4. Yes, becauseportfolio betasare relativelystable over time.

100%

Score: 1/1

1

4.

The anticipated market return is 15 percent. The risk-free rate is 4 percent, and AB Co. has a beta equal toone-half of the market beta. Its risk premium is:

Student

Response



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1. 9.5 percent.

2. 11 percent. 0% Risk premium = 0.5(15 4) = 5.5 perc

3. 5.5 percent.

4. 15 percent.

General Feedback: Risk premium = 0.5(15 4) = 5.5 percent

Score: 0/1

1

5.

Which of the following is not true for the P/E ratio?

Student

Response


1. It is also knownas the earningsmultiple.

2. All of the aboveare true for theP/E ratio.

3. Analysts use thismodel moreoften than theDDM .

4. It is the numberof timesinvestors valueearnings asexpressed in thestock price.

100%

Score: 1/1

1

6.

The intrinsic value of any stock is its:

Student

Response


1. future value ofexpecteddividends.

2. current market


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price.

3. present value offuture dividends.

100%

4. current dividendyield.

Score: 1/1

1

7.

Preferred stock is considered a perpetuity.

Student

Response


1. True 100%

2. FalseScore: 1/1

1

8.

Tyler Toys currently earns $3.00 per share and currently pays $1.20 per share in dividends. It is expected tohave a constant growth rate of 7 per cent per year. The required rate of return is 14 per cent. What is theintrinsic value of this stock?

Student

Response


1. $17.14

2. $42.86

3. $40.05

4. $18.34 100% D0 = $1.20D1 = 1.20(1.07) = 1.28P0 = 1.28 / (.14 .07) = $18.34

GeneralFeedback:

D0 = $1.20D1 = 1.20(1.07) = 1.28P0 = 1.28 / (.14 .07) = $18.34

Score: 1/1

1

9.

What is the estimated value of a stock with a required rate of return of 10 percent, a projected constantgrowth rate of dividends of 5 percent and expected dividend of $2.00?


52/64

Student

Response


1. $20

2. $4

3. $40 100% P0 = D1 / (k g) = 2 / (.10 .05) = $40

4. $44

General Feedback: P0 = D1 / (k g) = 2 / (.10 .05) = $40

Score: 1/1

2

0.

The required rate of return on a common stock investment is also known as the:

Student

Response


1. the anticipateddividend yield.

2. expected capitalgains yield.

3. the minimumexpected rate ofreturn.

100%

4. prevailingmarket rate ofinterest.

Score: 1/1

2

1.

The zero-growth dividend model:

Student

Response


1. provides highervalues forcommon stocksthan a positiveconstant growth.

2. assumes thehighest required


53/64

return possible.

3. is the mostaccurate modelto use.

4. is equivalent tothe valuation

model forpreferred stocksand perpetualbonds.

100%

Score: 1/1

2

2.

Markowitz's main contribution to the study of modern portfolio theory is:

Student

Response


1. that risk can bebest measuredfor individualassets but haslimitedapplications inportfolios.

2. risk whilemeasured in thepast is notquantifiable foruse in the future.

3. the measurementof portfolio riskthrough the useof variance andcovariancestatistics.

100%

4. that risk is bestmeasured bysubjectiveassessment.

Score: 1/1

2

3.


54/64

If two stocks had a correlation coefficient between them that decreased over time from a mildly positivecorrelation to zero correlation, all else remaining constant, the portfolio's risk would:

Student

Response


1. remain constant.

2. be negative.

3. increase.

4. decrease. 100%

Score: 1/1

2

4.

Which of the following correlation coefficients would provide the greatest benefit for diversification?

Student

Response


1. a mildly positivecorrelationcoefficient

2. a correlationcoefficient equalto zero

3. a perfectlypositivecorrelationcoefficient

4. a perfectlynegativecorrelationcoefficient

100%

Score: 1/1

2

5.

According to Markowitz's mean-variance model, the variance of a portfolio is equal to the weighted:

Student

Response


1. covariancesbetween allunique pairs of


55/64

securities.

2. average of theindividualvariances.

3. variances plusthe weighted

covariances ofall pairs ofsecurities.

100%

4. covariances plusthe weightedbetas of thesecurities.

Score: 1/1

2

6.

Which of the following conditions will result in the greatest amount of risk reduction if an investor were topurchase two securities instead of one for inclusion in a portfolio?

Student

Response


1. The assets arepositivelycorrelated with

each other.

100%

2. The assets are inthe same riskcategory, e.g.,blue chips.chips.

3. The assets areindependent ofeach other.

4. The assets arenegativelycorrelated witheach other.

Score: 1/1

2

7.

If an investor had a one-year holding period for an investment and would receive cash flows only at the endof that period without the potential to reinvest, then the best measure of return for that investment would be:


56/64

Student

Response


1. arithmetic mean. 100%

2. calculus mean.

3. arithmetic

median.

4. geometric mean.

Score: 1/1

2

8.

The measure that best shows returns over time in relation to the initial investment is the:

Student

Response


1. total yield.

2. return relative.

3. cumulativewealth index.

4. total return. 100%

Score: 1/1

2

9.

Calculation of wealth indexes involve compounding:

Student

Response


1. at the geometricmean return.

2. based on thesystematic riskfactor.

3. based upon thestandarddeviation.

4. at the arithmeticmean return.

0%

Score: 0/1


57/64

3

0.

Liquidity risk:

Student

Response


1. is the riskassociated withsecondarymarkettransactions.

2. is the risk thatinvestmentbankersnormally face.

3. increaseswheneverinterest ratesincrease.

0%

4. is lower forsmallOTCstocks than forlarge NYSEstocks.

Score: 0/1

3

1.

The total risk of an asset or a portfolio is measured by:

Student

Response


1. its standarddeviation.

100%

2. its covariancewith the marketportfolio.

3. its geometricreturn.

4. its correlationwith the marketportfolio.


58/64

Score: 1/1

3

2.

Investors should be willing to purchase a particular asset:

Student

Response


1. if the holdingperiod is longenough torecoup thepurchase priceof the assetthroughdividends orinterest

payments.

2. if the expectedreturn isadequate tocompensate forthe risk.

100%

3. if they are truespeculators.

4. if the expected

return is greaterthan the returnpaid on treasurybills.

Score: 1/1

3

3.

New regulations on open pit mining that affects the base metals industry is a type of:

Student

Response


1. liquidity risk.

2. market risk.

3. financial risk.

4. business risk. 100%

Score: 1/1


59/64

3

4.

A portfolio which lies above below the efficient frontier is described as:

Student

Response


1. unattainable.

2. inferior.

3. dominant.

4. optimal. 0%

Score: 0/1

3

5.

Which of the following statements regarding indifference curves is nottrue?

Student

Response


1. Investors have afinite number ofindifferencecurves.

2. Indifferencecurves cannotintersect.

3. The indifferencecurves for allrisk-averseinvestors will beupward sloping.

0%

4. The greater theslope of the

indifferencecurve, thegreater the riskaversion ofinvestors.

Score: 0/1

3

6.


60/64

Which of the following statements regarding systematic risk is true?

Student

Response


1. Virtually allsecurities havesystematic risk.

2. Only commonstocks havesystematic risk.

3. Systematic riskis measured bythe covariance.

0%

4. It is impossibleto measuresystematic risk.

Score: 0/1

3

7.

Assume that an investor is concerned with investing in not only risky assets, X, but also the risk-free assetRF. The standard deviation of such a portfolio would be calculated as:

Student

Response


1. p = RF,XRFX 0%

2. p = (1 wRF)X

3. p = (1 wX)X

4. p = (1 wX)RF

Score: 0/1

3

8.

The separation theorem states that:

Student

Response


1. systematic riskis separate fromunsystematicrisk.


61/64

2. the investmentdecision isseparate fromthe financingdecision.

100%

3. borrowingportfolios areseparate fromlendingportfolios.

4. the individualsecurity risk isseparate fromportfolio risk.

Score: 1/1

3

9.

In advance of an expected market decline, an investor reduces the holdings of the equity portion of herdiversified portfolio and uses the proceeds to purchase money market securities. The investor is attemptingto reduce her exposure towards:

Student

Response


1. country/politicalrisk.

2. systematic risk. 100%

3. inflation risk.

4. diversifiablerisk.

Score: 1/1

4

0.

Which of the following is true concerning the Markowitz portfolio selection model?

Student

Response


1. In practice allinvestors orportfoliomanagers willestimate the


62/64

inputs to themodel in thesame wayleading to onlyone efficientfrontier.

2. Conservative

investors wouldchooseportfolios on theright side of theefficient setwhile aggressiveinvestor wouldbe more apt tochooseportfolios on theleft side.

3. The modelgenerates anentire set ofefficientportfolios all ofwhich areequally goodwith none ofthese portfolioson the efficient

frontierdominating anyother.

4. The modeladdresses theissue ofinvestors usingborrowed moneyalong with theirown portfoliofunds to

purchase aportfolio of riskyassets.

0%

Score: 0/1

4

1.

Listed below are the end-of-year prices and annual dividends for ABC Corporation.


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Year ... End-of-year price.. Annual dividends2004 .......... $ 82 ............ $1.502005 .......... $ 85 ............ $1.802006 .......... $ 92 ............ $1.922007 .......... $ 87 ............ $1.562008 .......... $ 84 ............ $ 1.452009 .......... $ 90 ............ $ 1.672010 .......... $ 89 ............ $ 1.70

a) Calculate the total return (in %) for 2005, 2006, 2007, 2008, 2009 and 2010

b) Calculate the return relatives for each year mentioned in a)

c) Calculate the arithmetic average return over the 2005-2010 holding period.

d) Determine the cumulative wealth index for the 2006-2009 period.

e) Based solely on the historical information above, what is your best estimate for the return on ABCCorporation for 2011? Briefly explain.

StudentResponse:

a)Total Return (incl. Div.) 2004 = -1.76% 2005 = -5.65% 2006 = 7.95% 2007 = 5.43% 2008= -5.06% 2009 = 3.00% b)Return Relative (incl. div) 2004 = 98.24% 2005 = 94.35% 2006 =107.95% 2007 = 105.43% 2008 = 94.94% 2009 = 103.00% c) Arithmetic Average from 2005- 2010 = .0065169 d) Total Wealth = $103.16 CWI 2004 = 1 2005 = 0.943478261 2006 =1.018522739 2007 = 1.073813973 2008 = 1.019526711 2009 = 1.050112512 e) Based solelyon the historical information above, my best estimate for the return on ABC Corporation for2011 would be a positive return between 3 and 7% most likely around 5%.

Score: 5/20

Comments: Allincorrect.

4

2.

Calculate the risk (standard deviation) of the following two-security portfolio if the correlation coefficientbetween the two securities is equal to 0.5.

Security..... Variance ... Weight (in the portfolio)Security A ... 10% ....... 0.3Security B ... 20% ....... 0.7

StudentResponse:

Standard deviation of the portfolio = [w12 12 + w22 22 + 2(w1)(w2)( 1,2) 1 2]1/2 =[(0.3)2(10) + (0.7)2(20) + 2(0.3)(0.7)(0.5)(10)1/2(20)1/2]1/2 = 3.7 per cent

Score: 8/10

Comments: incorrect calculation;answer=0.37 or 37%

4

3.

You are evaluating two securities, XYZ and BB2B. Using historical data, you obtain their estimated


64/64

expected returns and standard deviations:

E(Rxyz) = 8%; ST DEVxyz = 20%

E(Rbb2b)= 6%; ST DEVbb2b = 12%

a) Suppose that the correlation coefficient between the returns on stock XYZ and market returns is 0.20,while it is 0.65 for stock BB2B. If the standard deviation of the market portfolio is 15%, estimate the beta

for each security.

b) b1) Estimate the required rate of return on each of the stocks if the expected return on the market is 9%and the risk-free rate is 4%. b2) Determine whether they appear to be overvalued or undervaluedaccording to CAPM.

c) c1) Estimate the required rate of return for a portfolio formed with 40% of wealth invested in XYZ and60% in BB2B, and c2) determine if it is undervalued or overvalued.

StudentResponse:

a) XYZ = (0.2) *(20)/15 = 0.2667 BB2B = (0.65) (12)/15 = 0.5200

b) required returns according to CAPM are: Ra = 4 + 0.2667 (9 4) = 3 + 1.6215 = 5.3335 %Since the estimated expected return of 8% > required rate of return, XYZ is currentlyundervalued. Rb = 4 + 0.52 (9 4) = 3 + 2.483 = 6.60% This is > estimated expected return of6%, which suggests that BB2B is currently overvalued.

c) p = Waa + Wbb = (0.4) (0.2667) + (0.6) (0.52) = 0.4187 Rp = 4 + 0.4187 (9 4) =6.0935% E (Rp) = 0.4(8) + 0.6(6) = 6.8% The estimated expected return of 6.8% exceeds thisrequired rate of return of 6.0935%, which suggests that the portfolio is currentlyundervalued.

Score: 30/30

Comments: Very good.

Documents

Finc4340 Midterm 1 2 and Final