Econ 134A
Test 2, Form A
John Hartman
May 20, 2015
Instructions:
YOU WILL TURN IN YOUR SCANTRON AND THE PROBLEMS PAGE. MAKE SURE ALL
WORK AND ANSWERS ARE PROVIDED ON THESE.
You have 40 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.
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.
 Equivalent annual cost problems are in real dollars.
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 5 multiple choice questions (10 points) and 2 problems (13 points). The maximum
possible point total is 24 points. If your test is incomplete, it is your responsibility to notify a proctor to
get a new test.
Grading:
For your reference, an example of a well-labeled graph is below:
Filling in scantron correctly, putting name, perm #, and
section day/time on problems page,
& having photo ID
___/1
(automatic unless something is incorrect)
Multiple choice portion
_____/10
Problems
_____/13
Total score
_____/24
MULTIPLE CHOICE: Answer the following questions on your scantron. 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. Evangelina’s Enchiladas, Inc. 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 4% per year. The final
dividend will be paid 25 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
14% and the current stock value is $80 per share.
A. $8
B. $8.50
C. $8.90
D. $9.20
E. $9.60
2. Two stocks, A and B, have a correlation coefficient of zero. Suppose that you invest 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 18% and the standard deviation of stock B’s return is 8%?
A. 13.3%
B. 13%
C. 12.8%
D. 12.3%
E. 12.1%
3. Over a five-year period, a stock’s annual returns were 5%, 20%, 80%, –10%, and X%. The geometric
average rate of return is 22%. What is X?
A. 15%
B. 18%
C. 21%
D. 26%
E. 32%
4. Gregory is thinking about investing in the Thorny Point Toothbrush Company. If he decides to invest
$80,000 today, he will receive $8,000 every six months, starting six months from today. His effective
annual discount rate is 19%. What is the annual internal rate of return for this investment?
A. 10%
B. 19%
C. 20%
D. 20.5%
E. 21%
5. An asset has a known distribution of rates of return. With 25% probability, the asset will have a 5% rate
of return. With 75% probability, the asset will have a 15% rate of return. What is the standard deviation of
this known distribution?
A. 4.3%
B. 4.5%
C. 4.8%
D. 5.0%
E. 5.4%
Name__________________ Perm #___________ Day/time of section/TA name__________________
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. 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.
6. (8 points) Down South Silly Spoon, Inc. specializes in the production of silly spoons. In anticipation of
a rush of silly spoon purchases, the executives decide to sell bonds to help fund additional spoon
production. Bonds sell today for $60 each, but the face value of the bond is $45. A 20% coupon of the
face value is promised twice: One year from today and two years from today. The bond also matures two
years from today. What is the yield to maturity, expressed as an effective annual interest rate?
7. (5 points) Away for the Day Airlines, Inc. has just paid out its annual dividend today of $3 per share
earlier today. The annual dividend will grow by 20% next year, and an additional 30% the year after. This
will be followed by 5% annual growth in the annual dividend every year after that forever. What will the
price of the stock be 3 years from today if the effective annual interest rate is 10%? (Note: Provide the
price AFTER the dividend has been paid.)
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
C
1 
PV  1 
r  (1  r )T 
Growing perpetuity
C
PV 
rg
Logarithmic rule
ab = c  b = log c / log a
Variance of a sample
1 T
Var 
( Ri  R ) 2

T  1 i 1
Variance of a distribution, with each outcome
having the same probability of occurring
1 T
Var   ( Ri  R ) 2
T i 1
Covariance formula
N
Growing annuity
T
 1
1
1  g  
PV  C 


 
 r  g r  g  1  r  
Quadratic formula
ax2 + bx + c = 0 
x
 b  b 2  4ac
2a
 X ,Y  Cov( X .Y )  
i 1
( xi  x )( yi  y )
N
Correlation of A and B
Cov( A, B)
, where SD stands
Corr ( A, B) 
SD( A)  SD( B)
for standard deviation
Variance of a portfolio
X A2 A2  2 X A X B A,B  X B2 B2