Econ 134A
Test 2, Version B
Instructions:
John Hartman
September 1, 2015
You have 80 minutes to complete this test, unless you arrive late. Late arrival will lower the time available to you, and you must finish at the same time as all other students.
Each question shows how many points it is worth. Show all work in order to receive credit. You will receive partial credit for incorrect solutions in some instances. Clearly circle your answer(s) or else you may not receive full credit for a complete and correct solution.
Cheating will not be tolerated during any test. Any suspected cheating will be reported to the relevant authorities on this issue.
You are allowed to use a nonprogrammable four-function or scientific calculator that is NOT a communication device. You are NOT allowed to have a calculator that stores formulas, buttons that automatically calculate IRR, NPV, or any other concept covered in this class. You are NOT allowed to have a calculator that has the ability to produce graphs. If you use a calculator that does not meet these requirements, you will be assumed to be cheating.
Unless otherwise specified, you can assume the following:

Negative internal rates of return are not possible.
You are allowed to turn in your test early if there are at least 10 minutes remaining. As a courtesy to your classmates, you will not be allowed to leave during the final 10 minutes of the test.
Your test should have 12 multiple choice questions (24 points) and 2 problems (14 points), one with multiple parts. The maximum possible point total is 39 points. If your test is incomplete, it is your responsibility to notify a proctor to get a new test.
For your reference, an example of a well-labeled graph is below:
Grading:
Filling in name, perm #, TA name, and day/time of section, & having photo ID
____ /1
(
)
Multiple Choice _____/24
Problems
Total score
_____/14
_____/39

MULTIPLE CHOICE: Answer the following questions by circling your answer on this test. Each correct answer is worth 2 points. All incorrect or blank answers are worth 0 points. If there is an answer that does not exactly match the correct answer, choose the closest answer.
1. Jack’s Jumpers is expected to pay out dividends as follows: A $ C dividend will be paid one year from today. Each subsequent dividend will be paid yearly, and grow by 3% per year. The final dividend will be paid 30 years from today. After the final dividend is paid, the company will go out of business and never pay out anything to stock holders again. Find C if the effective annual discount rate is 10% and the current stock value is $50 per share.
A. $3.50 B. $4.00 C. $4.50 D. $5.00 E. $5.50
2. Two stocks, A and B, have a covariance of zero. Suppose you invest in a portfolio of 70% of your money in stock A and 30% of your money in stock B. What is the standard deviation of this portfolio if the standard deviation of stock A’s return is 3% and the standard deviation of stock B’s return is 8%?
A. 3% B. 4% C. 6% D. 8% E. 10%

3. In the fictional country of Hogwin Castle, the average bond return was 5.4% in 2012, followed by 2.4% in 2013, and 8.3% in 2014. The average return on stocks in these years was 12.5%, 9.4%, and 6.3%, respectively. What was the average equity risk premium in Hogwin Castle over this three-year period.
Use the arithmetic mean.
A. 0.5% B. 1.5% C. 2.5% D. 4.0% E. 6.3%
4. POYTR, Inc. will not pay its first dividend until 6 years from today. This dividend will be $1, with each subsequent dividend payment decreasing by 10%. What is the present value of the stock if the effective annual discount rate is 8%?
A. Infinity B. $50 C. $10 D. $6 E. $4
5. Sheraby Slim Clothing, Inc. has a beta value of 3.5 and has an expected return of 31%. The expected return on the market is 10%. What is the risk-free rate?
A. 1.5% B. 2.5% C. 3.5% D. 4.5% E. 5.5%

6. A portfolio of stock is worth $9,000 today, it was worth $10,000 one year ago, $8,000 two years ago, and $7,000 three years ago. What is the geometric average rate of return over the last three years?
A. 10.2% B. 9.8% C. 9.5% D. 9.1% E. 8.7%
7. Futuristiche Electronics currently expects to pay out $5 in dividends (per share) each year, starting a year from today, with an effective annual discount rate of 15%. However, the company wants to increase its stock value to $40 per share by developing a product that pays out an additional special dividend 8½ years from today. How much will this dividend have to be in order to increase the stock value to $40?
A. $18 B. $20 C. $22 D. $24 E. $26
8. A zero-coupon bond is currently selling for $200. The bond will pay out $550 in 6½ years. What is the effective annual interest rate on this bond?
A. 16% B. 17% C. 18% D. 19% E. 20%

9. A stock’s rate of return over an 8-year period were –7%, 10%, 0%, 31%, –20%, 13%, 50%, and –50%.
What is the geometric average rate of return over this 8-year period?
A. –1% B. 0% C. 1% D. 2.2% E. 3.5%
10. Three stocks have annual returns of 4%, 6%, and 8%. The standard deviation of this sample is
A. 1.3% B. 2% C. 2.7% D. 3.5% E. 4%

11. Fruitcrush, Inc. has issued a bond with 15 remaining coupon payments of $130 each. The first will be paid in 9 months, and each subsequent payment will be made annually on the same date. The bond will also pay a face value of $1,000 on the same date as the last coupon payment. What is the present value of the bond if the effective annual interest rate is 12%?
A. $2900 B. $1900 C. $1400 D. $1100 E. $900
12. Marleigh buys a stock that pays a dividend of $5 today, followed by dividends that will be paid forever. The dividend will be paid every six months. Each subsequent dividend is 2% higher than the previous one. If these dividends will continue forever, what is the present value of the stock. Assume an effective annual interest rate of 12.36%.
A. $48 B. $54 C. $90 D. $125 E. $133

Name_____________________________________ Perm #________________________________
For the following problems, you will need to write out the solution. You must show all work to receive credit. Each problem (or part of problem) shows the maximum point value. Provide at least four significant digits to each answer or you may not receive full credit for a correct solution.
13. Alejandra is only interested in investing in either Halo Thick Donuts stock and a risk-free bond. Halo
Thick Donuts could have a rate of return of 0% or 38%, each with 50% probability. The risk-free bond has a rate of return of 10%.
(a) (3 points) If Halo Thick Donuts stock has a beta value of 1.9, what is the expected return of a stock with the same beta value as the market portfolio?
(b) (5 points) What is the standard deviation of a portfolio of 1/3 of Halo Thick Donuts stock and 2/3 of the risk-free bond?

14. (6 points) Goody Cowboy Horse, Inc. will pay dividends of $5 every 6 months, starting 7 months from today. What is the present value of this stock assuming a stated annual interest rate of 14%, compounded three times per year?

NOTE: YOU CAN TEAR THIS SHEET OFF
AND USE AS EXTRA SCRATCH PAPER.
PLEASE NOTE THAT ANYTHING ON
THIS SHEET WILL NOT BE GRADED
UNLESS EXPLICITLY SPECIFIED ON
THE TEST.
Perpetuity
PV

C r
Annuity
PV

C r

 1

( 1

1 r )
T


Growing perpetuity
PV
 r
C
 g
Growing annuity
PV

C


 r
1
 g
 r
1
 g
 x
Quadratic formula ax
2
+ bx + c = 0


 b
 b
2 
4 ac
2 a
1

1
 g r
 T



Logarithmic rule a b
= c

b = log c / log a
Variance of a sample
Var

T
1

1 i
T 

1
( R i

R )
2
Variance of a distribution, with each outcome having the same probability of occurring
Var

1
T
T  i

1
( R i

R )
2
Covariance formula

X , Y

Cov ( X .
Y )
 i
N 

1
( x i
 x )( y i
N
 y )
Correlation of A and B
Corr ( A , B )

Cov ( A , B )
SD ( A )

SD ( B )
, where SD stands for standard deviation
Variance of a portfolio
X
2
A

2
A

2 X
A
X
B

A , B

X
2
B

B
2