Sample Midterm Exam Fall 2014

Due Date: October 14, 2014

First Name: _________________

Last Name: ____________________________

Student ID: _________________________

NYUAD Code of Conduct: I pledge my honor that I have not violated the NYUAD Student
Code of Conduct in the completion of this examination.
Signature: __________________________________________________

The sample mid-term is divided into two sections. Multiple choice questions and Numerical
based questions. Starting on page 2, you will find Question 1 with 5 multiple choice questions.
Similarly Questions 2 and 3 are numerical questions. Write your name on this page. Multiple
choice questions are graded on a correct/incorrect basis. For the numerical questions, write down
how you got the answer in the space provided below the questions and write your final answer.
For the two numerical questions, there will be partial credit awarded for incorrect or partially
incomplete answers if some of the work is correct. To receive partial credit, you must show your
work in the space provided after each question.
Write legibly and only in the space provided. Be brief. Unless the question explicitly states
otherwise, I am looking for one answer. The point distribution is written next to each question
and each part. The maximum number of points you can earn is 30 and the total weight for the
sample midterm is 5%.
If you get stuck on a question, move on. You have 75 minutes to complete the exam.

Allocation of time and Marks:

Question 1:

(maximum allocation of time: 10 minutes)

Total Marks: 5

Question 2:

(maximum allocation of time: 30 minutes)

Total Marks: 10

Question 3:

(maximum allocation of time: 30 minutes)

Total Marks: 15

Good luck!

Question 1: Multiple Choice Questions (Points: 5)

(a) You put up $50 at the beginning of the year for an investment. The value of the
investment grows 4% and you earn a dividend of $3.50. Your HPR was ____.
A. 4.00%
B. 3.50%
C. 7.00%
D. 11.00%

(b) An investor's degree of risk aversion will determine his or her ______.
A. optimal risky portfolio
B. risk-free rate
C. optimal mix of the risk-free asset and risky asset
D. capital allocation line

(c) Consider the CAPM. The risk-free rate is 6% and the expected return on the market is
18%. What is the expected return on a stock with a beta of 1.3?
A. 6%
B. 15.6%
C. 18%
D. 21.6%

(d) 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 portfolio is _________.
A. 1.14
B. 1.20
C. 1.26
D. 1.50

(e) If the simple CAPM is valid and all portfolios are priced correctly, which of the situations
below are possible? Consider each situation independently and assume the risk free rate
is 5%.

A. Opiton A
B. Opiton B
C. Opiton C
D. Opiton D

Question 2 (Points: 10)

Suppose you are going to receive $9,500 per year for six years. The appropriate interest rate is
11 percent. (10 Points)

(a) What is the present value of the payments if they are in the form of an ordinary annuity?
(Hint: C = $9500) (2 Points)

(b) What is the present value if the payments are an annuity due? (2 Points)

(c) Suppose you plan to invest the payments for six years. What is the future value if the
payments are an ordinary annuity? (2 Points)

(d) Suppose you plan to invest the payments for six years. What is the future value if the
payments are an annuity due? (2 Points)

(e) Which has the higher present value, the ordinary annuity or annuity due? Which has the
higher future value? (2 Points)

Question 3: (Points: 15)

Imagine you are a financial analyst. Mr. Green (one of your clients) sets up an appointment with
you to discuss how he can allocate his wealth between two risky assets and a risk free asset. You
provide him with the following set of information:
(Note that ( )

and

Asset A: ( )
Asset B: ( )
Asset C: ( )
Correlation between two risky assets
Mr. Green thinks that a combination of two risky assets will result in a more risky portfolio.
Your job is to convince Mr. Green that adding two risky assets (using the above data) will result
in a diversified portfolio. In addition you also need to explain to Mr. Green how he should
allocate his wealth between risky and risk free assets. To do that, answer the following questions:
(1) Use the table below to explain Mr. Green the efficient frontier curve. You have to plot
expected return of the portfolio on the y axis and standard deviation of the portfolio on
the x axis. (You are plotting column 3 and column 4). Also Mark with symbol X the
global minimum portfolio. (1 Point)
( )

Weight (A)

Weight (B)

-0.1

1.1

26.5

0.55

0.0

1.0

25.0

0.50

0.5

0.5

17.5

0.29

0.7

0.3

14.5

0.22

0.9

0.1

11.5

0.20

1.0

0.0

10.0

0.20

(2) When you show the efficient frontier curve, Mr. Green gets excited about the global
minimum variance portfolio and therefore he would like to know how he can get to the
minimum variance portfolio. (Find the weights attached to each risky asset in the
portfolio as well as the corresponding expected return and standard deviation of such a
portfolio). (3 Points)

(3) Mr. Green insists that he would like to invest his wealth such that he puts some wealth in
risk free asset and some in the global minimum variance portfolio. You would need to
convince him that mixing risk free asset with a minimum variance portfolio is not
optimal.

a. Find the optimal risky portfolio P along with its expected return and standard
deviation. (3 Points)

b. Find the equation of the capital allocation line (

)generated by the

optimal risky portfolio and risk free portfolio. (This question requires you to find
the intercept and the slope of the capital allocation line. Hint: For slope: use
Sharpe ratio.) (2 Points)

c. Find the equation of the capital allocation line-minimum (

) generated by

the global minimum portfolio and risk free portfolio. (This question requires you
to find the intercept and the slope of the capital allocation line-minimum. Hint:
For slope: use Sharpe ratio.) (2 Points)

d. Compare the answers to part b and c to convince Mr. Green that

better than

. (2 points)

is

e. Mr. Green now insists that his risk aversion is much higher and therefore asks you
to find different optimal weights for optimal risky portfolio (compared to the
weights you recommended in part 3a). How would you respond to Mr. Greens
request? (2 points)

Formula Sheet:
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where n = number of compunding periods per year

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basis of wealth invested in each asset.

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is the weight attached to the beta on the