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Unformatted text preview: Business Finance 722 Midterm Review Questions Prof: Fousseni ChabiYo Pages 215: Structure of the Midterm (these questions are practice questions) Pages 1617: Formula Sheet Pages 1834: Additional practice questions 1 Section Multiple Choice and True /False. You do not have to show your work in this section 1. Suppose the market is efficient and the CAPM holds. If last month stock A experienced a higher return than stock B, then stock A must have a larger beta with the market than stock B: True or False? Answer : False. The CAPM only tells us that stock A must have a bigger beta with the market than stock B. 2. A riskfree security pays a 6% rate of return. A risk averse investor invest in a risky portfolio that pays 12% with a probability of 40% or 2% with a probability of 60% because . (a) might; she is rewarded a risk premium (b) would not; she is not rewarded any risk premium (c) would not; the risk premium is small (d) cannot be determined Answer: b) would not; because she is not rewarded any risk premium E ( r i ) = 0 . 4(0 . 12) + 0 . 6(0 . 02) = 6% 3. Stock prices and expected returns tend to move in the opposite direction unless all move ments in prices are due to changes in expected future dividends. True or False? Answer : True 4. Suppose the market is efficient, the CAPM holds, and you know the following: Stock ( r i ,r M ) A 0.06 B 0.08 C 0.13 According to the CAPM which stock is the riskiest? 2 a) A b) B c) C d) Cannot determine: not enough information. Answer: C .If it has a bigger covariance then it has a bigger beta and hence a higher expected return. 5. Which one of the following portfolios cannot lie on the efficient frontier composed of all risky assets? Portfolio E(r) σ ( r ) A 6% 15% B 10% 12% C 18% 29% D 20% 30% a) A b) B c) C d) D e) Cannot determine: not enough information. Answer : Stock A cannot be on the efficient frontier because it has a smaller expected return and bigger standard deviation than stock B. 6. Which one of the following portfolios cannot lie on the efficient frontier composed of all risky assets? Portfolio E(r) σ ( r ) A 5% 10% B 10% 20% C 15% 30% D 12% 18% a) A b) B c) C d) D e) Cannot determine: not enough information. Answer : b) B; portfolio B has a lower expected return and bigger standard deviation than portfolio D. 3 10 15 20 25 30 5 6 7 8 9 10 11 12 13 14 15 A B C D σ (r) in % E(r) in % 7. If a riskless asset is combined with a risky portfolio (P), then the resulting portfolio has the same variance as P because the riskless asset has no variance and no covariance with all the assets in P . Thus, the feasible investment opportunity set is a straight line. True or False? Answer : False. The variance of a portfolio comprised of a riskless security and a risky portfolio is, w 2 σ 2 ( r p ). Therefore, the new portfolio will have a different variance than portfolio P (the variance is a function of w )....
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This note was uploaded on 11/20/2011 for the course FINANCE 640,722 taught by Professor Chabiyo,reeves during the Fall '11 term at Ohio State.
 Fall '11
 chabiyo,reeves
 Finance

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