BUS 330
Spring 2015
Exam 2 For Real Test
Name____________________________
ID # _____________________________
Part I
Instructions: Select the ONE BEST response to each question below.
Some of the questions below may require you to understand how to use one or more of the following
Excel functions:
=nper(rate, pmt, pv, [fv], [type])
=pmt(rate, nper, pv, [fv], [type])
=pv(rate, nper, pmt, [fv], [type])
=fv(rate, nper, pmt, [pv], [type])
=rate(nper, pmt, pv, [fv], [type], [guess])
1. Suppose investors do not care about risk and do not require additional return in order to be
persuaded to hold a risky asset instead of a risk-free asset. If a Treasury note maturing in 3 years
has a 2.5% yield-to-maturity, and a similar Treasury note maturing in 4 years has a 2.6% yield to
maturity, then the interest rate investors expect to receive on one year notes starting 3 years
from now is:
a.
b.
c.
d.
e.
Approximately 2.8%.
Approximately 3.3%.
Approximately 2.9%.
Approximately 3.0%.
Approximately 3.1%.
2. Suppose investors do not care about risk and do not require additional return in order to be
persuaded to hold a risky asset instead of a risk-free asset. If investors believe that one-year
interest rates will be 2.0% in 2015 and 2016, 2.3% in 2017, and 2.9% in 2018, then the yield-tomaturity on a 3-year bond on January 1, 2015 should be ____ and the yield-to-maturity on a 4year bond should be _____.
a.
b.
c.
d.
e.
2.3%
2.15%
2.2%
2.1%
2.3%
2.4%
2.5%
2.7%
2.3%
2.9%
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3. Suppose you purchase a car for $20,000 and you make $1000 monthly payments for 24 months.
Which excel command will return the annual interest rate you are paying on the loan?
a.
b.
c.
d.
e.
=rate(2, -1000, 0, 20000)
=rate(24, 1000, 0, -20000)
=rate(2, 12000, 20000,0)
20000=pv(rate, 24, 1000)
None of the above.
4. If a bond is callable, that is ____ for the bond buyer. Given that the bond is callable, a higher call
premium is ____ for the bond buyer.
a.
b.
c.
d.
e.
good
good
good
bad
bad
bad
bad
good
None of the above.
5. In the USA, home buyers typically borrow money for 30 years at fixed interest rates to finance
the purchase of their homes. The bank lender collects a penalty payment if the homeowner
(borrower) decides to pay off the loan early. When interest rates fall, homeowners find that
they can lower their monthly loan payments by “re-financing” – taking out a new loan at the
lower interest rate that is used to pay off the old loan plus the early payment penalty. This
process makes the home loan similar to:
a.
b.
c.
d.
e.
A bond with warrants.
A convertible bond.
A callable bond.
A risk-free asset.
A perfectly-diversified market portfolio asset.
6. You own a bond with a face value (principal) of $1000, which matures in 10 years with a 6%
annual coupon rate. The bond issuer can call the bonds in 2 years if he pays a 10% call premium.
Which excel command will return your yield-to-call if the bond sells today for $1020?
a.
b.
c.
d.
e.
=rate(2,60,-1020,1100)
=pv(6%,10,60,1100)
=pv(6%, 2, 60,1100)
=rate(10, 60, -1020, 1000)
=rate(10, 60, -1020, 1100)
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7. The CAPM says that the ____ paid by an asset should be directly proportional to its _____.
a.
b.
c.
d.
e.
Expected return
Expected return
Expected return
Risk premium
Risk premium
variance
standard deviation
risk premium
stand-alone risk
“beta”
8. Risk that remains in a perfectly-diversified portfolio of assets is _____ risk. Risk that can be
reduced or eliminated by diversification is _____ risk.
a.
b.
c.
d.
e.
Stand-alone
Diversifiable
Market
Market
Diversifiable
diversifiable
stand-alone
stand-alone
diversifiable
market
9. If you write the return on the market asset as:
RET(M)i = RM + mi
Where RM is the expected return and mi is the deviation from the expected return in outcome i,
and the return on asset X is written as:
RET(X)i = RX + ai + 2.5▪mi
Where RX is the expected return on asset X and ai is a risk factor that is independent of mi , then
the covariance between the return on asset M and asset X will be:
a. RX – RM
b. (RX – RM)/σM2
c. (σM2 + σa2)/ σM2
d. 2.5
e. 2.5* σM2
10. I have $1 to begin my portfolio. Asset A that has a “beta” of -1, and asset B has a “beta” of 2.
How would I construct a portfolio out of assets A and B with a beta of one?
a.
b.
c.
d.
e.
Half of my money should be in A, half in B.
Two-thirds of my money in A, one-third of my money in B.
Borrow $1 of asset A and sell, use the money to buy $2 of asset B.
Borrow $2 of asset A and sell, use the money to buy $3 of asset B
None of the above.
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11. In order to create a portfolio worth $1 out of the “perfectly-diversified-market-portfolio” asset
M and the risk-free asset RF that has a “beta” equal to 3/4, the portfolio should contain ____
dollars of asset M and _____ dollars of asset RF.
a.
b.
c.
d.
e.
3/4
4/5
3
4
4
1/4
1/5
1
1
-3
12. According to CAPM, _____ risk can pay a risk premium because this is the risk that remains after
all attempts to reduce risk through _____ have been made.
a.
b.
c.
d.
e.
Stand-alone
Market
Interest rate
Diversifiable
None of the above.
diversification
diversification
leverage
financial engineering
13. If diversification is costless, tax distortions do not exist, and all assets are priced so that there
are no arbitrage opportunities, then:
(i)
(ii)
(iii)
(iv)
a.
b.
c.
d.
e.
Only the degree of market risk in an asset will generate a risk premium.
Every asset will pay a risk premium directly proportional to its beta.
Every portfolio of assets will pay a risk premium directly proportional to its beta.
The total value of a firm’s debt plus equities does not depend on what proportion is debt
and what proportion is equity.
Only (i) and (ii) are true.
Only (ii) and (iii) are true.
Only (iii) and (iv) are true.
Only (i) and (iv) are true.
(i), (ii), (iii), and (iv) are all true.
14. The amount of risk per unit of return, calculated as the standard deviation divided by the
expected return , is the:
a.
b.
c.
d.
e.
beta.
Standard deviation.
Covariance.
Stand-alone risk.
Coefficient of variation.
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15. A firm has $200 of assets that is financed 100% by equity. The beta of the company is 2. If the
management then issues $100 of risk-free debt to buy back the equity so that the company is
now 50% debt-financed and 50% equity-financed, the new value of beta of the company is:
a.
b.
c.
d.
e.
3
2.5
1
4
1.5
16. The flow of funds that can be used to pay interest to creditors, dividends to stockholders, or
used to finance debt reduction or stock buy-backs (without disrupting the normal operation of
the firm) is:
a.
b.
c.
d.
e.
Free cash flow.
Earnings before interest and taxes
Net Operating Working Capital
Net Income
None of the above.
17. If an investor pays a price P0 for a share that provides a dividend D1 beginning in time period 1
(the next period after zero), and the dividend will grow at the constant rate g forever so that:
D2 = (1+g)▪D1 and D3 = (1+g)▪D2 ; then the valuation of the share through the present value of
dividends will be:
a.
b.
c.
d.
e.
D1/(1+r - g)
D1 ▪ [g -r]
D1 ▪ [1+r +r2 + r3 + r4 +…]/g
D1/(r – g)
None of the above.
18. If investors require an 5% return on company Z’s debt, a 8% return on preferred stock, and a
10% return on company Z’s common stock, and company Z’s current capital structure is 50%
debt, 20% preferred stock and 30% equity, then company Z’s weighted-average-cost-of-capital
is:
a.
b.
c.
d.
e.
8%
7.1%
4.9%
5.5%
9.5%
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19. If your bank offers auto financing loans for 8% annual interest, which excel command will return
the monthly payment you would make (a negative number) if you borrow $18,000 to buy a car
and repay the loan with equal payments over 24 months?
a.
b.
c.
d.
e.
=pmt(8%/12, 24, 18000)
=pmt(8%*12, 24/12, 18000)
=pmt(8%, 24*12, 18000)
=pmt(8%, 24, 18000/12)
None of the above.
20. A student is trying to use Excel to find the annual interest rate for a $15,000 loan with 36
monthly payments of $600. He types into Excel:
=rate(36, 600, 15000) and receives the response: #NUM!
In order to get the correct answer he is seeking, he needs to:
a.
b.
c.
d.
e.
Divide the 36 by 12.
Divide the 1000 by 12.
Divide the 15000 by 12.
Change the “600” to “-600”.
None of the above.
Part II
Instructions: Answer the following questions, show your computations where applicable. (Use the back
of the page(s).
Suppose the perfectly-diversified-market-portfolio (asset M) pays a 15% return 50% of the time, and a
minus 5% return 50% of the time.
Suppose you are studying the return paid by asset X. You find that when asset M pays a 15% return,
asset X pays a 30% return 60% of the time, and a 10% return 40% of the time. When asset M pays a
minus 5% return, asset X pays a 0% return 60% of the time, and a minus 20% return 40% of the time.
1. Find the value of “beta” for asset X.
2. If asset X is priced correctly according to the Capital Asset Pricing Model, what is the risk-free
interest rate?
3. What return would you expect from your $1 portfolio if you borrowed $1 at the risk-free
interest rate and purchased $2 of asset X?
4. Assume that the risk-free rate is at the level you computed in question 2. Assume also that
company X initially has equal values of debt and equity outstanding, so it has financed its assets
until now with 50% debt and 50% shares. Suppose the management of company X is purchasing
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a rival company in the same industry. The acquisition will be financed entirely by issuing new
shares. The resulting company will be 50% bigger than company X is right now. What will
happen to the value of beta of company X shares once the acquisition is made? (Assume there
are no economies of scale or duplicated costs that can be eliminated when the acquisition is
completed.)
Hint: a good answer will tell me whether beta changes, and if so, in what direction. A great
answer will tell me what the new value of beta will be.
5. When the company’s management is considering the purchasing the rival in the industry, how
important should the consideration of how much shares and how much debt be in their decision
whether-or-not to make the deal? Explain your answer.
Part III Extra Credit
One point for each question
1. Whenever you discover what you believe to be an arbitrage opportunity, you should respond
by:
(i)
(ii)
(iii)
(iv)
(v)
a.
b.
c.
d.
e.
Buying at the low price and sell at the high price
Exploiting the opportunity as much as possible
Exploiting the opportunity as quickly as possible.
Double-checking your math and logic to make sure you aren’t making some mistake.
Start making a buzzing sound while wiggling your fingertips.
Only (i) and (ii) are true.
Only (ii) and (iv) are true.
Only (iii) and (v) are true.
Only (i), (iii), and (iv) are true.
(i), (ii), (iii), (iv), and (v) are all true.
2. Which of the following puns is funniest? (The answer selected by the most people is correct.)
a.
b.
c.
d.
e.
I dropped out of communism class because of lousy Marx.
When you get a bladder infection urine trouble.
I stayed up all night to see where the sun went. Then it dawned on me.
Jokes about German sausage are the wurst.
There were two ships. One had red paint, one had blue paint. They collided. At last report,
the survivors were marooned.
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