FBE441_Spring09_FinalExam_MW0406_SOLUTIONS

# FBE441_Spring09_FinalExam_MW0406_SOLUTIONS - FBE441...

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FBE 441-[MW2-4] Final Exam: Spring 2009 Page 2 1. (5 points) The global minimum variance portfolio formed from two risky securities will be riskless when the correlation coefficient between the two securities is i) 0.0 ii) 1.0 iii) 0.5 iv) -1.0 Solution: iv) -1.0 . The global minimum variance portfolio will have a standard deviation of zero whenever the two securities are perfectly negatively correlated. 2. (5 points) A statistic that measures how the returns of two risky assets move together is: i) variance. ii) covariance. iii) correlation. iv) covariance and correlation. Solution: iv) covariance and correlation. Covariance measures whether security returns move together or in opposition; however, only the sign, not the magnitude, of covariance may be interpreted. Correlation, which is covariance standardized by the product of the standard deviations of the two securities, may assume values only between +1 and -1; thus, both the sign and the magnitude may be interpreted regarding the movement of one security's return relative to that of another security. 3. (5 points) The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 11 percent, you should i) buy stock X because it is overpriced. ii) sell stock short X because it is underpriced. iii) buy stock X because it is underpriced. iv) none of the above, as the stock is fairly priced. Solution: iv) none of the above, as the stock is fairly priced. 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is fairly priced. 4. (5 points) 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 risk- free 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 _______.
FBE 441-[MW2-4] Final Exam: Spring 2009 Page 3 i) A, A ii) A, B iii) B, A iv) A, the riskless asset Solution: iii) B, A 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.

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FBE441_Spring09_FinalExam_MW0406_SOLUTIONS - FBE441...

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