FIN 3710
Investment Analysis
Zicklin School of Business
Baruch College
Spring 2006
Professor Rui Yao
FIN 3710
Final (Practice) Exam 05/23/06
NAME: ______________________________
(Please print your name here)
PLEDGE: ____________________________
(Sign your name here)
Instructions:
1. The exam is closed book and closed notes. You can bring in one page, double-sided,
8×11 formula sheet.
2. You can (and probably have to) use a calculator.
3. You have a total of 120 minutes for the exam.
4. The whole exam has a total of 45 points. It will count 45% for your final course grade.
There are 30 multiple choices questions, each worth 1.5 point.
5. Do not separate the exam book. Turn in the entire exam at the end.
6. Budgeting your time efficiently.
7. Good luck.
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Please use the following table for your answer to the multiple choice questions
Question
Your Answer
Question
1
16
2
17
3
18
4
19
5
20
6
21
7
22
8
23
9
24
10
25
11
26
12
27
13
28
14
29
15
30
Total
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Your Answer
1. According to the capital asset pricing model, a well-diversified portfolio's rate of return is
a function of __________.
A) market risk
B) unsystematic risk
C) unique risk
D) reinvestment risk
2. According to the capital asset pricing model, fairly priced securities have __________.
A) negative betas
B) positive alphas
C) positive betas
D) zero alphas
3. The beta, of a security is equal to __________.
A) the covariance between the security and market returns divided by the variance of
the market's returns
B) the covariance between the security and market returns divided by the standard
deviation of the market's returns
C) the variance of the security's returns divided by the covariance between the security
and market returns
D) the variance of the security's returns divided by the variance of the market's returns
4. __________ is not a true statement regarding the capital market line.
A) The capital market line always has a positive slope
B) The capital market line is also called the security market line
C) The capital market line is the best attainable capital allocation line
D) The capital market line is the line from the risk-free rate through the market portfolio
5. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of
13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of
return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio __________ and a long position in portfolio
__________.
A) A, A
B) A, B
C) B, A
D) B, B
6. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is
5% and the market expected rate of return is 15%. According to the capital asset pricing
model, security X is __________.
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A)
B)
C)
D)
fairly priced
overpriced
underpriced
None of the above answers are correct
7. Which one of following is NOT among the CAPM assumptions _____________
A) all investors have the same risk aversions
B) all investors share the same beliefs about expected return and variance for difference
securities
C) no transaction costs in buying and selling stocks
D) all investors have common investment horizon
8. You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of
.90. The beta of this formed portfolio is __________.
A) 1.14
B) 1.20
C) 1.26
D) 2.40
9. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock
X with a beta of .8 to offer a rate of return of 12 percent, then you should __________.
A) buy stock X because it is overpriced
B) buy stock X because it is underpriced
C) sell short stock X because it is overpriced
D) sell short stock X because it is underpriced
10. The risk-free rate and the expected market rate of return are 5% and 15% respectively.
According to the capital asset pricing model, the expected rate of return on security X
with a beta of 1.2 is equal to __________.
A) 12%
B) 17%
C) 18%
D) 23%
11. The expected return on the market portfolio is 15%. The risk-free rate is 8%. The
expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common
stock is 1.25. Within the context of the capital asset pricing model, __________.
A) SDA Corp. stock is underpriced
B) SDA Corp. stock is fairly priced
C) SDA Corp. stock's alpha is -0.75%
D) SDA Corp. stock alpha is 0.75%
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12. You purchase one IBM July 120 call contract for a premium of $5. You hold the option
until the expiration date when IBM stock sells for $123 per share. You will realize a
______ on the investment.
A) $200 profit
B) $200 loss
C) $300 profit
D) $300 loss
13. You purchase one IBM July 120 put contract for a premium of $5. You hold the option
until the expiration date when IBM stock sells for $123 per share. You will realize a
______ on the investment.
A) $300 profit
B) $200 loss
C) $500 loss
D) $200 profit
14. A(n) ______ option can only be exercised on the expiration date.
A) Mexican
B) Asian
C) American
D) European
15. All else the same, an ______ style option will be ______ valuable than a ______ style
option.
A) American, more, European
B) American, less, European
C) American, more, Canadian
D) American, less, Canadian
16. The writer of a put option ________________.
A) agrees to sell shares at a set price
B) agrees to buy shares at a set price
C) acquires the opportunity to buy shares at a set price
D) acquires the opportunity to sell shares at a set price
17. A put option on Snapple Beverage has an exercise price of $30. The current stock price
of Snapple Beverage is $24.25. The put option is __________.
A) at the money
B) in the money
C) out of the money
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D) none of the above
18. A writer of a call option will want the value of the underlying asset to __________ and a
buyer of a put option will want the value of the underlying asset to __________.
A) decrease, decrease
B) decrease, increase
C) increase, decrease
D) increase, increase
19. You buy one Chrysler August 50 call contract and one Chrysler August 50 put contract.
The call premium is $4.25 and the put premium is $4.50. Your strategy is useful if you
believe that the stock price __________.
A) will be lower than $41.25 in August
B) will be between $41.25 and $58.75 in August
C) will be higher than $58.75 in August
D) either a or c
20. The ___ is the stock price minus exercise price, or the profit that could be attained by
immediate exercise of an in-the-money call option.
A) Intrinsic value
B) Time value
C) State value
D) None of the above
21. A call option on Juniper Corp. stock with an exercise price of $75 and an expiration date
one year from now is worth $5.00 today. A put option on Juniper Corp. stock with an
exercise price of $75 and an expiration date one year from now is worth $2.75 today.
The risk-free rate of return is 8% and Juniper Corp. pays no dividends. The stock should
be worth __________ today.
A) $66.25
B) $71.69
C) $73.12
D) $77.25
22. According to the put-call parity theorem, the payoffs associated with ownership of a call
option can be replicated by __________________.
A) shorting the underlying stock, borrowing the present value of the exercise price, and
writing a put on the same underlying stock and with same exercise price
B) buying the underlying stock, borrowing the present value of the exercise price, and
buying a put on the same underlying stock and with same exercise price
C) buying the underlying stock, borrowing the present value of the exercise price, and
writing a put on the same underlying stock and with same exercise price
D) None of the above
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23. A hedge ratio of .70 implies that a hedged portfolio should consist of __________.
A) long .70 calls for each short stock
B) long .70 shares for each long call
C) long .70 shares for each short call
D) short .70 calls for each long stock
24. The delta of an option is __________.
A) the change in the value of an option for a dollar change in the price of the underlying
asset
B) the change in the value of the underlying asset for a dollar change in the call price
C) the percentage change in the value of an option for a one percent change in the value
of the underlying asset
D) the percentage change in the value of the underlying asset for a one percent change in
the value of the call
25. Lucy Corp. stock is current trading at $100 per share. You try to price an at-the-money
call on Lucy Corp. stock with one year expiration using one-period binomial model. You
believe that Lucy’s stock will either double or cut by half in a year. If the borrowing rate
is 5 % per year, what should be the price of the call option?
A) $00.00
B) $33.33
C) $34.92
D) $66.67
26. Using the information from Q25, what will be the hedge ratio for the call option if the
strike price is $125 __________.
A) 0
B) 1/3
C) 1/2
D) 1
Use the information below to answer question 27-28
Bond A is a one-year zero coupon bond selling at 900.
Bond B is a two-year zero coupon bond selling at 800.
Bond C is a two-year bond with annual coupon at 10% coupon rate.
All three bonds have a face value of $1000.
27. To eliminate arbitrage opportunity, what should be the price of bond C based on
information about bond A and bond B?
A) $ 950.00
B) $ 970.00
C) $1000.00
D) $1030.00
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28. If bond C is traded at par, what can you do to make money?
A) Nothing – bond C is correctly priced
B) Long bond A and B, and short bond C
C) Short bond A and B, and long bond C
D) Bond bond A and B and C.
29. Stock A has a beta of 1 and standard deviation of 50%. Market portfolio has a standard
deviation of 20%. What is the correlation of stock A with the market portfolio
A) 0.0
B) 0.2
C) 0.4
D) 1.0
30. How much of stock A’s total risk is due to market risk?
A) 0 %
B) 16%
C) 40%
D) 100%
For additional review questions from the first two midterms, please review:
From first practice midterm:
From second practice midterm:
Question 2, 6, 14, 16-20
Question 3, 12-15, 19, 21-25
Suggested solutions:
ADABC BACBB CBCDA BBADA BBCAC CBBCB
Page 8
Detailed solution for selected questions:
Q5.
Long 2 shares in A and short 1 share of B will eliminate factor risk, yet yield an expected return
of
2*13% - 15% = 11%
yet according to APT it should only get riskfree rate of 10%
Q6.
Market has a beta of 1. So market risk premium = E(rm) – rf = 15% - 5% = 10%. So security X
should receive an expected return of
5% + 1.15 * 10% = 16.5%
at 13% expected return, the price is too high
Q8.
Portfolio beta shuld be
0.6 * 1.5 + 0.4 * 0.9 = 1.26
Q9.
Market risk premium is
11% - 4% = 7%
so X should expect an return of
4% + 0.8 * 7% = 9.6%
at 12%, X is underpriced (note: price and return move in the opposite direction).
Q10.
Market risk premium is
15% - 5% = 10%
so X should expect an return of
5% + 1.2 * 10% = 17%
Q11.
Market risk premium is
15% - 8% = 7%
so X should expect an return of
8% + 1.25 * 7% = 16.75%
at 16%, X has a negative alpha = 16% - 16.75% = - 0.75%
Q12.
option payoff = 123 – 120 = 3; option profit = 3 -5 = -2
For one contract, which is 100 call options, profit = -2 * 100 = - 200
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Q13.
option will be out of money and you lost the whole 5*100 = 500 dollars.
Q19.
this is the case of straddle buy long call and put with the same strike prices. You profit from
dramatic price movement of either direction. You need the price to move at least
4.25 + 4.50 = 8.75
either up or down to make a profit.
Q21.
this question is another way to use put-call parity relationship
S = C – P + PV(X) = 5.00 – 2.75 + 75 / (1+0.08) = 71.69
Q25.
at-the-money call has a strike price of $100. hedge ratio is
(100 – 0) / (200 – 50) = 2/3
the certain payoff with 2/3 share of stock and 1 call written is
2/3 * 50 = 2/3 * 200 – 100
the call should have a price of
2/3 * S0 – (100/3) / (1+5%) = 34.92
Q26.
Hedge ratio will be smaller
(75 – 0) / (200 – 50) = ½
Q27.
0.1 of bond A and 1.1 of bond B can exactly replicate the payoff of bond C. So bond C should
have a price of
0.1*900 + 1.1*800 = 970
Q28.
if bond C is traded at face value of $1000, then it is too expensive. Buy 0.1 of A and 1.1 of B
while short 1 share of bond C will lead to a certain cash flow today of $30, with no future liability
associated with the portfolio strategy later.
Q29.
correlation = cov(ri, rm) / [std(ri) std(rm)] = cov(ri, rm) / var(rm) * [std(rm) / std(ri)]
= beta * [std(rm) / std(ri)] = 1 * (0.2 / 0.5) = 40%;
Q30.
R2 = correlation2 = 16% = beta2*var(rm) / var(ri) = 16%
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