Ec 173A final

Ec 173A final - Ec 173AFINANCIAL MARKETS Foster, UCSD,...

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Ec 173A–FINANCIAL MARKETS Foster, UCSD, Friday, DEC 9, 2011, 8-11 am FINAL EXAM ANSWER KEY (Version b = DEC 9) Pr 1 ____ _ 80 Pr 2 ____ _ 65 Pr 3 ____ _ 20 Pr 4 ____ _ 45 M-C 90 /300 Open book/calculator. Put final answers in space provided and SHOW WORK WHERE REQUESTED OR NO CREDIT . Carry 5+ decimal places where precision is appropriate. Point values in [boldface] . Partial credit in blue. Answers for other version in green Problem 1– CAPM and Rational Investing Consider common stock shares S. You have information from Regression A and from Figure A. (You may assume that capital markets are in equilibrium in Figure A.) SHOW ALL WORK! Regression A: R(s) t = -0.002 + 1.24R(m) t + u t t = 1…46, where R(s) = r s - r f and R(m) = r m - r f . A) What is the expected rate of return on stock S? [15] μ(r s ) = 11.68 % = r f - (µ m - r f ) β = 3 + 7 (1.24) [other = 8.72] [2] [ 4 ] [ 9 ] B) For any security, what is the rate of return that the CAPM defines or predicts? (I am looking for a description or concept here, not a formula.) [10] When the market is in equilibrium, the price of the security will have adjusted so that its expected return µ(r) is given by the CAPM equation. [2] This return is sufficient to compensate for the relevant risk of the security. [3] The relevant risk is the security’s market risk (its contribution to the riskiness of the market portfolio M). It does not include the firm-specific risk of the security. [5] At the CAPM price and µ(r), diversified investors are content to hold this security among the others in their respective portfolios. [Allow other correct answers, obviously]
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Ec 173A FINAL EXAM KEY (b) p. 2 of 8 C) What is the relevant risk of stock S? [10] σ* = 17.36 (%) = βσ m = 1.24 (14) [other = 11.76] [2] [4] [4] D) A fundamental analyst concludes that dividends on stock S are likely to grow at 1% per year for the foreseeable future, based onthe company market share and the industry probable rate of expan-sion. If the analyst is correct and if markets are in equilibrium as shown in Fig. A, then what shouldthe stock’s price be if themost recent annual dividend was D 0 = $3.50/share? [15] P 0 = $ 33.10 /share = [other = $15.70] [4] [ 3 ] [ 8 ] E) An investor has utility score function U = μ – 0.005 (6) σ 2 . If they have $40,000 to invest and follow the passive buy-and-hold strategy recommended by Tobin and by MPT, then how should they allo-cate it given the information in Figure A? (What kinds of securities will they be investing in? How much to each?) [30] Allocate $ 23,800 ± to risky securities like market index mutual fund or index ETF [other = 73,440] [Use student ϖ *; 3 for risky securities, 2 for example of such] Allocate $ 16,200 ± to riskless securities like T-bills and money market mutual funds [other = 16,560] [Use student 1- ϖ *; 3 for riskless securities, 2 for example of such] Proportion at risk ϖ * = = 0.595 0.595 × $40,000 = $23,800 [5] [10] [5]
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Ec 173A final - Ec 173AFINANCIAL MARKETS Foster, UCSD,...

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