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Unformatted text preview: 50 Luﬂom 15w vmsiry all
Waterloo University of Waterloo
Term Test #1
ACTSC 372 — Corporate Finance 1 Instructor: Peter Wood Date: June 4th, 2007 Time: 2:30 p.111. Duration: 1 hour Number of Pages: 10 (including the cover page and the blank page) Aids: Calculator, attached formula sheet Name: ID#: Mark
no
/30 AC TSC 3 72 Spring 2007 Term Test #1 M— ' PART 1 Circle the correct answer. There is no need to justify your work.
(1 mark each) 1. You bought 100 shares of stock at $20 each. At the end of the year, you received a
total of $400 in dividends, and your stock was worth $2,500 in total. What was your percentage rate of return? (a) 20%
25% (. 5%
(e) 145% Use the following information to answer Questions 2 and 3. The prices for IMB (a nondividend paying stock) over the last 3 years are given below. Year Price
0 $70 17 64
2 68
3 72 2. The average return for IMB over the 3 years is closest to. (a) 3.56% (c i ! 94% (d) 0.67%
(e) none of the above 3. The annualized holding period return (assuming we purchased IMB at time 0) is
closest to: (a) 3.56%
(b 1.2% (d) lu.7%
(e) none of the above Page 2 of 10 ACTSC 372 Spring 2007 Term Test #1 4. The market portfolio of common stocks returned 20.4% and T—bills returned
5.3%. If inﬂation averaged 2.5%, then the equity risk premium was: (a) 12.6%
(b) 22.9%
(c 25.7% m e 3.2% 5. When a security is added to an existing diversiﬁed portfolio, the appropriate risk
and return contributions are: (a the standard deviation and expected return of the asset.
beta and the expected return of the asset
(c) the beta of the portfolio before the addition, and the return on the asset.
(d) the standard deviation of the portfolio before the addition, and the return on the portfolio.
(e) none of the above. 6. Stock A has an expected return of 20%, and stock B has an expected return on
4%. However, the risk of stock A as measured by its variance is 3 times that of
stock B. If the two stocks are combined equally in a portfolio, what would be the expected return of the portfolio? (a) 20%
(b 0
c 12° greater than 20%
(e) More information is needed to answer this question. 7. Diversiﬁcation can effectively reduce risk. Once a portfolio is diversiﬁed, the
type of risk remaining is: ‘iarket risk (b) total standard deviations (c) individual security risk (d) no risk remains, since the portfolio is diversified
(6) none of the above Page 3 oflO ACTSC 372 Spring 2007 Term Test #1 8. The measure of beta associates most closely with: (a) idiosyncratic risk
@stematic risk
(0) riskfree return
((1) unexpected risk
(e) unsysternatic risk 9. Suppose the ABC Corporation’s common stock has a beta of 0.8. If the risk~free rate if 4% and the expected market return is 9%, then expected return for ABC
stock is: (a) 3.2%
(b) 4%
(C 7.2% '0 e '.0% 10. A portfolio contains two assets. The ﬁrst asset comprises 40% of the portfolio and
has a beta of 1.2. The other asset has a beta of 1.5. The portfolio beta is: (a
bi 1.3
e .70
(d) 1.5
(e) There is no way to calculate the portfolio beta Without the covariance. Page 4 of 10 ACTSC 372 Spring 2007 Term Test #1
———___._—___________— PART 2 Answer in the spaces provided. Show your work [6] 1. Suppose the riskfree rate is 5%, and the market risk premium is 7%. Suppose
there are two securities available in the market, A and B, with the following data. (a) According to CAPM, are securities A and B overpriced, underpriced or fairly
priced? Explain. m 1; ﬂfv LIV/72.) ; [914934 6" 3517/3 (Office!
E 2 554+ .wtm: M3310 e— 00w mast (b) Sketch the SML, and plot the securities A, B and the market portfolio on your
graph. Page 5 of IO ACTSC 372 Spring 2007 Term Test #1 [9] .2. Suppose two securities, X and Y, and expected returns of 5% and 10%
respectively, and suppose ox = 10% and or = 20% and the Correlation between the returns ofX and Y is —0.5. (21) Find the minimum variance portfolio. What is the return and standard deviation of
this portfolio? Tnml we a s m! M AV
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_ ‘ '1 _, 4‘ {:(I'é
,jaM/Jc who a 0 Sb ‘j’k Myra, (my PGrM/ab ha) 7/372, )‘PI'UPJLQL m. X
cam/l 31M?» v€~ ‘7’ ﬁr, = ’3)»le 2L 5’? t 3952002») = Avail;
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2 0.00%) M? :3» 0}, c. 6.57}; Page 6 of 10 ACTSC 372 Spring 2007 Term Test #1 (b) Assume these are the only two securities in the market. Sketch the efﬁcient
frontier. Clearly show Where the portfolio you found in part (3) appears on your
graph. (0) Assume your ﬁiend decided to invest 90% of her money in security Y and 10% in
security X. Is this is rational investment decision? Explain. 71“  m ftri'iii)it" 13’ cm ‘Hc («@‘QICIM
”QM/41W Meryl WI iii! mhM_ Page 7 of 10 AC T S C 3 72 Spring 2007 T erm Test #1 [5] 3. (a) (b) Assume a two factor model. is appmpriate to describesecurity returns. Data on
two securities and the factors are given below. Ex  ected Return Beta of Factor 1 Beta of Factor 2
I_—I__ Ex  ected Value Actual Value Ignoring unsystematic factors, what is the total return for each security. {2/4 : 7; *ﬁ' {gas—3’72l r/Gw(l7'32
': ll‘t5Z (in ,~. 2'; Jr/Ch(F«53'7‘Z) #01“) 377590 ' '9
.' Construct a portfolio that is not sensitive to the first risk factor. What is the
expected return on this portfolio? (Assume short selling is allowed) 5:: =5) tern Girls?“ chi lla—l—aqéro (Ag/nor}; A‘— 5‘5 77 q: 'VS / ~Ll.5 [lam +550“ : ‘152', Page 8 of 10 A CT SC 3 72 Spring 2007 Term T est #1 PART THREE (BONUS) [4] 1. Consider a universe with a vast number of risky securities, and one riskfree
security. Let M be the market portfolio, as described in CAPM. (a) Assume the riskfree rate increases, and let M1 be the new market portfolio. How
does M1 compare with M? Is it more risky, or less risky? Also, describe what
happens to the Sharpe Ratio of the new market portfolio as compared with the old
market portfolio? A: 4'41 NJ it lifee (Mic ﬁnancier}
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Ship: Mb [m 4 SAW Mow) (b) We have seen that in practice, investment professionals will use a proxy for the
market portfolio, since the theoretical market portfolio is very difficult to
determine. What effects might there be in using a proxy? 71mm one 71 {Mtg [J 15%
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