# Sample Quiz #3 Answers - Finance 355 Investments Sample...

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1 Finance 355: Investments Sample Quiz 3 1. There is a 20 percent probability that a particular stock will earn an 18 percent return and an 80 percent probability that it will earn 13 percent. What is the risk premium on this stock if the risk-free rate is 3.5 percent? a. 8.00 percent b. 10.50 percent c. 13.00 percent d. 16.00 percent e. 17.50 percent Answer: b. E(R) = (.20 × .18) + (.80 × .13) = .036 + .104 = .14 = 14.00 percent Risk premium = 14.00 percent 3.5 percent = 10.50 percent 2. Fruity Soft Drinks just announced that their quarterly earnings will be \$0.20 less than the prior quarter. This announcement will cause their stock price to: a. increase. b. either increase or remain constant. c. remain constant. d. decrease. e. increase, decrease, or remain constant. Answer: e. Announcement = Expected News + Surprise News We should always compare the announcement with investors’ expectation. In this question, there is no way to compare because we don’t know the expectation (the question does not imply that the earnings number in the prior quarter is investors’ expectation). Thus, we are not sure about the price movement. 3. You have a portfolio which is comprised of 60 percent of stock A and 40 percent of stock B. What is the expected rate of return on this portfolio? State of Probability of State Rate of Return if State Occurs Economy of Economy Stock A Stock B Boom 0.30 20% 14% Normal 0.70 12% 8% a. 10.38 percent b. 10.88 percent c. 12.56 percent d. 12.91 percent

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2 e. 13.05 percent Answer: c. Portfolio return in Boom state = (.60 × .20) + (.40 × .14) = .12 + .056 = .176 Portfolio return in Normal state = (.60 × .12) + (.40 × .08) = .072 + .032 = .104 E(R Port ) = (.30 × .176) + (.70 × .104) = .0528 + .0728 = .1256 = 12.56 percent 4. A security which plots _____ the security market line represents the best investment opportunity, all else equal. a. above b. on or above c. on d. on or below e. below Answer: a. A security is overvalued if it plots below the security market line. A security is fairly valued if it plots on the security market line.
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## This note was uploaded on 11/18/2011 for the course FIN 355 taught by Professor Phsiao during the Fall '08 term at S.F. State.

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Sample Quiz #3 Answers - Finance 355 Investments Sample...

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