SampleTest_Midterm1

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University of Illinois, Urbana Champaign *

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Finance

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Feb 20, 2024

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Midterm Review Instructions and Sample Test Concept review Slide01 Real asset vs. financial asset Role of financial market Slide03 Fixed income securities (three types of bonds) The role of Primary market vs. Secondary market Trading costs and what determines the Bid-Ask Spread? Slide04 PV and FV of single cash flow and annuity. PV of (growing) perpetuity, loan payment question Slide0506 Definition of APR and EAR The connection between APR, EAR, and periodic rate (Annualized) holding period return for stock (w/wo dividend reinvestment) Slide070809: Portfolio Theory (Single index model will not be covered in Midterm 1) Efficient frontier, investment opportunity set, minimum variance portfolio, short sell, risk-free asset Risk premium, Sharpe ratio, capital allocation line (equation for risk-return relationship) Understand gains from diversification (risk reduction) and how to form a zero-risk portfolio Three steps to find the optimal portfolio (MARKOWITZ PORTFOLIO OPTIMIZATION MODEL). Know how to compute the expected return, variance (standard deviation) of an asset and a portfolio (linear combination of two risky asset). Know how to compute the correlation between two portfolios. Systematic risk vs idiosyncratic risk

Formula Sheet FV = PV ( 1 + r ) t PV = FV/ ( 1 + r ) t PV(Annuity) = CF r ¿ ) t ] FV(Annuity) = CF r ¿ ] PV(Perpetuity) = CF r PV(Perpetuity) = CF r − g

Portfolio of two risky assets

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Additional Exercise 1, Financial intermediaries exist because small investors cannot efficiently: a. diversify their portfolios. b. assess credit risk of borrowers. c. All the options are correct. d. diversify their portfolios and assess credit risk of borrowers. e. advertise for needed investments. 2, A purchase of a new issue of stock takes place: a. in the secondary and primary markets. b. usually with the assistance of a commercial banker. c. in the primary market and usually with the assistance of an investment banker. d. in the secondary market. 3. You purchased a share of stock for $68. One year later, you received $5.00 as a dividend and sold the share for $74.50. What was your holding-period return? a. 16.91% b. 11.80% c. 12.50% d. 13.65% 4, The holding-period return (HPR) for a stock is equal to: a. the capital gains yield minus the tax rate. b. the real yield minus the inflation rate. c. the dividend yield plus the capital gains yield. d. the nominal yield minus the real yield. e. the capital gains yield minus the dividend yield. 5, Which combination of returns and standard deviation provides the highest Sharpe ratio? Assume a 3% risk free rate. a. return = 25%, standard deviation = 35% b. return = 21%, standard deviation = 25% c. return = 15%, standard deviation = 22% d. return = 12%, standard deviation = 20% 6 . You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a T-bill with a rate of return of 0.045. A portfolio that has an expected outcome of $114 is formed by: a. investing $100 in the risky asset. b. investing $43 in the risky asset and $57 in the risk-free asset. c. investing $80 in the risky asset and $20 in the risk-free asset. d. borrowing $46 at the risk-free rate and investing the total amount ($146) in the risky asset

8. The standard deviation of a two-asset portfolio is a linear function of the assets' weights when: a. the assets have a correlation coefficient greater than zero. b. the assets have a correlation coefficient less than zero. c. the assets have a correlation coefficient equal to zero. d. the assets have a correlation coefficient equal to one. 9. Other things equal, diversification is most effective when: a. securities' returns are negatively correlated. b. securities' returns are positively correlated. c. securities' returns are high. d. securities' returns are uncorrelated. 10. You have been given this probability distribution for the holding-period return for Cheese, Incorporated stock: Stock of the EconomyProbability HPR Boom 0.20 24% Normal growth 0.45 15% Recession 0.35 8% What is the standard deviation of these returns? a. 6.30% b. 5.74% c. 4.38% d. 4.72%

11, Consider the following information about a risky portfolio that you manage and a risk-free asset: E(r P )=11%, σ P =13%, r f =2%. Required: a. Your client wants to invest a proportion of her total investment budget in your risky fund to provide an expected rate of return on her overall or complete portfolio equal to 8%. What proportion should she invest in the risky portfolio, P, and what proportion in the risk-free asset? b. What will be the standard deviation of the rate of return on her portfolio? c. Another client wants the highest return possible subject to the constraint that you limit his standard deviation to be no more than 17%. Which client is more risk averse? 12, Consider the following 2 risky assets Expected Return Standard Deviation A 10% 30% B 20% 50% The correlation between the returns is 0. a. What is the expected return and the standard deviation on a portfolio with w A = 120% and w B = -20%? b. What is the weight for a portfolio with an expected return of 15%? What is the standard deviation of this portfolio? 13, You are thinking of buying a piece of art that costs $50,000. The art dealer is proposing the following deal: He will lend you the money, and you will repay the loan by making the same payment every TWO years for the next 20 years (i.e., a total of 10 payments). If the interest rate is 4% per year, how much will you have to pay every two years? 14, You bought Google stock 5 years ago for $100/share. It paid dividends at the end of the first, third and fifth years of $2/share, $4/share, and $6/share. You sold it for $90/share during financial crisis. Assuming you could reinvest the dividends at an annual rate of 10%, what is the annualized HPR on Google stock over this 5-year period?

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