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Midterm Fall 2010 Solution

# Midterm Fall 2010 Solution - Hong Kong University of...

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1 Hong Kong University of Science and Technology FINA 221: Investment Analysis and Portfolio Management Fall 2010 Instructor: Prof. Darwin Choi Midterm Examination Date: October 21, 2010 Registered Lecture Section (circle one – 1 point for correct answer) L2C: 9:00am-10:20am L2B: 10:30am-11:50am L2A: 3:00pm-4:20pm Name (in block letters) Suggested Solution __ _______________________________ I agree to abide by the HKUST Academic Honor Code in taking this exam. Sign _________________________________________________ Instructions: 1. Fill in the information above. 2. This is a closed-book, closed-notes exam. 3. Please check to be certain that your exam contains 11 pages. 4. You have 2 hours to complete this exam. 5. Total points: 120. Please answer all questions. Partial credit will be given if you provide sufficient evidence of approaching the problems correctly. 6. You may use the basic math functions of a calculator. 7. Be clear and brief. Vagueness and unnecessary wordiness may be penalized. 8. If you need more space you could use the back of each page, but make sure that your answers are easily identified. 9. Do not turn the page until instructed to do so. 10. Good luck!

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2 I. True or False. Circle the correct answer and briefly explain. (Total: 45 points) (1) (5 points) All limit orders are executed when the asset price falls below the specified price. TRUE or FALSE (briefly explain) FALSE. Limit sell orders and stop-loss buy limit orders are executed when the asset price rises above the specified price. (2) (5 points) In the Single Index Model, securities with the same betas must earn the same realized return. TRUE or FALSE (briefly explain) FALSE. Securities with the same betas must earn the same expected return, but the realized returns of these securities could be different due to different firm-specific surprises. (3) (5 points) There are two portfolios, A and B , where the expected return on A is larger than the expected return on B . It is possible that a risk-loving investor prefers holding B to A . TRUE or FALSE (briefly explain) TRUE. A risk-loving investor prefers higher risk. If the standard deviation of B is large enough, the utility score of B can be larger than the utility score of A .
3 (4) (5 points) If we combine N ( N > 2) risky assets to form different portfolios, the portfolio that gives the lowest standard deviation is the optimal risky portfolio. TRUE or FALSE (briefly explain) FALSE. The tangency portfolio (where the Capital Allocation Line touches the efficient frontier) is the optimal risky portfolio. The tangency portfolio, P *, is not necessarily the portfolio that gives the lowest standard deviation, A . E( r ) CAL (5) (5 points) In a multifactor model, a well-diversified portfolio with zero sensitivity to all factors must earn the riskfree rate. TRUE or FALSE (briefly explain)

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Midterm Fall 2010 Solution - Hong Kong University of...

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