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Exam+II+Practice - Exam II Practice Problems Econ 435 Fall...

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Exam II Practice Problems Econ 435 Fall 2001 There will be MC questions on the lecture note and readings. Below are some practice problems. 1) Stock X has an expected return of 12% and a variance of 30% Stock Y has an expected return of 13% and a variance of 35% There is a risk-free asset with a return of 4% Yingbin and Chris are risk averse. I give Yingbin $100 and tell her to invest it in stock X, stock Y, and a risk-free asset. Yingbin is a Ph.D. candidate so she computes Cov(X,Y) and chooses the portfolio to maximize his utility. She invests $20 in Stock X and $30 in Stock Y. I give Chris $200 and tell him to invest it in stock X, stock Y, and a risk-free asset. Chris maximizes his utility by investing $50 in stock X. How much does Chris invest in the risk-free asset? 2) Stock X and Y have returns consistent with the CAPM. Stock X has a variance of 30% and an expected return of 10%. Stock Y has a variance of 45% and an expected return of 12%. The entire market of risky securities has an expected return of 12% and a variance of 20%. If the risk-free rate is 2%, what is the beta of stock X with the market? 3) Stocks X, Y, and Z have expected returns consistent with the Arbitrage Pricing Theorem. E[R n ] = a + b 1n f 1 + b 2n f 2 + b 3n f 3 Where E[R n ] is the expected return of n-th stock. a = .05 = the risk-free rate The betas of stocks X, Y, Z and a fourth stock, Stock A, can be found in the following table. Stock Expected Return b 1n b 2n b 3n X .1 1 0 0 Y .15 0 1 0 Z .1 0 0 1 A ? -1 1 1 What is the expected return of stock A?
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