Exercise 1A

Information text
3

The use of Excel is recommended for accuracy for the online work. However,
to prepare for the paper-based exam, you should also practice with the
calculator to make sure that you get the same answers.
You must have a good scientific calculator similar to that used by senior high
school students in Australia. It must be capable of calculating a string of
numbers with high accuracy. A financial calculator is not recommended,
although it is permitted during the final exam.
It is important that you learn the concepts for each of the numerical
questions. A numerical question is an example of how to apply the
underlying concepts. If you learn by examples, it may take many examples
for a complete understanding of the underlying concepts. If you learn the
concepts, you may need only a few (2 or 3) numerical questions to check
your understanding of the concepts. It is more effective and more efficient to
learn by understanding the concepts.
For most calculated numerical answers, the tolerance is 0.01. For example if
the correct answer is 2.566, Moodle would accept any values between 2.555
and 2.575. That is both 2.56 and 2.57 would be correct answers. There is no
need to round your answer and you may leave your answer with more than 2
decimal places.
Note that Moodle would round down a value like 2.5755 to 2.575 instead of
2.576 when displaying values for multiple choice questions. You should take
note of this Moodle feature when answering numerical multiplte chocie
questions.

Question 1
Correct
Question text
3

Suppose the prices of Stock A are $2.75, $3.45, $7.48, $3.40, $8.28, $10.23
and $18.87 for the past 7 days. The sample mean of the stock prices is

Answer

. (Note: answer must be accurate to 2 decimal places.

7.78

The tolerance used is 0.01 and you may leave your answer with more than 2
decimal places.)
Feedback
Sample mean = (2.75+3.45+7.48+3.40+8.28+10.23+18.87)/7 = $7.78.
The correct answer is: 7.78

Question 2
Correct
Question text
3

Suppose x is a random variable which can take values 1, 2, 3, 4, 5 and 6 with

probabilities 1/9, 1/9, 1/9, 1/11, 0.340 and 0.23575757575758. The
expected value of x is Answer
. (Note: Answer must be
4.14

accurate to 2 decimal places).

Feedback
The expected value of x, E(x) =
1*P(x=1)+2*P(x=2)+3*P(x=3)+4*P(x=4)+5*P(x=5)+6*P(x=6) =
1*(1/9)+2*(1/9)+3*(1/9)+4*(1/11)+5*(0.340)+6*(0.23575757575758) =
4.1448484848485.
The correct answer is: 4.14

Question 3
Correct
Question text
4

Suppose x is a random variable which can take values 1, 2, 3, 4, 5 and 6 with

probabilities 1/8, 1/8, 1/8, 1/12, 0.440 and 0.10166666666667. The variance
of x is Answer
. (Note: Answer must be accurate to 2 decimal
2.59

places).

Feedback
The expected value of x, E(x) =
1*P(x=1)+2*P(x=2)+3*P(x=3)+4*P(x=4)+5*P(x=5)+6*P(x=6) =
1*(1/8)+2*(1/8)+3*(1/8)+4*(1/12)+5*(0.440)+6*(0.10166666666667) =
3.8933333333333.
The variance of x, Var(x) = P(x=1)*(1-E(x))2 + P(x=2)*(2-E(x))2 + P(x=3)*(3E(x))2 + P(x=4)*(4-E(x))2 + P(x=5)*(5-E(x))2 + P(x=6)*(6-E(x))2 = (1/8)*(13.8933333333333)2 + (1/8)*(2-3.8933333333333)2 + (1/8)*(33.8933333333333)2 + (1/12)*(4-3.8933333333333)2 + 0.440*(53.8933333333333)2 + (0.10166666666667)*(6-3.8933333333333)2 =
2.5852888888889.
The correct answer is: 2.59

Question 4
Correct
Question text
3

Suppose the values of the variable x are 13.81,18.33 and 7.39. The sample
variance of x is Answer
. (Note: answer must be accurate to 2
30.22

decimal places.)
Feedback
Sample mean=13.177. Sample variance=((13.81-13.177)^2 +(18.3313.177)^2 +(7.39-13.177)^2)/(3-1) =30.22
The correct answer is: 30.22

Question 5
Correct
Question text
3

Suppose the prices of Stock A are $6.31, $13.58}, $12.47 and $22.78 for the
past 4 days. The sample standard deviation of the stock prices is Answer
. (Note: answer must be accurate to 2 decimal places. The
6.80

tolerance used is 0.01 and you may leave your answer with more than 2
decimal places.)
Feedback
Sample mean = (6.31+13.58+12.47+22.78)/4 = $13.785. Sample variance
= (6.31-13.785)^2 + (13.58-13.785)^2 + (12.47-13.785)^2+ (22.7813.785)^2)/(4-1) = 46.185633333333. Sample standard deviation =
6.7960012752598.
The correct answer is: 6.80

Question 6
Correct
Question text
3

Suppose the values of the variable x are 9.19,19.61 and 4.93 and the
corresponding values of y are 9.29,1.98 and 11.86, respectively. The sample
covariance of x and y is Answer
. (Note: answer must be
-38.69

accurate to 2 decimal places.)

Feedback
Sample mean of x=11.243 and sample mean of y= 7.71. Sample covariance
of x and y = cov(x,y) = ((9.19-11.243)*(9.29-7.71)+(19.61-11.243)*(1.987.71)+(4.93-11.243)*(11.86-7.71))/(3-1)=-38.69.
The correct answer is: -38.69

Question 7
Correct
Question text
3

If the sample variances of x and y are 3.26 and 11.29, respectively.

Calculate the sample covariance of x and y when the sample correlation is
0.55. (Note: answer must be accurate to 2 decimal places.)
Answer:
3.34

Feedback
Sample covariance of x and y = cov(x,y) = 0.55 * (3.26*11.29)^0.5=3.34.
The correct answer is: 3.34

Question 8
Correct
Question text
3

If the prices of a stock on 25th July, 24th July, 23rd July, 22nd July and 21st July
were $23.83, $21.95, $24.44, $23.48 and $22.03, respectively. The average
daily return of the stock would be Answer
%. (Note: Answer
2.26

must be accurate to 2 decimal places).

Feedback
The daily stock returns are 0.065819337267363, 0.040885860306644,
-0.1018821603928 and 0.085649202733485. The 1-day return from 21st to
22nd is calculated as (23.48/22.03-1) = 0.065819337267363 and the 1-day
return from 22nd to 23rd is calculated as (24.44/24.44-1) =
0.040885860306644 The average daily return of the stock is calculated as
the sum of the 4 1-day returns divided by 4. That is (0.065819337267363 +
0.040885860306644 + -0.1018821603928 + 0.085649202733485)/4 =
0.022618059978673 = 2.2618059978673%.
The returns calculated above are known as simple returns or discrete
returns. We would use this type of returns most of the time. Discrete returns
are suitable for calculating a portfolio returns using the weights and returns
of its constituent stocks.
The other type of returns is known as logarithmic returns, log returns or
continuous returns, which would be used in conjunction with the BlackScholes options pricing model. Log returns are suitable for calculating the
average stock return over time.
The correct answer is: 2.26

Question 9
Correct
Question text

If the prices of a stock on 25th July, 24th July, 23rd July, 22nd July and 21st July
were $24.04, $21.38, $21.91, $21.75 and $24.67, respectively. The average
daily logarithmic (log or continuous) return of the stock would be Answer
%. (Note: Answer must be accurate to 2 decimal places).
-0.65

Feedback
The daily log stock returns are -0.12597417300657, 0.007329396072682,
-0.024487248010476 and 0.11726320407011. The 1-day log return from 21st
to 22nd is calculated as ln(21.75/24.67) = -0.12597417300657 and the 1-day
log return from 22nd to 23rd is calculated as ln(21.91/21.91) =
0.007329396072682 The average daily log return of the stock is calculated
as the sum of the 4 1-day log returns divided by 4. That is (0.12597417300657 + 0.007329396072682 + -0.024487248010476 +
0.11726320407011)/4 = -0.0064672052185647 = -0.64672052185647%.
Log returns are suitable for calculating the average stock return over time
and log returns are used in the Black-Scholes options pricing model. Log
(logarithmic) returns are also known as continuous returns or continuously
compounded returns.
The correct answer is: -0.65

Question 10
Not answered
Question text
2

If the stock prices at the end of 2013, 2012, 2011, 2010, 2009 and 2008
were $20.66, $19.36, $18.85, $17.01, $16.78 and $15.10, respectively.
Using the average annual growth rate of the stock price over the 5-year
period, the stock price in 2010 should be $ Answer
. (Note:
Answer must be accurate to the nearest cent).
Feedback
To calculate the average annual stock return, one can use the geometric
average of annual discrete stock returns or the simple average of annual log
stock returns. Discrete compounding must be used if one were to use the

geometric average of annual discrete stock returns. On the other hand,

continuous compounding must be used if one were to use the simple
average of annual log stock returns. However, it is easier to use the log
returns.
The annual log stock returns were 0.10549295721818, 0.01361370536871,
0.10271150748625, 0.026696167954411 and 0.064990381843062 for the
years 2009, 2010, 2011, 2012 and 2013, respectively. The annual log returns
for 2009 and 2010 are calculated as ln(16.78/15.10) = 0.10549295721818
and as ln(17.01/16.78) = 0.01361370536871, respectively. The average
annual log return is (0.10549295721818 + 0.01361370536871 +
0.10271150748625 + 0.026696167954411 + 0.064990381843062)/5 =
0.062700943974123 = 6.2700943974123%.
The stock price in 2010, 2 years after 2008, should be
$15.10*exp(0.062700943974123*2) = $17.117419543763.
The annual discrete returns were 0.1112582781457, 0.013706793802145,
0.10817166372722, 0.027055702917772 and 0.067148760330578 for the
years 2009, 2010, 2011, 2012 and 2013, respectively. The geometric
average of the annual discrete returns is
(1.1112582781457*1.0137067938021*1.1081716637272*1.0270557029178
*1.0671487603306)^(1/5) = 0.06470838415764 =6.470838415764%.
The stock price in 2010, 2 years after 2008, should be
$15.10*1.0647083841576^2 = $17.117419543763.
The correct answer is: 17.12
Exercise 1B
The first question is taken from BKM Chapter 1 Question 7.
The existence of efficient capital markets and the liquid trading of financial
assets make it easy for large firms to raise the capital needed to finance
their investments in real assets. If a company could not issue stocks or
bonds to the general public, it would have a far more difficult time raising
capital. Contraction of the supply of financial assets would make financing
more difficult, thereby increasing the cost of capital. A higher cost of capital
results in less investment and lower real growth.
If a company could not borrow from the bank to finance its investments in
real assets, or borrow at a higher cost, it would affect its ability to create real
assets.
The role of financial markets is important. While it is ultimately true that real
assets determine the material well-being of an economy, financial innovation
in the form of bundling and unbundling securities creates opportunities for
investors to form more efficient portfolios. Both institutional and individual
investors can benefit when financial engineering creates new products that

allow them to manage their portfolios of financial assets more efficiently.

Bundling and unbundling create financial products with new properties and
sensitivities to various sources of risk that allows investors to reduce
volatility by hedging particular sources of risk more efficiently.
Securitization leads to disintermediation; that is, securitization provides a
means for market participants to bypass intermediaries. For example,
mortgage-backed securities channel funds to the housing market without
requiring that banks or thrift institutions make loans from their own
portfolios. Securitization works well and can benefit many, but only if the
market for these securities is highly liquid. As securitization progresses,
however, and financial intermediaries lose opportunities, they must increase
other revenue-generating activities such as providing short-term liquidity to
consumers and small business and financial services.
The rest of the questions are based on Chapters 2 and 3.
While the Moodle exercise questions are mainly about calculations, you
should also pay attention to the underlying concepts. What are the main
concepts covered in Chapter 1? Each chapter has a summary of the
concepts together with a list of key terms and/or key equations. You should
know them well.
Question 1
Correct
Question text
5

CompSoft is a computer software company. It currently owns computer

equipment worth $30,000, a truck worth $21,000, office equipment worth
$3,000 and has cash on hand of $50,000 contributed by its owners.
CompSoft takes out a bank loan. It receives $90,000 in cash and signs a
note promising to pay back the loan over 3 years. CompSoft uses the cash
from the bank plus its cash on hand of $50,000 to finance the development
of a new financial planning software. A new financial planning software was
developed by CompSoft and its market value is $800,000.
The value of new real asset created is $Answer

. (Note:
800000

answer must be accurate to 2 decimal places. The tolerance used is 0.01 and
you may leave your answer with more than 2 decimal places.)
Feedback

With the bank loan and cash on hand, CompSoft developed a new financial
planning software. The new financial planning software is the newly created
real asset and it value is its market value of $800,000.
The correct answer is: 800000.00

Question 2
Correct
Question text
3

You buy 441 shares of a company for $69.93 per share and deposit initial
margin of 55%. The next day the companys share price changes to $48.75
per share. Your actual margin is Answer
%. (Note: answer must
35.45

be accurate to 2 decimal places.)

Feedback
Amount borrowed = $441*69.93*(1-0.55)=$13877.6085; Actual margin =
(441*48.75 - 13877.6085)/(441*48.75)=0.35449230769231 =
35.449230769231%.
The correct answer is: 35.45

Question 3
Incorrect
Question text
3

In order for you to be indifferent between the after tax returns on a corporate
bond paying 8.5% and a tax-exempt municipal bond paying 5.54%, your
marginal rate would be Answer
%. (note: answer must be
11.11

accurate to 2 decimal places.)

Feedback
0.0554=0.0850*(1-t), where t is the marginal tax rate of the investor. t= 10.0554/0.0850=34.82%.
The correct answer is: 34.82

Question 4
Correct
Question text
3

The prices of Stocks A and B in Year 1 were $55 and $135.25, respectively.
The corresponding prices in Year 2 were $40 and $64.62, respectively. The
price of Stock B was lower because of a two for one stock split. The priceweighted index of the two prices in Year 2 is Answer
. (note:
81.16

answer must be accurate to 2 decimal places.)

Feedback
Feedback:
The price-weighted index in Year 1 is (55+135.25)/2=95.125. The price of
Stock B after the stock split should be $135.25/2=$67.625. The divisor d
must be such that (55+135.25/2)/d = {=(55+135.25)/2. Hence d=
(55+135.25/2)/95.125=1.2890932982917. The price-weighted index in Year
2, after a two for one stock split would be (40 + 64.62)/d = (40 +
64.62)/1.2890932982917 = 81.157818552497.
Stock Bs price of $135.25 in Year 1 is the price for 1 original share. In the
case of a two for one stock split, you would get 2 shares (or 1 additional
share) for each Stock Bs share you own. The observed share price of $64.62
in Year 2 after the stock split is for 1 new share, which is equivalent to half
of the original share. For the 1 original share of Stock B that you own, you
would now have 2 new shares.
For the calculations, we divide the first price of $135.25 by 2 to get the value
of the new divisor to be used after the stock split. As the second price of
$64.62 is already divided by 2, since it was price for half of one original
share, there is no need to divide $64.62 by 2 to calculate the price-weighted
index for Year 2.
In the case of a two for one stock split, 1 original share equals to 2 new
shares and 1 new share equals half of 1 original share. The price of $135.25
in Year 1 is the price for 1 original share (or 2 new shares), and the price of 1
new share in Year 1 is $135.25/2=$67.625. The price of 1 new share in Year
1 was not observed as it happened after the stock market has closed. The
price of $64.62 in Year 2 is the price for 1 new share (or half of 1 original
share), and the price of 1 original share should be $64.62x2 = $129.24.
Stock Splits:

For further information regarding stock splits, I kindly refer you to the
following web page: http://en.wikipedia.org/wiki/Stock_split
A recent example is the 7-for-1 split of APPLEs shares in June 2014. It
means every Apple stockholder received six additional shares for every
share they owned as of June 2[, 2014]. The split was announced in late April
2014. For further reading, I kindly refer you to the following news page:
http://www.news.com.au/finance/business/stock-split-leads-to-radicalchange-in-apple-share-price-overnight/story-fn5lic6c-1226949756471
The correct answer is: 81.16

Question 5
Correct
Question text
3

The prices of Stocks A and B in Year 1 were $45 and $99, respectively. The
corresponding prices in Year 2 were $30 and $90, respectively. The price of
Stock B was lower because of a two for one stock split. The divisor to be
used for calculating the price-weighted index of the two prices in Year 2 is
Answer
. (note: answer must be accurate to 2 decimal places.)
1.31

Feedback
The price-weighted index in Year 1 is (45+99)/2=72. The price of Stock B
after the stock split should be $99/2=$49.5. The divisor d must be such that
(45+99/2)/d = {=(45+99)/2. Hence d= (45+99/2)/72=1.3125.
The correct answer is: 1.31

Question 6
Not answered
Question text
2

You sold short 284 shares of common stock at $46.97 per share. The initial
margin is 55%. The stock paid no dividends during the period, and you did
not remove any money from the account before making the offsetting
transaction. Ignoring interest on margin, the stock price at which you would

receive a margin call if the maintenance margin is 35% is $ Answer

. (Note: answer must be accurate to the nearest cent.)

Feedback
Investors initial equity = 0.55*284*46.97 = $7336.714; Cash proceeds of
short selling 284 shares at $46.97 = 284*46.97 = $13339.48; Asset = Short
sales cash proceeds + Investors initial equity = 284*46.97*(1+0.55) =
$20676.194; Initial liability = 284*46.97=$13339.48; The investors liabilities
(value of her short position) would change as the share price changes =
284*p. Investors initial equity = (Assets Liabilities) = (20676.194 13339.48) = $7336.714. The initial margin = 0.55 = (initial equity)/(value of
short position) = 7336.714/13339.48. Refer to Examples 3.3 and 3.4. For the
examples on buying on margin, refer to Examples 3.1 and 3.2.
At any time, the investors margin = (investors equity)/(value of short
position) = (asset value of short position)/(value of short position) =
(20676.194 - 284P)/(284P). The investor would receive a margin call when
the investors margin is equal to or less than the maintenance margin. If the
maintenance margin is 0.35, then 0.35 = (20676.194- 284P)/(284P); Rewrite
the equation as 284*0.35P = 20676.194 284P; 383.4P = 20676.194;
Solving for P, we have P =$20676.194/383.4 = $53.928518518519.
The correct answer is: 53.93

Question 7
Correct
Question text
3

Assume you sell short 283 shares of common stock at $33.54 per share, with
initial margin at 50%. Your rate of return if you repurchase the stock at
$38.88/share would be Answer
%. The stock paid no dividends
-31.84

during the period, and you did not remove any money from the account
before making the offsetting transaction. (Note: answer must be accurate to
2 decimal places.)
Feedback

Profit on stock=(33.54-38.88)*283=-1511.22; initial investment =

$33.54*283*0.5= $4745.91. return = (33.54-38.88)*283/(33.54*283*0.5)=31.842576028623%.
The correct answer is: -31.84

Question 8
Correct
Question text
3

If the bid and asked quotes of a Treasury bill with 235 days to maturity are
1.115 and 1.11, respectively. An investor buying the bill with a face value of
$610,000 would pay $Answer
. (Note: answer must be accurate
605580.04

to the nearest cent.)

Feedback
For the investor's purchase price, use the asked quote of 1.11% or 0.0111.
Discount=1.11*235/36000=0.0072. Purchase price=$610,000*(10.0072)=$605580.04.
For the investor's selling price, if the investor is selling the Treasury bill, use
the bid quote of 1.115% or 0.01115. Discount=1.115*235/36000=0.0073.
Sold price=$610,000*(1-0.0073)=$605560.13.
The correct answer is: 605580.04

Question 9
Correct
Question text
3

The price quotations of Treasury bonds in the Wall Street Journal show an ask
price of 86:07 and a bid price of 86:03. As a seller of the bond what is the
dollar price you expect to receive? (Note: answer must be accurate to the
nearest cent.)

Answer:
860.94

Feedback
The seller of the bond would receive the bid price, which is $(86+ 3/32)*10
= $860.9375. As an investor, if you are buying the bond, your purchase
price would be $862.1875. The bond trader would receive $1.25.
The ask price quote of 86:07 may also be reported as 86'07 or 86-07.
The correct answer is: 860.94

Question 10
Correct
Question text
3

Three stocks A, B and C have 600, 800 and 400 shares outstanding,
respectively. The corresponding stock prices are $41.42, $73.99 and $11.70,
respectively. The value-weighted index constructed with the three stocks
using a divisor of 100 is Answer
. (note: answer must be
887.24

accurate to 2 decimal places.)

Feedback
The value weighted index = (41.42*600+73.99*800+11.70*400)/100=
887.24.
The correct answer is: 887.24
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