Ch 5 answers questions for review
10. Expected return = .3 8% + .7 18% = 15% per year
Standard deviation = .7 28% = 19.6%
11. Investment proportions:
30.0% in T-bills
.7 27% =
18.9% in stock A
.7 33% =
23.1% in stock B
.7 40% =
28.0% in stock C
12. Your r
6
Student: _
1. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with 2
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate
of return of 0.14 a
12
Student: _
1. The current yield on a bond is equal to _.
A. the internal rate of return
B. the yield to maturity
C. annual interest divided by the par value
D. annual interest divided by the current market price
E. none of these
2. Of the following fou
5
Student: _
1. A T-bill pays 6 percent rate of return. Would risk-averse investors invest in a risky portfolio that pays 12
percent with a probability of 40 percent or 2 percent with a probability of 60 percent?
A. Yes, because they are rewarded with a r
15
Student: _
1. _ is equal to the total market value of the firm's common stock divided by (the replacement cost of
the firm's assets less liabilities).
A. Book value per share
B. Liquidation value per share
C. Market value per share
D. Tobin's Q
E. None
8
Student: _
1. As diversification increases, the total variance of a portfolio approaches _.
A. 0
B. 1
C. the variance of the market portfolio
D. infinity
E. none of these
2. The index model was first suggested by _.
A. Graham
B. Markowitz
C. Miller
D. S
Answers assignment # 2
12. Since A and B are perfectly negatively correlated, a risk-free portfolio can be created and
its rate of return in equilibrium will be the risk-free rate. To find the proportions of this
portfolio (with wA invested in A and wB =
Ch 5 questions fro review
You manage a risky portfolio with an expected rate of return of 18 percent and a standard deviation of 28
percent. The T-bill rate is 8 percent. Use these data for problems 1019.
10. Your client chooses to invest 70 percent of a
Capital Asset Pricing Model
CAPM I: The Theory
CAPM
Builds on portfolio theory but contains all
assets.
All investors seek the tangency portfolio
The exact distribution of the risk free asset
and the market portfolio depends on U
function ( in particula
A few notes on YTM
A few points about YTM
1) You hold the bond to maturity
2) All interim cash flows are reinvested at
the interest rate that solves for the
computed YTM.
8% reinvested for 25 years
7100 end of wealth value
4100 interest on interest
2000 c
CAPM1
Capital Asset Pricing Model
overview
1
Power of Diversification
Risk
Nonsystematic
Risk
(idiosyncratic,
diversifiable)
Portfolio
Risk
Market Risk
Systematic Risk
Number of Stocks
2
2
Market Portfolio
3
The Market Portfolio
The market portfolio repr
16. The revised estimate of the expected rate of return on the stock would be the old estimate
plus the sum of the products of the unexpected change in each factor times the respective
sensitivity coefficient, that is,
Revised estimate = 12% + [(1 2%) + (
Term structure of interest
rates
Overview of Term Structure
Information on expected future short term
rates can be implied from the yield curve
The yield curve is a graph that displays the
relationship between yield and maturity
Three major theories ar
Bond intro
Bond Pricing
PB
T
=
t=
1
C
t
(1+ )
r
ParValue
+
T
(1+ )
r
PB =
Price of the bond
Ct =
interest or coupon payments
T = number of periods to maturity
y = semi-annual discount rate or the semi-annual yield
to maturity
Price: 10-yr, 8% Coupon, Face
Utility max
1 Risk-Free Asset and 1 Risky
Asset
Suppose we construct a portfolio P consisting of
1 risk-free asset f and 1 risky asset A:
E (rp ) w f r f w A E (rA )
2
p
2
A
= w 0 0
2
A
p = wA A
Note: The variance of the risk-free asset is 0, and the co
Ch 4
Characteristics of Probability
Distributions these are called
MOMENTS
1) Mean: most likely value
2) Variance or standard deviation
3) Skewness
4) Kurtosis
* If a distribution is approximately normal, the
distribution is described by characteristics 1
3
Student: _
1. A purchase of a new issue of stock takes place
A. in the secondary market.
B. in the primary market.
C. usually with the assistance of an investment banker or dealer.
D. a and b.
E. b and c.
2. The trading of stock that was previously issu
13
Student: _
1. The term structure of interest rates is:
A. The relationship between the rates of interest on all securities.
B. The relationship between the interest rate on a security and its time to maturity.
C. The relationship between the yield on a
7
Student: _
1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is
A. unique risk.
B. beta.
C. standard deviation of returns.
D. variance of returns.
E. none of these.
2. According to the Capital Asset Pricing Model (
2
Student: _
1. Which of the following is not a characteristic of a money market instrument?
A. liquidity
B. marketability
C. long maturity
D. liquidity premium
E. c and d
2. Which one of the following is not a money market instrument?
A. a Treasury bill
4
Student: _
1. Over the past year you earned a nominal rate of interest of 10 percent on your money. The inflation rate was
5 percent over the same period. The exact actual growth rate of your purchasing power was
A. 15.5%.
B. 10.0%.
C. 5.0%.
D. 4.8%.
E.
CAPM EXERCISE - Ta ken from ch. 7 in the text. CAPM
Are the following scenarios valid? Why or why
not?
Portfolio
A
B
Portfolio
A
B
Expected
return
.20
.25
Beta
Expected
return
.30
.40
Standard
Deviation
.35
.25
1.4
1.2
Portfolio
Risk free
market
A
Portfol
CAPM 2
A Fun Proof of the CAPM
2
CAPM Says that
E(R port )
for any security i that we pick, the
expected return of that security is given
by
Capital
Market
Line
M
security i
port
3
Why does CAPM work?
E(R port )
Green line traces out the set of
possible
Introduction to Finance
Finance is the study of how people
allocate scarce resources over time
costs and benefits are distributed over time
but the actual timing and size of future cash
flows are often known only probabilistically
Understanding financ
1
Student: _
1. The net wealth of the aggregate economy is equal to the sum of _.
A. all financial assets
B. all real assets
C. all financial and real assets
D. all physical assets
E. none of these
2. The material wealth of a society is a function of _.
A