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Unformatted text preview: 132 A Final KEY 1. According to the Capital Asset Pricing Model (CAPM), under priced securities 3.. have positive betas.
b. have zero alphas. e. have negative betas.
Q have positive alphas.
e. none of the above. Bodie  Chapter 09 #12
Difficulty: Moderate 2. Suppose that the average P/E multiple in the oil industry is 22. Exxon Oil is expected to have an EPS of $1.50
in the coming year. The intrinsic value of Exxon Oil stock should be A $33.00
b. $35.55
c. $63.00
cl. $72.00
e. none of the above 22 X $1.50 = $33.00. Bodie  Chapter [8 #54
Diﬁiculty: Easy 3. An important difference between CAPM and APT is a. CAPM depends on riskreturn dominance; APT depends on a no arbitrage condition. b. CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few
large changes are required to bring the market back to equilibrium. 0. implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments. d. all of the above are true. 2 both A and B are true. Under the riskreturn dominance argument of CAPM, when an equilibrium price is violated many investors will
make small portfolio changes, depending on their risk tolerance, until equilibrium is restored. Under the no
arbitrage argument of APT, each investor will take as large a position as possible so only a few investors must act
to restore equilibrium. implications derived from APT are much stronger than those derived from CAPM, making
C an incorrect statement. Eadie  Chapter it? #35
Dg’ﬁeuigv: Egbert?! 4. Given the following two stocks A and B Scourrm wasted rate of return Beta
A 0 12 1.2 B 0.14 1.8 If the expected market rate of return is 0.09 and the riskfree rate is 0.05, which security would be considered
the better buy and why? a. A because it offers an expected excess return of 1.2%.
b. B because it offers an expected excess return of 1.8%.
Q A because it offers an expected excess return of 2.2%.
d. B because it offers an expected return of 14%. e. B because it has a higher beta. A’s excess return is expected to be 12% — [5% + 1.2(9%  5%)] = 2.2%. B's excess return is expected to be 14% 
[5% + 1.8(9%  5%)] = 1.8%. Bodie  Chapter 09 #32
Diﬂiculty: Moderate 5. An investor invests 40 percent of his wealth in a risky asset with an expected rate of return of 0.18 and a
variance of 0. 1 0 and 60 percent in a Tbill that pays 4 percent. His portfolio’s expected return and standard deviation are and , respectively. a. 0.114;0.112
b. 0.087; 0.063
Q 0.096; 0.126
d. 0.087; 0.144
e. none of the above E(r )= 0.4(18%)+ 0.6(4%) = 9.6%; s = 0.40310)”2 = 12.6%.
P P Bodfe — Chapter 06 #50
Diﬁicuhjv: Moderate 6. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B has a
beta of 0.8 and an expected return of 12%. The riskfree rate of return is 6%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio and a long position in
portfolio 3 a. A
b. A,
_C_ B»
d. B
e. U33>CU> w :3" A, t e riskless asset A: 16% = 1.0F + 6%; F = 10%; B: 12% = 0.8F + 6%: F = 7.5%; thus, short B and take a long position in A. Bodie  Chapter [0 #9
Dijﬁculty: Moderate 7. Which of the following orders is most useful to short sellers who want to limit their potential losses? a. Limit order
b. Discretionary order
0. Limitloss order _I__)_ Stopbuy order
e. None of the above By issuing a stopbuy order, the short seller can limit potential losses by assuring that the stock will be purchased
(and the short position closed) if the price increases to a certain level. Bodie  Chapter 03 #23
Difﬁculty: Moderate 8. The provides an unequivocal statement on the expected returnbeta relationship for all assets,
whereas the implies that this relationship holds for all but perhaps a small number of securities. a. APT, CAPM b. APT, 0PM Q CAPM, APT d. CAPM, 0PM e. none of the above The CAPM is an asset~pricing modei based on the risidreturn relationship of all assets. The APT impiies that this
relationship holds for all well—diversiﬁed portfoiios, and for all but perhaps a few individual securities. tiedie ~ Chapter IQ #8
Difﬁculty: Moderate 9. Consider a Tbill with a rate of return of 5 percent and the following risky securities:
Security A: E(r) = 0.15; Variance = 0.04
Security B: E(r) = 0.10; Variance = 0.0225
Security C: E(r) = 0.12; Variance = 0.01
Security D: E(r) = 0.13; Variance = 0.0625
From which set of portfolios, formed with the T—bill and any one of the 4 risky securities, would a risk—averse
investor always choose his portfolio? a. The set of portfolios formed with the Tbill and security A.
b. The set of portfolios formed with the T—bill and security B.
Q The set of portfolios formed with the T—bill and security C.
d. The set of portfolios formed with the T—bill and security D. e. Cannot be determined. Security C has the highest rewardto—volatility ratio. Bodée ~ Chapter 06 #32
Difficulty: Dwicult Suppose you purchase one IBM May 100 call contract at $5 and write one IBM May 105 call contract at $2.
Eadie  Chapter 20 10. The maximum loss you could suffer from your strategy is a. $200.
_1_3_ $300. C. zero. (1. $500.
e. none of the above. —$5 + $2 = —$3 X 100 = —$300. Bodie  Chapter 20 #69
Dgﬁcuity: Dgﬁicult 11. If, at expiration, the price ofa share of IBM stock is $103, your proﬁt would be a. $500.
b. $300.
$2 zero.
(1. $100.
e. none of the above. $103 ~ $i00 = $3  $5 2 $2; +$2; $0 X100 x $0. Eadie ~ Chapter 20 #68
Dtﬂiculty: Dsﬂicult 12. What is the lowest stock price at which you can break even? a. $101.
1). 102.
Q $103.
d. $104.
e. none of the above. x = $100 +$5 ~$2gx= $103. Eadie u Chapter 20 #70
Difﬁculty: Dzﬁicuh 13. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would
be the maintenance margin if a margin call is made at a stock price of $60? a. 40%
B 33% c. 35%
d. 25%
e. none of the above $5,000 X 1.6 = $8,000; [$8,000  lOO($60)]/IOO($60) = 33%. Bodie — Chapter 03 #20
Dtﬁkulty: Diﬁicult 14. The riskiness of individual assets a. should be considered for the asset in isolation.
b. should be considered in the context of the effect on overall portfolio volatility.
c. combined with the riskiness of other individual assets (in the proportions these assets constitute of the entire portfolio) should be the relevant risk measure. 12 B and C.
e. none of the above. The relevant risk is portfolio risk; thus, the riskiness of an individual security should be considered in the context
of the portfolio as a whole. Eadie u Chapter 06 #1 ?
Dggicaigfz Easy 15. The market capitalization rate on the stock of F lexsteel Company is 12%. The expected ROE is 13% and the
expected BPS are $3.60. If the ﬁrm’s plowback ratio is 75%, the P/E ratio will be a. 7.69
b. 8.33
c. 9.09 2 11.11
e. none of the above g = 13% X 0.75 = 9.75%; .25/(.12—.0975) = 11.11 Sadie  Chapter 18 #67
Dtﬁlculm Dtﬁicuit 16. According to the meanvariance criterion, which one of the following investments dominates all others? A E(r) = 0.15; Variance = 0.20
b. E(r) = 0.10; Variance = 0.20
c. E(r) = 0.10; Variance = 0.25
d. E(r) = 0.15; Variance = 0.25
e. none of these dominates the other alternatives. A gives the highest return with the least risk; return per unit of risk is .75, which dominates the rewardrisk ratio
for the other choices. Bodie  Chapter 06 #ll
Diﬂiculty: Difﬁcuft 17. You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend of $3
in the upcoming year while Stock D is expected to pay a dividend of $4 in the upcoming year. The expected
growth rate of dividends for both stocks is 7%. The intrinsic value of stock C a. will be greater than the intrinsic value of stock D b. will be the same as the intrinsic value of stock D Q will be less than the intrinsic value of stock D d. cannot be calculated without knowing the market rate of return
e. none of the above is a correct answer. PVO : D 1/(k—g); given k and g are equal, the stock with the larger dividend will have the higher value. gedz‘e .. Chapter 55 #73
Dgﬁeuints Easy 18. The potential loss for a writer of a naked call option on a stock is a. limited 1} unlimited c. larger the lower the stock price.
d. equal to the call premium. e. none of the above. If the buyer of the option elects to exercise the option and buy the stock at the exercise price, the seller of the
option must go into the open market and buy the stock (in order to sell the stock to the buyer of the contract) at the
current market price. Theoretically, the market price of a stock is unlimited; thus the writer’s potential loss is unlimited. Bodte — Chapter 20 #42
Difﬁculty: Moderate 19. Which statement about portfolio diversiﬁcation is correct? a. Proper diversiﬁcation can reduce or eliminate systematic risk.
b. The risk—reducing beneﬁts of diversiﬁcation do not occur meaningfully until at least 50—60 individual securities have been purchased.
c. Because diversiﬁcation reduces a portfolio’s total risk, it necessarily reduces the portfolio’s expected return. 2 Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate.
e. None of the above statements is correct. Diversiﬁcation can eliminate only nonsystematic risk; relatively few securities are required to reduce this risk, thus
diminishing returns result quickly. Diversiﬁcation does not necessarily reduce returns. Bodie — Chapter 07 #29
Dzﬁculty: Moderate 20. A protective put strategy is _A_ a long put plus a long position in the underlying asset. b. a long put plus a long call on the same underlying asset.
c. a long call plus a short put on the same underlying asset.
d. a long put plus a short call on the same underlying asset. 6. none of the above. If you invest in a stock and purchase a put option on the stock you are guaranteed a payoff equal to the exercise
price; thus the protection of the put. Bodte ~ Chapter 2Q #58
Dgﬁeulne: Moderate 21. You are considering acquiring a common stock that you would like to hold for one year. You expect to receive
both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is if you wanted to earn a 10% return.
A $30.23 1). $24.11 C. $26.52 cl. $27.50 e. none of the above .10 =(32 ~P +1.25)/P;.10P =32 P +1.25; 1.10P =33.25; P= 30.23. Eadie  Chapter 18 #33
Di'ﬂiculry: Moderate 22. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the Capital
Allocation Line must: a. lend some of her money at the riskfree rate and invest the remainder in the optimal risky portfolio.
b. borrow some money at the riskfree rate and invest in the optimal risky portfolio. c. invest only in risky securities. d. such a portfolio cannot be formed. E B and C The only way that an investor can create portfolios to the right of the Capital Allocation Line is to create a
borrowing portfolio (buy stocks on margin). In this case, the investor will not hold any of the riskfree security, but will hold only risky securities. Eadie — Chapter 07 #22
Dzﬁiculty: Moderate 23. Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year. Dividends are
expected to decline at the rate of 2% per year. The riskfree rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of 0.25. The intrinsic
value of the stock is a. $80.00
_1_3_ 133.33
c. $200.00
(1. $400.00 e. none of the above k z 6% +[0.25(14%  6%)] z: 41%;? = s .2104  9.02)} = $133.33. Sadie — Chapter 18 #60
Dwica/ly: Dgﬁwk 24. Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the
rate of 15% per year. The risk—free rate of return is 6% and the expected return on the market portfolio is 14%.
The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is a. 10%
b. 18%
g; 30%
d. 42%
e. none of the above 6% + 3(l4%  6%) = 30%. Eadie — Chapter I 8 #48
Dyfﬁculty: Moderate 25. Consider the singlefactor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The
riskfree rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of a. 0.67
b. 1.00
c. 1.30
d. 1.69
13: none of the above A: 15%= 6%+bF;B: 8%= 6%+1.0F;F = 12%; thus, beta ofA = 9/12 = 0.75. Bodie — Chapter 10 #13
Difficulty: Moderate 26. Which one of the following statements regarding orders is false? a. A market order is simply an order to buy or sell a stock immediately at the prevailing market price. b. A limit sell order is where investors specify prices at which they are willing to sell a security. c. If stock ABC is selling at $50, a limitbuy order may instruct the broker to buy the stock if and when the share
price falls below $45. d. A day order expires at the close of the trading day. E None of the above. A11 of the order descriptions above are correct. Eadie » Chapter 03 #38
Bgﬁicufty: Moderate 27. A covered call position is a. the simultaneous purchase of the call and the underlying asset.
b. the purchase of a share of stock with a simultaneous sale of a put on that stock. (2. the short sale of a share of stock with a simultaneous sale of a call on that stock.
Q the purchase of a share of stock with a simultaneous sale of a call on that stock.
e. the simultaneous purchase of a call and sale of a put on the same stock. Writing a covered call is a very safe strategy, as the writer owns the underlying stock. The only risk to the writer is
that the stock will be called away, thus limiting the upside potential. Bodie — Chapter 20 #55
Dmculiy: Moderate 28. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50% and
the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin. a. 0.33
b. 0.55
e. 0.43
d. 0.23
1?; 0.25 100 shares * $45/share * 0.5 = $4,500 * 0.5 = $2,250 (loan amount); X = [100($30) — $2,250]/100($30); X = 0.25. Eadie  Chapter 03 #16
Diﬁ’z‘cuity: Diﬂicu/t 29. Low Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 14%.
An appropriate required return on the stock is l 1%. If the ﬁrm has a dividend payout ratio of 40%, the intrinsic value of the stock should be a. $22.73
b. $27.50
o. $28.57
12 $38.46
6. none of the above g = 14% X 0.6 = 8.4%; Expected DPS : $250634) = $l .00; P = 1 !(.ll  .084) == $38.46. 8362??  Chapter 3:? .5233
03413361351}: Digital! 30. The valueiof the market portfolio equals a. the sum of the values of all equity securities. b. the sum of the values of all equity and ﬁxed income securities. c. the sum the values of all equity, ﬁxed income, and derivative securities. d. the sum of the values of all equity, ﬁxed income, and derivative securities plus the value of all mutual funds. I}; the entire wealth of the economy. The market portfolio includes all assets in existence. Bodle  Chapter 09 £46
Dzﬂicultys Moderate 31. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%,
respectively. The riskfree rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of a. 1.33
b. 1.50
C 1.67 d. 2.00
e. none of the above 19% = 10% + 5%(0.8) + 3%(x); x = 1.67. Eadie  Chapter 10 #19
Diﬁ'iculry: Moderate 32. Standard deviation and beta both measure risk, but they are different in that a. beta measures both systematic and unsystematic risk.
3 beta measures only systematic risk while standard deviation is a measure of total risk. c. beta measures only unsystematic risk while standard deviation is a measure of total risk.
d. beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk. e. beta measures total risk while standard deviation measures only nonsystematic risk. B is the only true statement. Eadie  C hapler ()9 $36
Dgﬁﬁcalty: Easy 33. Consider the onefactor APT. Assume that two portfolios, A and B, are well diversiﬁed. The betas of
portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist, the riskfree rate of return must be a. 4.0%
g 9.0%
c. 14.0%
d. 16.5%
e. none of the above A: 19% = rf+ 1(F); B:24°/o = rf+ 1.5(F); 5% == .5(F); F = 10%; 24% = rf+ 1.5(10); ff: 9%. Eadie  Chapter 10 #18
Dr'ﬂiculty: Moderate 34. In developing the APT, Ross assumed that uncertainty in asset returns was a result of a. a common macroeconomic factor
b. ﬁrmspeciﬁc factors c. pricing error (1. neither A nor B 151 both A and B Total risk (uncertainty) is assumed to be composed of both macroeconomic and ﬁrmspeciﬁc factors. Eadie  Chapter 10 #7
Dg’fﬁculty: Moderate 35. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08
and the riskfree rate is 0.05. The alpha of the stock is A 1.7%.
b. ~1.7%.
c. 8.3%.
d. 5.5%.
e. none of the above. 10% — [5%+1.1(8% 5%)] z 1.7%. Eadie » Chapter 09 #2 .1
Dﬁeuky: Madame 36. When borrowing and lending at a riskfree rate are allowed, which Capital Allocation Line (CAL) should the
investor choose to combine with the efﬁcient frontier?
I) with the highest reward—to—variability ratio.
II) that will maximize his utility.
III) with the steepest slope.
IV) with the lowest slope. at. I and HI
b. I and IV
c. II and IV (1. Ionly
E I, II, and III The optimal CAL is the one that is tangent to the efﬁcient frontier. This CAL offers the highest rewardto~
variability ratio, which is the slope of the CAL. It will also allow the investor to reach his highest feasible level of
utility. Eadie  Chapter 07 #44
DiﬁicuIW: Diﬁicult 37. Efﬁcient portfolios of N risky securities are portfolios that a. are formed with the securities that have the highest rates of return regardless of their standard deviations. _B_ have the highest rates of return for a given level of risk.
0. are selected from those securities with the lowest standard deviations regardless of their returns. d. have the highest risk and rates of return and the highest standard deviations.
e. have the lowest standard deviations and the lowest rates of return. Portfolios that are efﬁcient are those that provide the highest expected return for a given level of risk. Bodie  Chapter 07 #10
Dtﬁiculty: Moderate 38. The intrinsic value of an outof—themoney call option is equal to a. the call premium. 3 zero.
0. the stock price minus the exercise price. d. the striking price.
6. none of the above. The fact that the owner of the option can buy the stock at a price greater than the market price gives the contract
an intrinsic vaiue of zero, and the holder will not exercise. Bridle ~ Chaprer 20 $43
Difﬁculty" Easy ‘r 39. Your personal opinion is that a security has an expected rate of return of 0.1 1. It has a beta of 1.5. The riskfree
rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is a. underpriced.
b. overpriced. g fairly priced.
d. cannot be determined from data provided. e. none of the above. 1 1% == 5% + l.5(9%  5%) = l 1.0%; therefore, the security is fairly priced. Bodie  Chapter 09 #18
Dgﬁculty: Moderate 40. According to the Capital Asset Pricing Model (CAPM), a. a security with a positive alpha is considered overpriced. b. a security with a zero alpha is considered to be a good buy. 0. a security with a negative alpha is considered to be a good buy.
Q a security with a positive alpha is considered to be underpriced. e. none of the above. A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the
perceived risk of the security, and thus is underpriced. Bodie  Chapter 09 #14
Diﬂiculty: Moderate ...
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