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Quiz #3

# Quiz #3 - Finance 355 Investments Fall 2011 Shuming Liu...

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1 Finance 355: Investments Fall 2011 Shuming Liu QUIZ 3 QUIZ PAPER A 1 b 6 d 11 c 16 c 2 d 7 a 12 d 17 a 3 c 8 c 13 b 18 e 4 b 9 e 14 a 19 c 5 a 10 d 15 e 20 d QUIZ PAPER B 1 d 6 b 11 c 16 c 2 a 7 d 12 a 17 d 3 c 8 c 13 e 18 b 4 e 9 b 14 c 19 a 5 d 10 a 15 d 20 e See the next few pages for detailed answers.

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2 QUIZ 3 Quiz Paper A 1, Quiz Paper B 6 Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and is overvalued? a. to the right of the overall market and above the SML b. to the right of the overall market and below the SML c. to the left of the overall market and above the SML d. to the left of the overall market and below the SML e. on the SML Answer: b. Quiz Paper A 2, Quiz Paper B 7 Wilson Farms' stock has a beta of 1.5 and an expected return of 12%. The risk-free rate is 3% and the market risk premium is 7%. This stock is _____ because the CAPM return for the stock is _____ percent. a. undervalued; 7.5 b. undervalued; 9 c. fairly valued; 12 d. overvalued; 13.5 e. overvalued; 15 Answer: d. E(R A ) = .03 + 1.5 (.07) = .135 percent The stock is overvalued because its expected return of 12% is lower than the CAPM return of 13.5%. Quiz Paper A 3, Quiz Paper B 8 The following portfolio has 50% in stock A and 25% in each of stock B and C. What is the portfolio standard deviation? State of Economy Probability of State of Economy Stock A Returns Stock B Returns Stock C Returns Boom 0.5 10% 15% 20% Bust 0.5 8% 4% 0% a. 3.830% b. 6.187% c. 4.375% d. 0.191% e. 5.560% Answer: c. The portfolio return: when the economy booms
3 Rp = 0.5 × 10% + 0.25 × 15% + 0.25 × 20% = 13.75% when the economy goes bust Rp = 0.5 × 8% + 0.25 × 4% + 0.25 × 0% = 5% The portfolio expected return: E(Rp) = 0.5 × 13.75% + 0.5 × 5% = 9.375% The portfolio variance: 0.001914 .09375) (.05 .50 .09375) (.1375 .50 σ 2 2 2 p = × + × = So the portfolio standard deviation is 4.375% or 0.04375 .0019141 σ p = = Quiz Paper A 4, Quiz Paper B 9 Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?

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