FBE441_Spring08_FinalExam_MW0406_SOLUTIONS

FBE441_Spring08_FinalExam_MW0406_SOLUTIONS - FBE441:...

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FBE441: Investments Solutions for Spring 2008 Final Exam [Section 15362: MW 04.00-05.50pm] Policy on re-grading: If after reading the solution, you genuinely believe that the score given was in error, you may submit your exam for re-grading during office hours. However , if your answer is STILL incorrect, you may be deducted additional points for making frivolous claims. (After reading the solution, you should know whether your answer was correct or not!) Question Answer Points Earned 1. i ii 5 points 2. i ii 5 points a) i ii iii iv 3. b) i ii 10 points a) i ii iii iv 4. b) i ii iii iv 10 points a) i ii iii iv b) i ii c) i ii iii iv 5. d) E(R) = 16% Stdev (R) = 30% 20 points a) Portfolio P = 1.667 Portfolio Q = -2.667 Risk-free = +1 6. b) i ii iii iv 15 points 7. i ii iii iv 5 points 8. i ii iii iv 5 points 9. a) Alpha (A) = 1% Alpha (B) = 2% SR (A) = 0.4907 SR (B) = 0.3373 TR (A) = 0.08833 TR(B) = 0.105 15 points b) i ii a) i ii iii iv b) i ii iii c) i ii iii iv 10. d) i ii iii iv e) Rf= $0.02mln MKT= $0.98mln SMB= $0.302mln HML= $0.591mln WML= -$0.257mln f) E(R) = 13.943% 30 points Total 120 points
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FBE 441-15362 Final Exam: Spring 2008 [SOLUTIONS] Page 2 1. (5 points) A stock has a correlation of 0 with the market. Does this imply that the stock has a beta of 0? i) Yes, always ii) No, not always (no explanations necessary) SOLUTION: i). Yes, always. Since the Beta of a portfolio p versus the market is Beta(p) = cov(p,M) / sigma(M) and this can be written as Beta(p) = corr(p.M) * [sigma(p) / sigma(M]), then if correl(p,M) = 0 Beta is also =0, independent of the volatilities. 2. (5 points) The USC Endowment fund is currently invested in equities and government bonds. The portfolio has a Sharpe Ratio of 0.40. The fund is considering adding real estate to its portfolio by investing in a REIT (Real Estate Investment Trust). The REIT has a Sharpe ratio of 0.12 and a correlation with current portfolio is 0.35. Based on this information, what would you recommend? i) Invest on REIT ii) Not invest on REIT (no explanations necessary) SOLUTION: ii).According to the Sharpe Ratio analysis a new asset (new) should be added to an existing portfolio (p) if SR(new) > SR(p) * corr(p,new) . In this case, 0.12 < 0.4 * 0.35 so the USC Endowment fund should not add the REIT to the existing portfolio. 3. Your current portfolio is entirely invested in a single mutual fund, M. You are considering diversifying into one additional fund. You are trying to decide between three funds offering the same expected return and standard deviation of return: funds X, Y, and Z. You determine the correlations between your current fund and the others as: corr(M,X) = 0.5, corr(M,Y) = 0.4, and corr(M,Z) = 0.3. 3.a. (5 points) Which fund should you add to your portfolio? i) X ii) Y iii) Z iv) Cannot be determined without more information (no explanations necessary) SOLUTION: iii) fund Z. THIS IS A REPEAT OF A MIDTERM QUESTION. The fund you should add is the fund that provides the highest diversification benefit – which is the one with the lowest correlation with your current fund M [corr(M,Z)=0.3].
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FBE 441-15362 Final Exam: Spring 2008 [SOLUTIONS] Page 3 3.b. (5 points) Suppose that in addition to investing in one more stock you can invest in T- bills as well. Would your answer to 3.a. above change?
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This note was uploaded on 04/26/2011 for the course FBE 441 taught by Professor Callahan during the Spring '07 term at USC.

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FBE441_Spring08_FinalExam_MW0406_SOLUTIONS - FBE441:...

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