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Unformatted text preview: FIN 367: Spring 2008 Quiz # 1: Basic Intuition about Risk and Return
January 28, 2008 (SOLUTI 0 Ms) NAME: SECTION: Time allowed: 20 minutes.
Maximum possible score: 20. NOTE: 0 If I cannot understand your calculations, 1 will not be able to give you full credit even
if your ﬁnal answer is correct. You cannot say “these calculations are obvious." o If a problem is missing some key information that you think is necessary to solve
the problem, please ask me to clarify the question or state your confusions clearly.
Alternatively, please make appropriate assumptions, state them clearly and proceed.
No credit will be awarded if you fail to state your confusions or assumptions eXplicitly
even if the question is wrong. 0 Partial credits may be awarded if you show your calculations or provide arguments
to support your answers. Basic Intuition 1, (2 points) Which of the following statements about risk averse investors is true? They only accept investments that offer risk premium over the risk—free rate.
(b) They only care about the rate of return. Mo, 1&5}: (5 Vest! impotha’l‘ v ( c) They accept investments that are fair gambles. ‘
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(d) Both a and b are true statements. ) {:01 “Ifle  (e u ’1 m
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(f) a, b, and c are true statements. F a“ ?qja_‘j_¥ ; 0 . Both b and c are true statements, 2. (2 points) Which statement about portfolio diversiﬁcation is correct? Proper divcrsiﬁcation can reduce or eliminate idiosyncratic risk. (b) Proper diversiﬁcation can reduce or eliminate systematic risk. Canno‘l’ get h‘af 9.? .535 . (c) Proper diversiﬁcation reduces the portfolio’s expected return because it reduces in“; a portfolio’s total risk. (d) The riskvreducing beneﬁts of diversiﬁcation do not occur meaningfully until at least 30 individual securities are included in the portfolio. EVﬂA no) ik 2 Seenvibes
753}: (an be “(related . 3. (2 points) In a fully efﬁcient ﬁnancial market, arbitrage opportunities exist.
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(b) must (c) might not 9 NO ATE. oFPOThKHE‘ (d) might 4. (2 points) If some securities are mis—priced relative to their fundamental values, an arbitrage opportunity ——m exist in the market.
® might OPPOT {'3 f5 “0+ jua'rawhege bCCaqs¢ (b) must it”: M43 19.: MfS?‘}"c€nj Tefa‘h'vc +0 Fuualnuem+a£
(0) must not Vﬁlws butt no "retaix‘ve mispx‘cxaj _ (d) none of the above 5. (2 points) If investors start to discount the future at a higher rate due to some external
shock (e.g., an oil shock) to the economy, the prices of risky assets (cg, stocks) are
likely to: d The deemOMlna‘lot in +k€ Pm‘u‘vj eﬂuaii'aw “0’1”er
ecrease Pm‘(c MRS‘!" 38 down. increase
(c) remain unchanged ((1) none of the above to 6. (2 points) The owner of an American put option has a speciﬁc stock, on or before a speciﬁc date, at a speciﬁc price. a right: sell YD“ are Moi“ Obilba'iegQ +13 exerct‘be The BibHan.
(b) a right, buy ((3) an obligation, sell ((21) an obligation, buy 7. (8 points) You purchase an European call optionon stock XYZ with a strike price
of $60. You pay $3 for the call option. Draw a graph indicating your net proﬁt from
this investment at the expiration date for stock prices in the range of $0 to $90. Please
label the axes clearly. See class notes. ...
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