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FIN 7013

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FIN7013
FIN7013-chap5-8exam

There are 50 multiple choice questions on the exam. Each question is worth 2 points. For a total of 100 points.
Please highlight the correct answer for the multiple choice questions. GOOD LUCK!

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1. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 7%.
What is your approximate annual real rate of return if the rate of inflation was 3% over the year?
A. 4%.
B. 10%.
C. 7%.
D. 3%.
E. none of the above.

2. You purchased a share of stock for $20. One year later you received $1 as dividend and sold
the share for $29. What was your holding period return?
A. 45%
B. 50%
C. 5%
D. 40%
E. none of the above

3. Which of the following determine(s) the level of real interest rates?


I) the supply of savings by households and business firms
II) the demand for investment funds
III) the government's net supply and/or demand for funds
A. I only
B. II only
C. I and II only
D. I, II, and III
E. none of the above

4. Other things equal, an increase in the government budget deficit


A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. increases business prospects.
E. none of the above.

5. Ceteris paribus, a decrease in the demand for loanable funds


A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rate.
D. results from an increase in business prospects and a decrease in the level of savings.
E. none of the above.

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You have been given this probability distribution for the holding period return for KMP stock:

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6. What is the expected holding period return for KMP stock?
A. 10.40%
B. 9.32%
C. 11.63%
D. 11.54%
E. 10.88%

7. What is the expected standard deviation for KMP stock?


A. 6.91%
B. 8.13%
C. 7.79%
D. 7.25%
E. 8.85%

8. Toyota stock has the following probability distribution of expected prices one year from now:

If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is
your expected holding period return on Toyota?
A. 17.72%
B. 18.89%
C. 17.91%
D. 18.18%
E. None of the above

9. In words, the real rate of interest is approximately equal to


A. the nominal rate minus the inflation rate.
B. the inflation rate minus the nominal rate.
C. the nominal rate times the inflation rate.
D. the inflation rate divided by the nominal rate.
E. the nominal rate plus the inflation rate.

10. The historical arithmetic rate of return on small stocks over the 1926-2005 period has been
_______. The standard deviation of small stocks' returns has been ________ than the standard
deviation of large stocks' returns.
A. 12.43%, lower
B. 13.11%, lower
C. 16.24%, higher
D. 17.95%, higher
E. 21.53%, higher

See Table 5-5.


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11. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of
2.5%. What is your approximate annual real rate of return if the rate of inflation was 3.4% over
the year?
A. 0.9%.
B. -0.9%.
C. 5.9%.
D. 3.4%.
E. none of the above.

12. If a portfolio had a return of 12%, the risk free asset return was 4%, and the standard
deviation of the portfolio's excess returns was 25%, the risk premium would be _____.
A. 8%
B. 16%
C. 37%
D. 21%
E. 29%

13. In the mean-standard deviation graph an indifference curve has a ________ slope.
A. negative
B. zero
C. positive
D. northeast
E. cannot be determined

Assume an investor with the following utility function: U = E(r) - 3/2(s2).

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14. To maximize her expected utility, she would choose the asset with an expected rate of return
of _______ and a standard deviation of ________, respectively.
A. 12%; 20%
B. 10%; 15%
C. 10%; 10%
D. 8%; 10%
E. none of the above

15. According to the mean-variance criterion, which one of the following investments dominates
all others?
A. E(r) = 0.15; Variance = 0.20
B. E(r) = 0.10; Variance = 0.20
C. E(r) = 0.10; Variance = 0.25
D. E(r) = 0.15; Variance = 0.25
E. none of these is dominates the other alternatives.

16. The presence of risk means that


A. investors will lose money.
B. more than one outcome is possible.
C. the standard deviation of the payoff is larger than its expected value.
D. final wealth will be greater than initial wealth.
E. terminal wealth will be less than initial wealth.

17. According to the mean-variance criterion, which of the statements below is correct?

A. Investment B dominates Investment A.


B. Investment B dominates Investment C.
C. Investment D dominates all of the other investments.
D. Investment D dominates only Investment B.
E. Investment C dominates investment A.

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18. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference
curves, which of the following is true? Assume that the graph shows expected return on the
vertical axis and standard deviation on the horizontal axis.
I) Steve and Edie's indifference curves might intersect.
II) Steve's indifference curves will have flatter slopes than Edie's.
III) Steve's indifference curves will have steeper slopes than Edie's.
IV) Steve and Edie's indifference curves will not intersect.
V) Steve's indifference curves will be downward sloping and Edie's will be upward sloping.
A. I and V
B. I and III
C. III and IV
D. I and II
E. II and IV

19. The Capital Allocation Line can be described as the


A. investment opportunity set formed with a risky asset and a risk-free asset.
B. investment opportunity set formed with two risky assets.
C. line on which lie all portfolios that offer the same utility to a particular investor.
D. line on which lie all portfolios with the same expected rate of return and different standard
deviations.
E. none of the above.

20. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of
0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. His portfolio's
expected return and standard deviation are __________ and __________, respectively.
A. 0.114; 0.12
B. 0.087;0.06
C. 0.295; 0.12
D. 0.087; 0.12
E. none of the above

21. What percentages of your money must be invested in the risky asset and the risk-free asset,
respectively, to form a portfolio with an expected return of 0.09?
A. 85% and 15%
B. 75% and 25%
C. 67% and 33%
D. 57% and 43%
E. cannot be determined

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22. Treasury bills are commonly viewed as risk-free assets because
A. their short-term nature makes their values insensitive to interest rate fluctuations.
B. the inflation uncertainty over their time to maturity is negligible.
C. their term to maturity is identical to most investors' desired holding periods.
D. Both A and B are true.
E. Both B and C are true.

Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P)
and T-Bills. The information below refers to these assets.

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23. What is the expected return on Bo's complete portfolio?
A. 10.32%
B. 5.28%
C. 9.62%
D. 8.44%
E. 7.58%

24. What is the standard deviation of Bo's complete portfolio?


A. 7.20%
B. 5.40%
C. 6.92%
D. 4.98%
E. 5.76%

25. Market risk is also referred to as


A. systematic risk, diversifiable risk.
B. systematic risk, nondiversifiable risk.
C. unique risk, nondiversifiable risk.
D. unique risk, diversifiable risk.
E. none of the above.

26. Diversifiable risk is also referred to as


A. systematic risk, unique risk.
B. systematic risk, market risk.
C. unique risk, market risk.
D. unique risk, firm-specific risk.
E. none of the above.

27. Other things equal, diversification is most effective when


A. securities' returns are uncorrelated.
B. securities' returns are positively correlated.
C. securities' returns are high.
D. securities' returns are negatively correlated.
E. B and C.

28. Consider an investment opportunity set formed with two securities that are perfectly
negatively correlated. The global minimum variance portfolio has a standard deviation that is
always
A. greater than zero.
B. equal to zero.
C. equal to the sum of the securities' standard deviations.
D. equal to -1.
E. none of the above.

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29. Which of the following statements is (are) true regarding the variance of a portfolio of two
risky securities?
A. The higher the coefficient of correlation between securities, the greater the reduction in the
portfolio variance.
B. There is a linear relationship between the securities' coefficient of correlation and the portfolio
variance.
C. The degree to which the portfolio variance is reduced depends on the degree of correlation
between securities.
D. A and B.
E. A and C.

30. Efficient portfolios of N risky securities are portfolios that


A. are formed with the securities that have the highest rates of return regardless of their
standard deviations.
B. have the highest rates of return for a given level of risk.
C. are selected from those securities with the lowest standard deviations regardless of their
returns.
D. have the highest risk and rates of return and the highest standard deviations.
E. have the lowest standard deviations and the lowest rates of return.

Consider the following probability distribution for stocks A and B:

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31. The expected rates of return of stocks A and B are _____ and _____ , respectively.
A. 13.2%; 9%
B. 14%; 10%
C. 13.2%; 7.7%
D. 7.7%; 13.2%
E. none of the above

32. The standard deviations of stocks A and B are _____ and _____, respectively.
A. 1.5%; 1.9%
B. 2.5%; 1.1%
C. 3.2%; 2.0%
D. 1.5%; 1.1%
E. none of the above

33. The coefficient of correlation between A and B is


A. 0.47.
B. 0.60.
C. 0.58
D. 1.20.
E. none of the above.

34. Portfolio theory as described by Markowitz is most concerned with:


A. the elimination of systematic risk.
B. the effect of diversification on portfolio risk.
C. the identification of unsystematic risk.
D. active portfolio management to enhance returns.
E. none of the above.

35. The unsystematic risk of a specific security


A. is likely to be higher in an increasing market.
B. results from factors unique to the firm.
C. depends on market volatility.
D. cannot be diversified away.
E. none of the above.

36. Security X has expected return of 12% and standard deviation of 20%. Security Y has
expected return of 15% and standard deviation of 27%. If the two securities have a correlation
coefficient of 0.7, what is their covariance?
A. 0.038
B. 0.070
C. 0.018
D. 0.013
E. 0.054

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37. As diversification increases, the total variance of a portfolio approaches ____________.
A. 0
B. 1
C. the variance of the market portfolio
D. infinity
E. none of the above

38. As diversification increases, the firm-specific risk of a portfolio approaches ____________.


A. 0
B. 1
C. infinity
D. n-1 * n
E. none of the above

39. A single-index model uses __________ as a proxy for the systematic risk factor.
A. a market index, such as the S&P 500
B. the current account deficit
C. the growth rate in GNP
D. the unemployment rate
E. none of the above

40. Analysts may use regression analysis to estimate the index model for a stock. When doing
so, the slope of the regression line is an estimate of ______________.
A. the α of the asset
B. the β of the asset
C. the σ of the asset
D. the δ of the asset
E. none of the above

41. In a factor model, the return on a stock in a particular period will be related to _________.
A. firm-specific events
B. macroeconomic events
C. the error term
D. both A and B
E. neither A nor B

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42. Suppose the following equation best describes the evolution of β over time:
β t = 0.31 + 0.82β t-1
If a stock had a β of 0.88 last year, you would forecast the β to be _______ in the coming year.
A. 0.88
B. 0.82
C. 0.31
D. 1.03
E. none of the above

43. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.9RM + eA
If σ M = 0.25 and R2A = 0.25, the standard deviation of return of stock A is _________.
A. 0.2025
B. 0.2500
C. 0.4500
D. 0.8100
E. none of the above

44. Security returns


A. are based on both macro events and firm-specific events.
B. are based on firm-specific events only.
C. are usually positively correlated with each other.
D. A and B.
E. A and C.

45. The expected impact of unanticipated macroeconomic events on a security's return during
the period is
A. included in the security's expected return.
B. zero.
C. equal to the risk free rate.
D. proportional to the firm's beta.
E. infinite.

46. In the single-index model represented by the equation ri = E(ri) + β iF + ei, the term ei
represents
A. the impact of unanticipated macroeconomic events on security i's return.
B. the impact of unanticipated firm-specific events on security i's return.
C. the impact of anticipated macroeconomic events on security i's return.
D. the impact of anticipated firm-specific events on security i's return.
E. the impact of changes in the market on security i's return.

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47. The idea that there is a limit to the reduction of portfolio risk due to diversification is
A. contradicted by both the CAPM and the single-index model.
B. contradicted by the CAPM.
C. contradicted by the single-index model.
D. supported in theory, but not supported empirically.
E. supported both in theory and by empirical evidence.

48. Consider the single-index model. The alpha of a stock is 0%. The return on the market index
is 10%. The risk-free rate of return is 3%. The stock earns a return that exceeds the risk-free rate
by 11% and there are no firm-specific events affecting the stock performance. The β of the stock
is _______.
A. 0.64
B. 0.75
C. 1.17
D. 1.33
E. 1.50

49. Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.25 and σ M was 0.21, the β of the
portfolio would be approximately ________.
A. 0.64
B. 1.19
C. 1.25
D. 1.56
E. none of the above

50. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.94RM + eA
If σ M = 0.30 and R2A = 0.28, the standard deviation of return of stock A is _________.
A. 0.2025
B. 0.2500
C. 0.4500
D. 0.5329
E. none of the above

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