Finance Final

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Midterm #2-Final: Chapter 6.1-6.5: 1. Asset a: weight=.55, standard deviance: .38 Asset b: weight=.45, standard deviation= .39 correlation= .43 Calculate standard deviation : (.55^2*.38^2) + (.45^2*.39^2) + 2(.55*.45*.38*.39*.43) =.106026^(.5) =.3256 2. Consider a two-asset portfolio containing two risky assets with positive portfolio weights. As the correlation between the two stocks goes down, the variance of returns of the portfolio a. Goes down 3. When you form a portfolio with two risky assets that have a correlation of ___________, the standard deviation of the portfolio is simply a weighted average of the standard deviations of the two stocks. a. Positive 1 (1) b. 4. What is correlation here a. It is =0

5. What is correlation a. It is (-1) 6. What is correlation a. It is (+1) 7. You are a portfolio manager building a low-risk portfolio. Two of your analysts are arguing over whether the portfolio should include shares in Intelsat, the satellite manufacturer. Which of the following of the analysts’ arguments is correct? a. The stock should be included, because it is low risk. The event of a launch failure is uncorrelated with the risks affecting the other stocks in the portfolio. 8. If you calculate the standard deviation of returns for a single stock, what type of risk are you measuring? a. Total risk 9. The Wilshire 5000 index includes the shares of 5,000 U.S.-listed equities. If you measure the standard deviation of returns on the index, what type of risk are you (mostly) measuring? a. Systematic (non-diversifiable risk)

10. What is another name for unsystematic risk? a. firm-specific risk 11. What type of risk can be eliminated through greater diversification and is due to firm-specific or industry-wide factors such as strikes or resource price changes? a. unsystematic (diversifiable) risk 12. Which index is popularly thought to best represent changes in technology company stocks a. NASDAQ 100 13. Which of the following is a risk-free asset? a. a 52-week T-Bill 14. What is % change inTMI from day 1 to day 2: Day 1: 8*500= 4000 11*1900= 20900 =24,900 Day 2: 8.56*500=4280 12.1*1900=22,990 =27,270 (27,270/24,900) -1 *100 =9.52% 15. What is portfolio weight for company a on day 1:

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a. =10*500=5000 11*1500=16,500 =21,500 =(5000/21500)-1 *100 =23.3% 16. The value of the shares in the S&P 500 index is $12,270B. Apple Inc. is the largest company in the index — it is worth $552.15B. If you want to build a portfolio that earns the same return as the S&P 500, what is the portfolio weight on Apple? a. 552.15/12270 =4.5% 17. The Dynamic Duo is a value-weighted index with two stocks: A and B. A constituted 75% of the value of the index at the beginning of the year. During the year, A went up 15% and B rose 6%. What was the percentage change in Dynamic Duo index over the year? a. .75(.15) + (.25)(.06) =12.75% 18. Which of the following is/are true for a stock with beta equal to 1.5? I) The stock has a 50% higher expected return that the market portfolio. II) Given a market risk premium of 10%, the expected return on the stock would be 15%. III) The stock has 50% more systematic risk than the average stock. a. Only III 19. The Templeton mutual fund has a beta of 0.9 and the Fidelity fund has a beta of 1.65. If you had invested 67% of your wealth in Templeton and the remainder in Fidelity, then what was your portfolio's beta? a. .67(.9) + .33(.1) =1.1475 20. What is the beta of a portfolio where you invest 50% of your money in the risk-free asset and the rest in the market portfolio? =.5(0) + .5(1) =.5 21. What is the beta of a portfolio where you invest 40% of your money in the risk-free asset and the rest in the market portfolio? a. =.4(0)+(.6)(1) =.6

22. Which one of the following risks is relevant in determining the size of the beta of the shares of EA Games, the popular computer gaming manufacturer? EA Games makes titles such as Madden NFL Football, James Bond 007, FIFA Soccer, and Need for Speed. a. =Computer games are a luxury good with high income elasticity of demand. If the economy weakens, sales will likely fall . 23. A sales representative for a popular mutual fund is telling you why you should invest in their fund instead of the market portfolio. The sales rep claims that their fund is as good as the market when the market rises, but that it provides down-side protection. In other words, it doesn’t fall as much as the market when the market falls. What is the sales rep saying about the fund’s beta? a. The beta is equal to 1 when the market rises and less than 1 when the market falls. 24. You sell some of your Exxon co ./mmon stock (which tends to earn the same return every year) and replace it with the common stock of GoldCorp, Inc. (whose shares tend to rise sharply when the economy grows and fall dramatically when the economy is in recession). Your portfolio's beta should a. Increase. 25. Calculate Beta a. (.074-.093)/(.035-.045) =1.9 26. a. Pulite

27. a. (.01-.04)/(.01-.05) =.75 28. A line that shows all of the return and beta combinations that are possible by combining a given risky asset with the risk-free asset is the: a. portfolio possibility line 29. You want to build a two-asset portfolio which includes the risk-free asset and the market portfolio. You want the portfolio to have an expected return of 8.5%. The expected return on the risk-free asset is 4% and the expected return on the market is 10%. What is the portfolio weight on the market portfolio? a. (.085-.04)/(.1-.04) =.75 29. You have $19,200 to invest and you want to buy 100 shares of Vandalay Industries at $485 per share. Since you don’t have enough money to make the purchase, you will have to borrow some money. (You will buy the shares on margin.) What is the portfolio weight of Vandalay Industries in this simple margin portfolio? = purchase/amount invested purchase= 100*485=48,500 =48,500/19,200 =2.5 30. A friend says that she expects to earn 6.5% on her portfolio with a beta of 0.5. You have a two-asset portfolio including stock X and a risk-free security. The expected return of stock X is 14.2% and its beta is 1.7. The expected return on the risk-free security is 4%. If you construct your portfolio so that its beta is equal to the beta on your friend's portfolio, then what is the expected return of your portfolio?

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Weight =.5/1.7 =.2941 = .2914(.142) + (1-.2914)(.04 =.07 31. You want to build a two-asset portfolio which includes the risk-free asset and the market portfolio. You want the portfolio to have an expected return of 13%. The expected return on the risk-free asset is 4% and the expected return on the market is 10%. What is the portfolio weight on the risk-free asset? =(.13-.04)/(.1-.04) =weight 1.5 =1-weight: 1-1.5 =-.5 32. The Socially Responsible Fund (SRF) has a portfolio beta of 0.714. You have a two-asset portfolio including the market portfolio and the risk-free asset. The expected return on the market is 10% and the expected return on the risk-free asset is 3%. If you construct your portfolio so that its beta is equal to the beta on SRF, then what is the expected return of your portfolio? = .714(.1) + (1-.714)(.03) =.08 33. TREYNOR INDEX: = (12-.03)/1.4 = .064 34. You are building two-asset portfolio out of the risk-free asset and a risky asset, Stock X. The risk-free rate is 2%, the expected return on Stock X is 5.25%, and its beta is 0.5. You want the portfolio to have an expected return of 20.85% and a beta of 2.9. You only have $120 to invest. How much do you have to borrow? Weight: (.2085-.02)/(.0525-.02) =5.8 =1-5.8= -4.8 Amount borrowed = (-1) * (-4.8) * 120 =$576

48. You have a portfolio of two stocks: one long position and one short position. You bought 1,385 shares of Moose Inc. at $65 per share. Part of the funds needed to take the long position were derived from selling 600 shares of Squirrel Ltd. for $50 a share. You invested the difference from your own funds. What is the portfolio weight on the Squirrel position? Weight: cost of buying moose/investment moose= 1385*65= 90,025 Selling squirrel= 600*50 investment= moose-squirel =90025-30000 =60025 Weight Moose= 90,025/60,025 =1.5 Weight squirrel= (-1) * 30,000/60,025 =-.50 49. The risk-free rate is 3.5% and the expected return on the market is 7.5%. Wayne Enterprises has a beta of 1.625. What is the expected return for Wayne Enterprises according to the CAPM? =.035 + 1.625(.075-.035) =.10 50. A mutual fund manager expects her portfolio to earn a rate of return of 13.5% this year. The fund has a beta of 1.5. The risk-free rate is 2% and the expected return on the market is 10%. Should you invest in her mutual fund? =.02 + 1.5(.1-.02) =.14 Therefore you should not invest bc anticipated return is only 13.5% 51. Shares in Seafun Safari are currently trading today, January 1, for $14 per share. Seafun's next dividend (on December 31st) is expected to be $0.47. You plan to sell your shares after the next dividend and expect to receive $15. Seafun's beta is 1.2, the expected return on the market is 8.5%, and T-Bills are expected to earn 2%. = 15-14+.47/14 HPR=.105 E(ki)= .02 + 1.2(.085-.02) =.098 HPR is greater than E(ki) so investing is a GOOD idea 52. Asset A has an expected return of 7.5%. The expected market return is 9% and the risk-free rate is 3% . What is Asset A's beta? =.075-.03/.09-.03 =.75 53. You own two risky assets, both of which plot on the security market line. Asset A has an expected return of 7.6% and a beta of 0.9333 . Asset B has an expected return of 9.2% and a

beta of 1.2. If your portfolio beta is the same as the market portfolio, what proportion of your funds are invested in Asset A? =(1-1.2)/(.933-1.2) =.75 54. The SML implies that if you could find an investment with a negative beta, its expected return, E(k), would be: =E(k) < k f 55. Assume the market has a trenor Index of 4%. What is the Treynor Index of your portfolio consisting of the risk-free asset and the market portfolio if the portfolio weight on the market is 25% (and the balance is in the risk-free security)? = 4% = A portfolio comprised of the risk-free asset and the market portfolio is on the SML and has the same Treynor index as the SML Chapter 18: 1. You have a long position in one wheat futures contract. At the close of trading yesterday, the futures price was $5.50 per bushel. Today, the settlement price for wheat futures is $5.25. What is your daily profit? (Remember that there are 5,000 bushels in a contract.) a. Daily profit = (5.25-5.5) * 5000 = -$1,250 2. You have a short position in one wheat futures contract. At the close of trading yesterday, the futures price was $5.50 per bushel. Today, the settlement price for wheat futures is $5.15. What is your daily profit? a. (5.5-5.15) * 5000 = $1,750 3. you buy 10 soybean futures contracts with a September maturity. The soybean futures price when you initiate the long position is $14.00 per bushel. By August the soybean futures price has risen to $15.50 per bushel. You execute an offset trade. What is your cumulative profit on the trades? a. (15.5-14)*5000*10 =75,000 4. The dollar value of one Big Dow Index futures contract is the product of the futures price and the futures contract multiple ($25). If the futures price is 10,000, then the contract value is $250,000 (10,000 x $25). The contract is cash settled, so at the settlement date, cash is exchanged between the long and short positions. The current level of the index is 12,000. You are a mutual fund manager and you think that the Dow Jones Industrial Index is going to rise. To speculate on this expectation, you buy 50 of the Big Dow futures contracts in the September maturity. Assume that one week passes and the index rises to 12,080 and the futures prices rise accordingly. Assume that you execute an offset trade at that time and sell 50 of the Big Dow futures contracts in the September maturity. What is your cumulative profit on the trades? a. =(12,080-12,000)*25*50 = $100,000

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5. Natural gas (NG) futures contracts trade on the CME. Each NG contract calls for the delivery of 10,000 million British thermal units (mmbtu) of natural gas to the Henry Hub, a pipeline junction in Louisiana. Prices on the NG futures contracts are quoted as U.S. dollars and cents per mmbtu. If the price is quoted as 8.30, that means 1 million British thermal units (1 mmbtu) costs $8.30. Typical daily volume for the NG contract is 60,000 contracts. In the summer of 2007, Brian Hunter of Amaranth Advisors, a hedge fund, lost $6.6 billion trading NG futures. Assume that Mr. Hunter took a long position in the October futures contract in July of 2007 at a price of 8.30 and offset that position in September at a price of 4.25. How many contracts did Mr. Hunter have in his long position in order to lose $6.6B when he reversed in September? a. -6.6/(4.25-8.30) *1000 =162,963 contrats 6. You forecast a cold, rainy summer so you expect wheat harvests to be poor and prices to rise. To profit from your expectation, you take a long position in 15 wheat futures contracts at a futures price of $6.86 per bushel (each contract is for 5,000 bushels). You execute an offset trade near the maturity date of the futures contract at a price per bushel of $10.52. What is your cumulative profit? a. (10.52-6.86)*5000*15 =$274,500 7. Last November you obtained an advance copy of the Florida Orange Juice Growers crop report. The report forecasted a warm winter with abundant harvests and, consequently, low prices. To profit from this information, you took a short position in 20 orange juice futures contracts (for May delivery) at a futures price of 150.80. Each orange juice futures contract calls for delivery of 15,000lbs of orange juice solids. Prices are quoted in cents and hundreds of a cent per pound. So a futures price of 150.80 is $1.5080 per pound. In April, the May orange juice futures contract is trading for 175.8 and you execute an offset trade. What is your cumulative profit? =(1.508-1.758) * 15,000 * 20 = -75000 8. The basis of a futures contract is defined as the difference between the spot price and the futures price. Basis t = Spot price t – Futures price t The CME June soybean futures contract just traded at 1401’0. Today is April 1. The spot price today is 1395’4. If the spot price falls to 1390’0 by mid-June, then what will the basis be when the June contract stops trading? =future price is equal to spot price at settlement date so it will be ZERO 9. You are short one gold contract with a December maturity. You want to close out the position. What is the offset trade?

=long one December gold futures contract 10. You have a short position in one wheat futures contract. The initial margin was $3,000 and the maintenance margin is $1,500. At the close of trading yesterday, the futures price was $6.48 per bushel and the balance in your margin account was $1,750. Today, the settlement price for wheat futures is $6.58. Will you receive a margin call and what deposit will you be required to make? = 5000* (6.48-6.58) =-500 =1750 + (-500) =1,250 =3000-1250 =$1750 11. Tifany & Co. Jewelry Company sells 400 gold rings per day. Each ring uses about 0.2 of an ounce of gold. Over a year, Tifany uses 600,000 ounces of gold. Tifany buys all of its gold on one day. Tifany uses CME gold futures contracts to hedge the price risk of gold. The CME futures contract calls for the delivery of 100 ounces of gold. The contract is priced in dollars and cents per ounce. To hedge the price risk, should Tifany buy or sell gold futures and how many contracts should it trade? =600,000/100’ =6000 buy 12. You grow wheat on 1,250 acres near Normal, Illinois. It is late May. You just finished planting. Your typical yield is 32 bushels per acre, so you expect to harvest 40,000 bushels in the fall. You worry that the price of wheat might decline and you want to hedge your price risk. Wheat futures contracts trade on the CME. The wheat contract calls for the delivery of 5,000 bushels. To hedge the price risk, should you buy or sell December wheat futures? How many contracts should you trade? =40000/5000 =8 contracts sell 13. Jack Straw grows soybeans on a 2,000-acre farm outside Wichita Kansas. It is late May and Jack has just finished planting. His typical yield is 90 bushels per acre, so he expects to harvest 180,000 bushels of soybeans in the fall. Soybean futures contracts trade on the CME. The soybeans contract calls for the delivery of 5,000 bushels of soybeans. Assume that Jack enters the appropriate futures position (in the December contract) to hedge his price risk at a futures price of $5.3325/bu. In the fall, Jacks sells his harvest to his local grain elevator, who pays him the prevailing spot price of $5.665/bu. Simultaneously, Jack executes an offset trade in the futures market. Assume that, due to convergence, the futures price on that date is equal to the spot price. What is Jack’s cumulative profit from the futures transaction and what are his proceeds from selling his wheat Cumulative profit= (5.3325-5.665)*5000*36 = -(59,850)

Sales Revenue= 5.665 * 180,000 =$1,109,700 14. Which of the following items gives the long position the right to sell an asset at a specified price if they so choose? =put option 15. In which type of option does the short side pay the premium to the long side? [This is the stem.] =neither 16. Which type of option restricts the buyer to exercising on the expiration day only? = european 17. You have a long position in the December put option on the shares of Heartless Enterprises Inc. with a strike price of $40. It is a European option. Today (in November), Heartless shares are trading for $30 and you want to close your position. What do you do? =sell december put option 18. You are long a put option with an exercise price of $100. The option expires today and the underlying security is trading at $94. If you purchased the option for $4, should you exercise the option? = MAX(0,100,-94) =$6 =therefore yes you should 19. Simon Templar bought 1 call option on shares of Massive Dynamic for a premium of $2.00 (per share). The strike price of the option is $30 and the stock price was $31. Subsequently, the price of Massive Dynamic shares rose to $33.00 and Simon sold one call option at a premium of $3.50 (per share). What was Simon’s profit (or loss) per share on the transactions? = 3.50-2 =1.50 20. Shares of VersaLife Corporation are currently trading for $30. Call options on VersaLife Corporation shares, which expire in six months with a strike price of $20, are trading for $15. A trader buys one call option contract. Assume that there is one share per contract. At maturity, what is the payoff to the call option holder if the stock price is $30? =Max(0,30-20) =Max (0,10) 21. Shares of ACME Corp. are currently trading for $15. Call options on ACME Corp. shares, which expire in six months with a strike price of $25, are trading for $7.5. A trader writes one call option contract. Assume that there is one share per contract. At maturity, what is the payoff to the call option writer if the stock price is $35? = -1 * MAX(0, 35-25) =-$10 22. Shares of Vapid Motors are currently trading for $55. Put options on Vapid shares, which expire in six months with a strike price of $50, are trading for $5. A trader buys one put option

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contract. Assume that there is one share per contract. At maturity, what is the payoff to the put option holder if the stock price is $40? =MAX (0, 50-40) =$10 23. Shares of Maddoff Bank Inc. are currently trading for $25. Put options on Maddoff shares, which expire in six months with a strike price of $20, are trading for $5. A trader writes one put option contract. Assume that there is one share per contract. At maturity, what is the payoff to the put writer if the stock price is $25? = -1 * Max (0, 20-25) = $0 24. The recession has caused car owners to defer a new car purchase and keep their existing car. Thus, analysts do not expect automotive stocks to rise for the next few months. You plan to profit from this by taking a short position in a call option on BorgWarner Inc., the car parts manufacturer. Shares of BorgWarner are currently trading for $80. You write a call option that expires in nine months and has a strike price of $85. The option is trading for $5. At maturity, what is the profit of this call writing strategy if BorgWarner's stock price is $80? Assume that there is one share per contract. = -1 * (0,80-85) + $5 =$5 25. In the age of high-speed internet, you can buy video games online and download them to your game console. As a result, you think that the brick & mortar video game store chain, GameStop, has no future. To profit from your expectation, you buy one put contract on Gamestop’s shares. Gamestop shares are selling for $35. Put options on Gamestop shares, which expire in six months with a strike price of $30, are trading for $5. At maturity, what is the profit to your long put position if the stock price is $20? Assume that there is one share per contract. =Max(0,10) - 5 =$5 26. The Atlanta Braves have lost the first ten games of the season. Everyone is betting against them. You’re more optimistic and decide to write put options on shares of the Liberty Braves Group (NASDAQ: BATRK). BATRK shares are currently trading for $18. Put options on BATRK shares, which expire in three months with a strike price of $15, are trading for $5. You write one put option contract. Assume that there is one share per contract. At maturity, what is your profit if the stock price is $10? = -1 * (0, 15-10) + 5 = $5 27. Draw the profit diagram for a long position in a put option on shares of the Wireless Electricity Co. The strike price of the option is $20 and the put premium is $3. What is the maximum loss that you could earn on this position in this option? Assume that the option contract is for one share only. =$3 bc it is the premium 28. Draw the profit diagram for a long position in a put option on shares of the Wireless Electricity Co. The strike price of the option is $20 and the put premium is $3. What is the break- even price for this position in this option? Assume that the option contract is for one share only. =20-3

=$17 29. Draw the profit diagram for a long position in a call option on shares of the Wireless Electricity Co. The strike price of the option is $20 and the call premium is $3. What is the maximum profit that you could earn on this position in this option? Assume that the option contract is for one share only. = infinity 30. C. Montgomery Burns just bought a controlling interest in Springfield Nuclear, a local utility. You have observed Mr. Burns’ ownership style and you predict that Springfield’s share price will rise. You are considering either buying shares of Springfield or purchasing call options on the shares. The stock price is currently $30. The call option expires in three months, has a strike price of $30, and has a premium of $4.00 (per share). Assume that the stock price rises to $40 by the maturity date of the option. What is the rate of return on each investment? Express your answer in percentage form rounded to one decimal place. = Max(0,40-30) -4 = $6 HPR: $6/$4 = 1.5*100 =150% Stock Return: =40-30/30 =.3333 =33.3% 31. C. Montgomery Burns just bought a controlling interest in Springfield Nuclear, a local utility. You have observed Mr. Burns’ ownership style and you predict that Springfield’s share price will rise. You are considering either buying shares of Springfield or purchasing call options on the shares. The stock price is currently $40. The call option expires in three months , has a strike price of $40, and has a premium of $6.00 (per share). Assume that the stock price falls to $36 by the maturity date of the option. What is the rate of return on each investment? (Option return, stock return.) Max: (0,36-40) - 6 = -$6 HPR: -6/6 =-1*100 = -100 Stock Return: =36-40/40 =-.1*100 = -10%

32. Gamestop Inc. (NYSE: GME) operates a chain of brick & mortar stores selling video games. With the advent of high-speed internet, you are convinced that online purchasing will drive GME out of business. To profit from your prediction, you are trying to choose between short selling GME shares or buying put options. The stock price is currently $40. If you short sell, then your broker requires you to deposit 50% margin into your brokerage account. So if you sell 100 shares, you will need to deposit $2,000. The put option expires in three months, has a strike price of $40, and has a premium of $6 (per share) . Assume that the stock price falls to $20. What is the rate of return on each investment? (Option return, stock return.) Max: 0, 40-20) - 6 = $14 HPR: 14/6 =2.33*100 =233 Stock Return: = (100*40 +2000 -100*20) - 2000/ 2000 =1*100 =100% 33. Gamestop Inc. (NYSE: GME) operates a chain of brick & mortar stores selling video games. With the advent of high-speed internet, you are convinced that online purchasing will drive GME out of business. To profit from your prediction, you are trying to choose between short selling GME shares or buying put options. The stock price is currently $30. If you short sell, then your broker requires you to deposit 50% margin into your brokerage account. So if you sell 100 shares, you will need to deposit $1,500. The put option expires in three months, has a strike price of $30, and has a premium of $4 (per share) . Assume that the stock price rises to $33. What is the rate of return on each investment? Express your answer in percentage form. MAX: (0,30-33)-4 = -4 HPR: -4/4 = -1 HPR: (100*30 +1500 -1000*33) - 1500/1500 = -.2 34. To profit from the growing popularity of ocean voyages, you take a long position in a call option on the shares of White Star Line, a steamship company whose shares are currently trading for $30. The call option expires in three months, has a strike price of $29, and has a premium of $3. What is the intrinsic value of the option? = MAX(0, 30-29) = $1

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35. To profit from the declining usage of directories, you take a long position in a put option on the shares of Yellow Pages Inc. whose shares are currently trading for $12. The option expires in three months, has a strike price of $15, and has a premium of $5. What is the intrinsic value of the option? =(0, 15-12) =$3 36. With the proliferation of news and opinion web sites and YouTube channels, you think that the main stream media is going to die. To profit from this expectation, you are considering put options on the shares of The New York Times Company (NYT). The company’s stock is currently trading for $50. Put options on NYT shares that expire in 3 months with a strike price of $40 are trading for $2. Which of the following best characterises these puts? = out of the money 37. With the growing popularity of electric cars, you think that the demand for lithium batteries will grow for many years. To profit from this expectation, you are considering call options on the shares of Lithium America (NYSE: LAC), a lithium mining company. The company’s stock is currently trading for $14. Call options on LAC shares that expire in 3 months with a strike price of $10 are trading for $8. Which of the following best characterises these puts? = in the money 38. Today is April 1. June call options on shares of Gamestop Corporation (GME) with a strike price of $145 are trading for a premium of $45. The shares of GME are currently trading for $150. What is the time value of the option? =45 - (0,150-145) =40 39.Today is April 1. June put options on shares of Gamestop Corporation (GME) with a strike price of $155 are trading for a premium of $42. The shares of GME are currently trading for $150. What is the time value of the option? =42- (155-150) =$37 40. Last October you bought a call option on shares of Tesla with an April expiry and $120 strike price. You paid a call premium of $12. Today (January 15), Tesla is trading for $150 per share and the April call (with the $120 strike) is trading for $36. You think that Tesla has reached its peak price and will start declining. You want to get out of your long option position today because as the price drops, the intrinsic value will fall. Answer the following questions. a. What is your profit if you exercise? (Assume the option is American.) Max: (0,150-120) i. =$30-$12= $18 b. What is your profit if you execute an offset trade? i. = 36-12= $24 c. The difference in the profits to the two methods of completion is equal to the i. Time value Chapter 7:

1. The issuer of a zero coupon bond _________ money. The owner has a ________ position in the bond and the issuer has a _________ position. a. borrows; long; short 2. Cyberdyne Systems is issuing a series of zero coupon bonds to raise $500M to fund research and development at its Skynet division. Each bond will have a face value of $1,000 and will mature in 12 years. The yield on the bond is 7.935%. What is the fair price for one of Cyberdyne’s zero coupon bonds? a. FV/(1+k)^n =1000/(1.07935)^12 =399.99 3. You just bought a strip bond with a face value of $1,000 and 8 years to maturity. You paid $627.41. What is the yield on the bond? = (FV/Price)^(1/n) -1 =(1000/627.41)^(⅛) -1 =.06 4. What is the percentage change in price for a zero coupon bond if the yield falls by 1% from 5.5 % to 4.5%? The bond has a face value of $1,000 and it matures in 7 years. (P after – P before .) =caluclate price for both rates = (price aft price bef)/ price bef 5. Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 8 years, for $858.31. What is the implicit interest in the first year of the bond's life? =SAME FORMULA AS YIELD =(1000/858.31)^(⅛) -1 =1.928% Interest in first year: 1.928% * 858.31 =$16.55 6. Consider the treasury spot rate yield curve. That is, the yield curve constructed from zero coupon bonds issued by the Government with no default risk. If expected inflation rises in all future periods (by an equal amount), then the yield curve will: =shift up (and get steeper) 7. If the nominal rate of interest is 5.06% and the real rate of interest is 2%, what is the expected rate of inflation? = (1.0506/1.02)-1

=.03 8. The real rate of interest is 3% and the expected rate of inflation is 1.94%. What is the nominal rate of interest? = .03+.1094+(.03*.0194) =.05 9. The 1-year spot rate is 3% and the expected spot rate next year is 5.0097%. What is the 2- year spot rate predicted by the expectations theory? = (1.03)*(1.050097) =1.081^(.5) =4% 10. The 1-year spot rate is 1%. The 1-year spot rate expected for next year is 5.0396% and the 1-year spot rate expected in two years is 6.0292%. What are the 2-year and 3-year spot rates predicted by the pure expectations theory? 2 year: ={(1.01)*(1.050396)}^.5 -1 = 3% 3 year: ={1.01*1.050396*1.060292}^(⅓) - 1 =4% Coupon Bonds: 1. 2. What is the default risk premium of a corporate bond if the real rate is 4%, the expected inflation is 4%, the liquidity premium is 3%, the maturity risk premium is 1%, and the nominal yield of the bond is 14.16%? a. .1416-.04-.04 - (.04*.04) - .01 -.03 i. =.02 3. C* 1/(1+k) + (C+FV)*(1/(1+k)^2 a. =7*.939 + 107*.8638 =$99 4. Springfield Nuclear Energy Inc. bonds are currently trading for $97.86. The bonds have a face value of $100, a coupon rate of 5% with coupons paid annually, and they mature in 5 years. What is the yield to maturity of the bonds? a. RATE(5,5,-97.86,100,0,.1)

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=.055 5. A bond has 8 years remaining to maturity, pays annual coupons (yesterday) of $5, and has a face value of $100. The current price of the bond is $88.057 and the price next year is expected to be $89.221. (Interest rates are not expected to change over the coming year.) What is the yield to maturity on the bond? =C/Pn + Pn-Pc/Pc =5/88.057 + (89.221-88.057)/88.057 =.07 6. What is the price of a bond with 3 years to maturity, a 5% coupon rate (annual coupons), and $100 face value if the yield to maturity is 6.125% ? =C*PVIFA + FV*pvif 7. A Ford Motor Co. coupon bond has a face value of $100, a coupon rate of 2%, and pays annual coupons. The next coupon is due tomorrow and the bond matures 15 years from tomorrow. The yield on the bond issue is 3.282 %. What is the fair price for the bond today? =C + (C*PVIFA) + (FV*pvif) 8. City Wok Inc. bonds trade for a price of $88.298. The bonds have 10 years to maturity and a yield to maturity of 3.4 %. The bonds pay annual coupons (the next coupon is due in one year) and the face value is $100. What is the coupon rate of the bond? = Price- FV*pvif/PVIFA =88.298-71.6/ 8.359 =2 =C/FV =2/100 =2% 9. Hooli Inc. bonds trade for a price of $109.197. The bonds have a coupon rate of 6% (annual) and a yield to maturity of 4.6 %. The face value is $100. How many years until the maturity of the bond? =NPER(.046,6,-109.197,100,0) =8 years 10. Consider an annual coupon bond with a face value of $ 100, 10 years to maturity, and a price of $95. The coupon rate on the bond is 5%. If you can reinvest coupons at a rate of

7.2792 % per annum, then how much money do you have if you hold the bond to maturity? =C*FVIFA + FV =5*14 + 100 =$170 11. Rudy purchased a 7.5% coupon rate bond one year ago for its face value of $100. He bought the bond just after the coupon date. Yesterday the bond paid its annual coupon. The bond currently has 17 years until maturity and has a yield to maturity of 7.395%. If Rudy sells the bond today, then what is his return for the last year? a. Calculate price of bond currently =7.5*PVIFA + 100*pvif = $101 b. Calculate HPR =101-100+7.5/ 100 =.085 12. A U.S. Government T-bond matures in 30 years and has a face value of $100. The bond has a coupon rate of 8% and the next (annual) coupon is due in one year. You bought the bond today for $92. If you can re-invest the coupons at 3.7220%, then what is your total return (per annum) on the bond? a. Total return: =(FV/price)^(1/n) -1 FV= C*FVIFA + Face FV= 528.40 b. (528.40/92)^(1/30) -1 =.06 13. Calculate the spot rate: ={1.05250^(2)/1.05} -1 = .055

14. Assume that the one-year spot rate is 1% (k 1 =1%) and the expected future spot rate is 3.01% (E(k 1 ) = 3.01%). What two-year spot rate is consistent with these values under the expectations theory and what is the shape of the yield curve? ={(1.01)*(1.0301)}^(.5) -1 = 2% BECAUSE 2% IS GREATER THAN 1% IT IS UPWARD SLOPING 15. Consider a 2-year coupon bond with a face value of $100 and a coupon rate of 8% (the next annual coupon is due in one year). The one-year spot rate is 8%, the two-year spot rate is 9.0964%, and the bond is trading today for $98.148. What is the expected price for the coupon bond after the first coupon? = (1.0964)^2/(1.08) -1 = .102039 price= 108/(1.102039) = 98 16. Consider a two-year coupon bond with a face value of $100 and a coupon rate of 8.5% (the next annual coupon is due in one year). The one-year spot rate is 5.5% and the two- year spot rate is 7.2357%. What is the expected holding period return if you buy the bond after the first coupon? (Assume no change in the economy.) =(1.072357)^2/1.055 -1 = .09 Price = 108.5/1.09 = $99.541 HPR= (100 - 99.541 + 8.5)/99.541 = .09 17. Consider a two-year coupon bond with a face value of $100 and a coupon rate of 3.5% (the next annual coupon is due in one year). The one-year spot rate is 6%, the two-year spot rate is 5.499%, and the bond is trading today for $96.292. What is the expected holding period return if you can sell the bond after the first coupon? =1.05499^2/1.06 -1 = .05

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price= 103.5/1.05 =98.569 HPR= (98.569-96.292+3.5)/96.292 =.06 Chapter 8: 1. A share of preferred stock pays a dividend of $0.20 annually. The required rate of return is 4%. What is the preferred stock's price per share? a. =.2/.05 =$5 2. If investors require an 8% return, and the preferred stock pays an annual end-of-year dividend of $6.75 , what is the market price per share? =6.75/.08 =$84.375 3. What is the price of a share of preferred stock that has a dividend of $2.56 if the return required on preferred stock is 14.9% ? =2.56/.149 = $17.18 4. If preferred stock sold for $90 a share and $2.70 dividends were paid annually, what would be the required rate of return? =2.70/90 =3% 5. Because of declining sales, Wayne Enterprises Inc. announced today that it is suspending dividend payments on its preferred shares. The shares have a 5.8% annual dividend, have a par value of $55, and are not cumulative. The next dividend would have been paid tomorrow (if it were not suspended). Analysts expect Wayne's profits to rebound strongly in the coming year and also expect Wayne to resume regular annual dividend payments of $3.19 in two years. What is the fair price for the shares today if investors require a return of 7.2% ? = 3.19/ .072

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= 44.31 =44.31/1.071 $41.33 6. Because of declining world-wide sales of its number one confection, the petit Bearsbum Confection announced today that it is suspending dividend payments on its preferred shares. The shares have a 6% annual dividend, a par value of $100, and are cumulative . The next dividend would have been paid tomorrow (if it were not suspended). Analysts expect Bearsbum's profits to rebound strongly in the next year and half due to the introduction of a new line of sour gummy bear paws. As a result, analysts expect that Bearsbum will resume dividends of $6.00 in two years’ time. What is the fair price for the shares today if investors require a return of 7% ? =2(6)/1.07^(2) + (1/1.07)* (6/1.07) =$90.59 7. Vandalay Industries paid $2.00 per share in dividends yesterday. Its dividends are expected to grow steadily at 7% per year. What are dividends expected to be for each of the next 3 years? Round your answers to the nearest cent. One year div: 2* (1.07) = 2.14 Two year div: 2.14* (1.07)= 2.29 Three year div: 2.29*(1.07)= 2.45 8. You are contemplating the purchase of a stock you will hold for 2 years. You will receive $0.82 per year in dividends, and then you expect to sell it for $21. If the required return is 9% , what is the most you would pay for the stock? =.82/(1.09) + .82/(1.09)^(2) + 21/(1.09)^(2) = $19.12 9. Carlson Enterprises' common stock dividend is expected to grow at 1% per year. The dividend recently paid was $0.46 per share, and the required return is 4%. What is the estimated value of the common stock? D1 =.46 * (1.01) = $.4646 P0= .4646/(.04-.01) = $15.49

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10. Kramerica Industries paid $2.05 per share in dividends yesterday. Its dividends are expected to grow steadily at 6% per year. If the required return is 6.9% , what is the estimate of the stock's price 1 year from now ( P 1 )? D2= 2.05 * (1.06)^2 = 2.30 =2.30/(.069-.06) =$255.93 11. The Peterman Company does not currently pay dividends. However, investors expect that, in 6 years, Peterman will pay its first dividend of $1.50 per share and will continue to grow at 10% per year forever. If investors require a 12% annual return on the stock, what is the current price? =1.50/(.12-.1) =75 75/(1.12)^5 = $42.56 12. Teal Corp. has been having trouble. The last dividend was $2.86 , and it's projected to fall 3% per year indefinitely. If the required return is 6% , what is Teal Corp.'s stock price? =2.86 * (1-.03) =2.7742/(.06-(-.03) =30.82 13. What would you pay for a share of common stock where the last dividend was $3 and that was expected to grow at −5% per year indefinitely, assuming a 25% cost of equity? =3*(1-.05) =2.85/(.25-(-.05)) =9.5 14. Suppose you have some extra money to invest for 1 year. After a year, you will need to sell your investment to pay tuition. After listening to Bloomberg , you decide that you want to buy Intel Corp. stock. You call your broker and find that Intel is currently selling for $50.96 per share and pays $0.15 per year in dividends. The analyst on Bloomberg predicts that the stock will be selling for $59.50 in 1 year. Assume that you would be satisfied to earn 11.9%. What is the current value of the stock based on the dividend pricing model? = .15/(.119) + 59.50/(1+.119)

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=$53.31 15. If dividends for ABC Corp. were $1.44 at the end of 2002 and $3.06 at the end of 2011 , what is the average compounded growth rate? = (3.06/1.44)^(1/9) -1 =.0874 16. Company A's common stock recently paid a dividend of $1.00. The next dividend is expected to be $1.02. If the required return is 9% , what is the estimated value of the common stock? =(1.02/1)^1/1 -1 =.02 Value: 1.02/(.09-.02) = 14.57 17. What is the price of a share of stock if the beta is 1.5, its next dividend is projected to be $2.50 , and its growth rate is expected to be a constant 9% , assuming the market return is 13% and the risk-free rate is 6% ? .06+ 1.5(.13-.06)= .165 D1= 2.5/(.165-.09) =$33.33 18. You are contemplating the purchase of a stock you will hold for 2 years. You will receive $0.82 per year in dividends, and then you expect to sell it for $22. If the required return is 8% , what is the most you would pay for the stock? =.82/(1.08) + .82(1.08)^2 + 22/(1.08)^2 =20.32 19. Shares of Luna Sea Hotels Inc. currently sell for $44.42. Yesterday, Luna Sea paid a dividend of $0.81 per share. Assume that the growth rate of dividends will be 7.7% and that dividends will grow at a constant rate forever. Given this, what is the implicit return of the stock? =.81*(1.077)/44,42 + .077 =9.7% 20. The last dividend paid by Abbot Company was $3.29. Dividends are expected to grow at 15% for the next 2 years, then grow at a constant 4% indefinitely. If the required return is 6% , what should be the current stock price?

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D1= 3.29 * 1.15= 3.78 D2= 3.29* (1.15)^2= 4.35 D3= 4.35* (1.04)= 4.52 D3: 452/(.06-.04) = 226.25 3.78/(1.06) + 4.35/(1.06)^2 + 226.25/(1.06)^2 =$208.8 21. What is the price of a share of stock if the beta is 1.5, its next dividend is projected to be $2.50 , and its growth rate is expected to be a constant 6% , assuming the market return is 13% and the risk-free rate is 5% ? = .05 + 1.5(.13-.05)= .17 D1: 2.5/(.17-.06) =$22.73 22. The next dividend for ABC Corp. is expected to be $1.26. It will rise to $2.17 the next year and grow at a constant 5.9% from then on. The required return is 11.7%. What is the current price of the stock? D1: 1.26 D2: 2.17 D3: 2.17*(1.059) = 2.3 2.3/(.117-.059) =39.62 1.26/(1.117) + 2.17/(1.117)^2 + 2.3(1.117)^2 =$34.62 23. Shares of S&M Family Outlet Inc. trade on the NYSE (NYSE: S&M). The shares traded today at a price of $15.88. Yesterday, S&M paid a dividend of $1.09 per share. The next dividend is expected in one year's time. If investors require a 9% return and if the

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dividends are expected to grow at a constant rate forever, what growth rate is currently priced into the shares? The implicit growth rate of the stock is: = [.09*15.88 -1.09]/(15.88+1.09) =.01998 24. Analysts expect Sturk Industries to make payouts of $4.825 billion at the end of this year. Assume that all payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts forecast that Sturk's payouts will grow at 4.5 % in perpetuity. Sturk stockholders require a return of 9 %. Sturk has 0.95 billion shares outstanding. What is the fair price for Sturk's shares today? = 4.825/(.09-.045) = 107.222.95 =$112.87 25. Yesterday, Cyberdyne Systems paid out $1.825 billion in dividends and repurchased $4.795 billion worth of shares. Assume that all payouts occur at the end of the year. Next year's payouts (due in one year) are expected to be 1% bigger than last year's and are expected to grow at that same rate in perpetuity. Cyberdyne Systems has 1.48 billion shares outstanding and its shareholders require an 8 % rate of return. What is the fair price for Cyberdynes's shares today? =(1.825+4.795)*(1.01)/(.08-.01) =95.517/1.48 =64.54 26. Analysts expect Oscorp Industries to make payouts of $2.18B at the end of this year. Assume that all payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts forecast that Oscorp's payouts will grow at a constant rate of 1.5% in perpetuity. Oscorp has 2.74B shares outstanding and its shares are currently trading for $16.54. What required return has the market priced into Oscorp's share price?

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= 2.18/(k-.015) = 16.54 * 2.74 =6.3% 27. Analysts expect Virtucon to make payouts of $3.365 billion at the end of this year. Assume that all payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts forecast that Virtucon's payouts will grow at 1.5 % in perpetuity. Virtucon stockholders require a return of 6 %. Virtucon has 2.13 billion shares outstanding and has cash on hand of $6.42billion. What is the fair price for Virtucon's shares today? =3.365/(.06-.015) + 6.42 = 81.1977/2.13 = $38.12 28. Because of the weak economy, Nakatomi Trading Corp. has suspended stock repurchases for the current year. Nakatomi makes its payouts annually at the end of each year. Today is the first day of a new year. Nakatomi has announced that it will pay dividends of $1.045 billion (in aggregate) at the end of the current year. Next year Nakatomi will hold dividends constant and it will resume stock repurchases. It plans to spend $4.045 billion repurchasing shares. In the years following, analysts expect payouts to grow in perpetuity at 3 % per annum. Stockholders require a return of 10 % and there are 1.03 billion shares outstanding. What is the fair price for Nakatomi's shares today? =(1.045+4.045)/(.1-.03) E1= 72.71 E0: 72.71/(1.1) + 1.045/(1.1) =67.05/1,03 = $65.1 29. Sirius Cybernetics faces tough competition from Cyberdyne systems. Sirius has decided to suspend payouts and instead invest the cash in R&D. Sirius makes its payouts annually at the end of each year. Today is the first day of a new year. Sirius has announced no payouts at the end of this year or next year. Payouts will resume three years from yesterday and analysts expect it will pay dividends of $1.445 billion (in aggregate) and repurchase $4.055 billion worth of shares. In the years following, analysts expect payouts to grow in perpetuity at 5 % per annum. Stockholders require a return of 9 % and there are 1.23 billion shares outstanding. What is the fair price for Sirius's shares today? =(1.445+4.055)/(.09-.05)

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= 137.5 =137.5/(1.09)^2 =115.73/1.23 =$94.09 30. Bearsbum Confection is experiencing declining world-wide sales of its number one confection, the petit ourson. It announced today that it is suspending dividends and stock repurchases and will resume them in two years. Analysts expect that total payouts will be $2.3 billion in two years and that payouts will continue to be paid annually thereafter in perpetuity, growing at a rate of 1.8%. Bearsbum has 443 million shares outstanding and its investors require a return of 7.2%. What is the fair price for the shares today? =2.3/(.072-.018) =42.59/ (1.072) =39.73/.443 =89.68 31. Company Z is currently priced at $42. They just reported earnings per share of $1.15. What is the P/E ratio that investors are willing to pay for a share of Company Z's stock? =42/1.15 =36.52 32. Harper Industries has a P/E constant of 15 and 140 million shares outstanding. Analysts forecast net income to be $257.6 million in the next fiscal year. What is the fair price for a share of Harper? =257.6/140 =1.84*15 =27.60 33. The P/E ratio for a firm is 18.7. Expected earnings per share are $1.67. What is the current price of the firm's stock? a. 18.7*1.67 =31.23 Chapter 5:

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1. The relationship between risk and return can best be described as______. =direct 2. If there is absolutely no risk to an investment, =there will be some return 3. You have invested in Even Temper Dog Collars Inc. Your initial investment is $101.12. After a year your investment is valued at $111.76. The firm paid a $2.56 dividend at the end of the year. What is the holding period return? HPR= [111.76-101.12+2.56]/101.12 =13.05% 4. Assume you buy a share of stock at $40 , it pays $1.86 in dividends, and you sell it 193 days later for $34. What is your annualized return? Enter a negative percentage for a loss and assume a 365-day year. [34-40+1.86]/40 * (365/193) = -19.57% 5. You bought a stock for $76.81 and sold it after 4 years for $100.37. What is the average compound annual return? =(100.37/76.81)^(¼) -1 =6.92% 6. What is the expected return for a security if there's a 45% probability of returning 11% and a 55% probability of returning 18% ? =.45(.11) + .55(.18) =14.85% 7. Suppose you purchased 1,700 shares of Pan Am Airlines at the beginning of the year for $16.03. By the end of the year, the stock price had appreciated to $21.02. At the end of the year, Pan Am paid a dividend of $1.43 per share. Calculate the dividend yield on this investment over the year. =1.43/16.03 =8.92%

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8. It costs $100 to enter the following game of chance based on the outcome of a coin toss (fair coin). If the coin comes up 'heads,' you walk away with $125. However, if the coin comes up 'tails,' you walk away with $55. What is the expected return on this gamble? (125/100)-1= .25 (55/100)-1= -.45 =.25(.5) + (-.45)(.5) = -10% 9. You believe that next year there is a 10 % probability of a recession and 90 % probability that the economy will be normal. If your stock will yield −7 % in a recession and 18 % in a normal year, what is the standard deviation of the stock E(k): .1(-.07) + .9(.18) =.155% Standard dev: [(-.07-.155)^2 * .1)] + [(.18-.155)^2 *.9)] ^(.5) 10. If Microsoft stockholders expect either a 25.6% return or a 1.8% return, each with a 50% probability, and Apple Computer shareholders expect a 10.3% return with certainty, what is the expected return from a portfolio comprised of equal amounts of stock from both firms? Microsoft= .256(.5) + .018(.5) = 13.7% Portfolio: 13.7(.5) + 10.3(.5) =12% 11. Assume you currently hold one type of security and decide to construct a portfolio. Which of the following would provide the greatest degree of risk reduction? =Adding a security that has perfect negative correlation with the one you are holding. 12. Is it possible to hold a portfolio where the risk of the whole portfolio is lower than the risk of any asset within it? =Yes – diversification among stocks lets the positive and negative swings due to individual security attributes cancel. Old Exam Q’s:

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1. Shares of Bell Canada are trading for $30.46. You decide to purchase call options which expire in three months with a strike price of $28.67. The call options are trading for $7.68. What is the time value of the option? =28.67 - 30.46 + 7.68 = 5.89 2.

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