Bus 320 Quiz 3 White Version

$15.00

 

 

True/False Questions: Circle the correct response. (2 points each)

 

1. T F In theory, if two assets have the same expected cash flows they will always have the same price.
 

2.

 

T

 

F

 

Using margin to buy stocks can negate the limited liability aspect of investing in corporations.

 

3.

 

T

 

F

 

Management of a company generally prefers non-cumulative to cumulative share voting.

 

4.

 

T

 

F

 

Since the returns of well-diversified portfolios move very much in line with the returns for all stocks in the market, portfolio betas are equal to the beta for the market which is 1.0.

 

5.

 

T

 

F

 

People who employ technical analysis when investing do not believe that markets are weak-form efficient.

 

6.

 

T

 

F

 

An investor is considering adding another investment to a portfolio. To achieve the maximum diversification benefits, the investor should add an investment that has a correlation coefficient with the existing portfolio closest to 0.

 

7.

 

T

 

F

 

If investors expected inflation to increase in the future, and they also became less risk averse, the SML would shift up and the slope would increase.

 

8.

 

T

 

F

 

Normally, the Security Market Line has an upward slope. However, at one of those unusual times when the yield curve on bonds is downward sloping, the SML will also have a downward slope.

 

9.

 

T

 

F

 

An increase in the risk-free interest rate will increase a security’s beta.

 

10.

 

T

 

F

 

Combining securities that are not perfectly positively correlated helps to reduce the risk of a portfolio.

 

11.

 

T

 

F

 

The addition of foreign securities to the domestic portfolio opportunity set will likely shift the efficient frontier up and to the left.

 

12.

 

T

 

F

 

If markets are strong-form efficient, the expected return on each stock will be the same as the return on the market.

 

13.

 

T

 

F

 

Illiquid stocks tend to have wider spreads between the bid and ask price.

 

14.

 

T

 

F

 

For dividend paying stocks, prices fall in predictable ways on the ex-dividend date.

 

 

 

15. T F If a stock were to issue new stock (to raise money) this year it would be considered a secondary market transaction since the company already has stock outstanding.
 

16.

 

T

 

F

 

All else equal (the expected return on the market and beta do not change), an

increase in the risk free rate will increase a stock’s expected return.

 

17.

 

T

 

F

 

Empirical evidence that markets are not strong form efficient would also be

      evidence that markets are not semi-strong form efficient.
 

18.

 

T

 

F

 

A proxy fight typically refers to a competition to gain enough shareholder votes to determine who will serve on the board of directors.

 

19.

 

T

 

F

 

A limit order to buy a security will transact at the current lowest ask price.

 

20.

 

T

 

F

 

When a stock splits 2-for-1 the stock price falls and the expected return increases.

 

Multiple Choice Questions: Circle the correct response. (4 points each)

Scenario Dividend Stock Price
Boom $4.00 $68
Normal $3.00 $55
Recession $1.00 $43

 

  1. 21. A stock currently sells for $50 and has the following potential payoffs (to be received one year from today). Each scenario is equally likely.

What is the standard deviation for the stock?

  1. a)     5.23% b)   14.51% c) 16.08%
  1. d)   19.07%
  2. f)   22.86%
a) $ 27.10
b) $ 27.35
c) $ 27.85
d) $ 28.10
e) $ 29.76
f) $ 30.36

 

  1. 22. A company has a beta of 0.9 and the market risk premium is 5.4% percent. The risk-free rate is 3.2%. If an investor paid $26.00 for a share a year ago and they just received a dividend of $0.25 for the year, what would be a fair price for the share today?
  1. 23. Consider the following information:

Price           E[R]         Beta

Google

$1,130.00

8.4%         0.90

Apple

Yahoo

$ 530.00

$   38.00

7.8%         0.80

9.6%         1.10

You have a portfolio of these 3 stocks and the beta is 1.0. If your $217,307.69 portfolio includes 50 shares of Google, how many shares of Yahoo do you own?

  1. a)       112
  1. b)       238 c)       915 d)     2,313 e)     2,839 f)   3,317
a) 25%
b) 35%
c) 50%
d) 65%
e) 75%

 

  1. 24. Stocks A and B are perfectly negatively correlated. The expected return on A is 8% with a standard deviation of 12%. The expected return on B is 18% with a standard deviation of 36%. You’d like to combine these two stocks into a riskless portfolio. What fraction of the portfolio should be held in A?
a) 0.6
b) 0.8
c) 1.2
d) 1.5
e) 1.6
f) 1.8

 

  1. 25. You hold a diversified portfolio consisting of a $7,500 investment in each of 10 different stocks. The portfolio’s beta is 1.60. Now suppose you decide to sell one of those stocks in your portfolio for $7,500. If the sold stock had a beta of 1.80, and the proceeds are used to purchase a replacement stock, what does the beta of the replacement stock have to be for the new portfolio beta to be 1.50?
  1. 26. (24 points). As an analyst following WinConn, you’ve obtained the following information:

× Dividends

You expect the company to pay its first dividend of $2.00 exactly 6 years from today.

Dividends will then grow at 13% for 4 years (until 10 years from today). After this high growth phase, dividends will grow more slowly. Dividends will grow at 11% for one year (11 years from today), and then 9% for one year (12 years from today), and then grow at

6% forever after that.

× Market Conditions

You generally use CAPM to gage whether a stock is undervalued or overvalued. The return on 3-month Treasury securities (the risk-free rate) is 3%. The expected return on the S&P500 Index (a portfolio of 500 large stocks that you use to measure market returns) is 9%, and the standard deviation of S&P returns is 28%. You’ve estimated the standard deviation of WinConn’s returns to be 56%, and the correlation between WinConn and S&P is 0.80.

  1. a) What’s your estimate of the required rate of return for WinConn?
  2. b) What’s your estimate of the fair price today for one share of WinConn?
  3. c) How much would a share sell for 9 years from today?
  1. 27. (8 points). In your assessment, stock A has the following probability distribution of expected returns:
Probability

0.1

Rate of Return

-40%

0.2 0
0.4 10%
0.2 30%
0.1 40%

The risk-free rate is 5.0% and the expected return on the market is 10.0%. If the standard deviation of the market is 18.0%, and the correlation of A with the market is 0.6, is the stock fairly valued?

  1. 28. (8 points). Complete the following table, indicating whether each of the following portfolios cannot lie on the efficient frontier:
    Standard Deviation Cannot lie on the Efficient
Portfolio Expected Return Of Returns Frontier? Yes or No
A 6% 11%  
B 7% 11%  
C 5% 10%  
D 7% 12%  
E 6% 10%  

 

Consider a portfolio that has five securities. The financial manager is considering adding a sixth investment to the portfolio. Which of these candidates do you recommend, and why?

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