FIN 412 Practice Midterm Exam
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FIN 412: Investment Principles
Alberta School of Business, University of Alberta
Practice Questions – Midterm Exam
Multiple choice
Choose the option that most accurately answers each question.
1.
[1]
are financial assets.
A. Bonds
B. Rural property
C. Computer
D. Factory
2.
[1]
An entrepreneur sets up a watch factory by issuing and selling 10,000 shares in a firm set up to
run the factory. The factory is a
asset and the shares are
assets.
A. real; financial
B. financial; real
C. real; real
D. financial; financial
3.
[1]
Consider a market-value-weighted index composed of the three stocks listed below. What is
the growth of the index from 2010 to 2015?
Stock
Shares outstanding
2010 price (
$
)
2015 price (
$
)
A
200
90
100
B
100
25
45
C
150
20
20
A. 17.02%
B. 22.22%
C. 30.37%
D. None of the above
4.
[1]
Consider a price-weighted index composed of the three stocks listed below. What is the growth
of the index from 2010 to 2015?
A. 1.46%
B. 4%
C. –1.44%
Stock
Shares outstanding
2010 price (
$
)
2015 price (
$
)
A
100
30
40
B
90
25
10
C
250
20
22
D. None of the above
5.
[1]
If you want to buy shares in a company once the price goes over some threshold price, you have
to place a:
A. market order.
B. stop-buy order.
C. limit-buy order.
D. limit-sell order.
E. stop-loss order.
6.
[1]
A portfolio had a return of 5% and a standard deviation of 11% last year. At the same time,
the risk-free rate was 1%. The excess return last year was:
A. 4%
B. 13%
C. 36%
D. 45%
E. None of the above
7.
[1]
Your savings account in 1974 provided you with 13% in interest. Over the same period, the
consumer price index went up by 17%. Your real purchasing power grew by:
A. -4.84%
B. -3.42%
C. 3.54%
D. 4.73%
E. None of the above
8.
[1]
If we are told that the 5% CTE of a portfolio is –9.75%, it means:
A. the average return of the portfolio is 5%.
B. the average loss on the portfolio is 9.75%.
C. there is a 5% probability of a return less than –9.75%.
D. the average return in the worst 5% of cases is –9.75%.
E. none of the above.
Page 2
9.
[1]
We run a portfolio that has normally-distributed returns, with
E
(
r
) = 2% and
σ
= 4%.
A
potential investor asks for the 5% VaR for the portfolio. Using the appropriate tables, we find
z
0
.
05
=
−
1
.
645. How do we answer the investor?
A. 5% VaR is 0.71%.
B. 5% VaR is -3%.
C. 5% VaR is -4.58%.
D. What is 5% VaR?
10.
[1]
If you are especially concerned about the risk of extreme negative returns, which of these
measures is most helpful?
A. Expected return (
E
[
r
])
B. Standard deviation (
σ
)
C. Variance (
σ
2
)
D. Value at Risk (VaR)
E. None of the above
11.
[1]
Alice is a risk-averse investor. Bob is a less risk-averse investor than Alice. Based on that, we
know:
A. Bob tolerates more risk than Alice for a given level of return.
B. Bob tolerates less risk than Alice for a given level of return.
C. Bob requires more return than Alice for a given level of risk.
D. None of the above.
12.
[1]
Assume an investor has a risk aversion of 5. Which of the following assets would she like best?
A.
E
[
r
] = 10%
, σ
= 20%
B.
E
[
r
] = 8%
, σ
= 22%
C.
E
[
r
] = 15%
, σ
= 27%
D.
E
[
r
] = 13%
, σ
= 22%
13.
[1]
A security with a beta of 1.4 has an expected return of 13%. The market risk premium is 8%
and the risk-free rate is 2%. The alpha on this security is:
A. -0.4%
B. -0.2%
C. 0%
D. 0.2%
E. 0.4%
14.
[1]
The Security Market Line:
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A. is also called the Capital Market Line.
B. includes only efficient portfolios.
C. is tangent to the minimum variance frontier.
D. represents the expected return-beta relationship.
15.
[1]
Stock A has a CAPM beta of 1.25 and an expected return of 13%. Stock B has a CAPM beta
of 1.75 and an expected return of 18%. The market expected return is 11% and the risk-free
rate is 3%. Which security would be considered the better purchase and why?
A. Stock A because it offers an alpha of 0%.
B. Stock B because it offers an alpha of 1%.
C. Stock A because it offers an alpha of 1%.
D. Stock B because it offers an alpha of 0%.
16.
[1]
All else equal, diversification is most effective when
A. security returns are high.
B. security correlations are +1.
C. securities are uncorrelated.
D. securities are negatively correlated.
17.
[1]
If T-bills have a return of 3% and the risky portfolio has an expected return of 8% and a
standard deviation of 16%, which of the following is the equation for the Capital Allocation
Line?
A.
E
[
r
C
] = 0
.
03 +
5
16
σ
C
B.
E
[
r
C
] = 0
.
03 +
1
2
σ
C
C.
E
[
r
C
] = 0
.
08 +
3
16
σ
C
D. None of the above.
18.
[1]
A Capital Allocation Line can be described as:
A. the set of all portfolios possible by combining a risky asset and a risk-free asset.
B. the set of all portfolios possible by combining two risky assets.
C. the set of all portfolios with the same utility for an investor.
D. the set of all portfolios with the same expected return and risk.
E. none of the above.
19.
[1]
You believe that XYZ stock has an expected return of 12%. XYZ stock has a beta of 1.25. The
market risk premium is 10%. According to CAPM, XYZ stock:
A. is overpriced.
B. is fairly priced.
Page 4
C. is underpriced.
D. cannot be determined.
20.
[1]
Studies of liquidity spreads in security markets have shown that:
A. liquidity of stocks has no effect on returns.
B. more liquid stocks earn greater returns.
C. less liquid stocks earn greater returns.
D. there have been no studies of liquidity spreads and returns.
21.
[1]
Arbitrageurs may be unable to exploit behavioural biases due to
I) fundamental risk.
II) implementation costs.
III) model risk.
IV) conservatism.
V) regret avoidance.
A. I and II only
B. IV and V
C. I, II, and III
D. II, III, and IV
E. I, II, III, and V
22.
[1]
are financial assets.
A. Bonds
B. Machines
C. Stocks
D. Bonds and stocks
E. Bonds, machines, and stocks
23.
[1]
Assume you purchased 200 shares of GE common stock on margin at
$
70 per share from your
broker. If the initial margin is 55%, how much did you borrow from the broker?
A.
$
6,000
B.
$
4,000
C.
$
7,700
D.
$
7,000
E.
$
6,300
Page 5
24.
[1]
Which of the following measures of risk best highlights the potential loss from extreme negative
returns?
A. Standard deviation
B. Variance
C. Value at risk (VaR)
D. None of the options are correct.
25.
[1]
Assume an investor with mean-variance utility and risk aversion coefficient of 3.
To max-
imize her expected utility, she would choose the asset with an expected rate of return of
and a standard deviation of
, respectively.
A. 12%; 20%
B. 10%; 15%
C. 10%; 10%
D. 8%; 10%
E. 5%; 10%.
26.
[1]
The change from a straight to a kinked capital allocation line is a result of
A. reward-to-volatility ratio increasing.
B. borrowing rate exceeding lending rate.
C. an investor’s risk tolerance decreasing.
D. increase in the portfolio proportion of the risk-free asset.
E. Borrowing rate lower than lending rate.
27.
[1]
Based on CAPM, the best capital allocation line provided by a risk-free security and N risky
securities is
A. the line that connects the risk-free rate and the global minimum-variance portfolio
of the risky securities.
B. the line that connects the risk-free rate and the portfolio of the risky securities that
has the highest expected return on the efficient frontier.
C. the line tangent to the efficient frontier of risky securities drawn from the risk-free
rate.
D. the horizontal line drawn from the risk-free rate.
E. the vertical line drawn from the variance of the risky security.
28.
[1]
Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and
a risk free rate of 3%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.39
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C. 0.08
D. 0.13
E. 0.36
29.
[1]
According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio’s rate of
return is a function of
A. systematic risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
E. None of the options are correct.
30.
[1]
Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta
of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to
the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
31.
[1]
The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X
with a beta of 1.0 to offer a rate of return of 10%, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell short stock X because it is underpriced.
D. buy stock X because it is underpriced.
E. None of the options, as the stock is fairly priced.
32.
[1]
may be responsible for the prevalence of active versus passive investments
management.
A. Forecasting errors
B. Overconfidence
C. Mental accounting
D. Conservatism
E. Regret avoidance
33.
[1]
Suppose on August 27, there were 1,455 stocks that advanced on the NYSE and 1,553 that
declined. The volume in advancing issues was 852,581, and the volume in declining issues was
Page 7
1,058,312. The trin ratio for that day was
, and technical analysts were likely
to be
.
A. 0.87; bullish
B. 0.87; bearish
C. 1.15; bullish
D. 1.15; bearish
E. 0.81; bearish
34.
[1]
If you place a short sale order and want to limit the potential for losses, you should also place
a:
A. market order.
B. stop-buy order.
C. limit-buy order.
D. limit-sell order.
E. stop-loss order.
35.
[1]
If you make the right choice of risky portfolio, the Capital Allocation Line is a line between
the risk-free asset and:
A. the portfolio of risky securities with the minimum variance.
B. the portfolio of risky securities with the highest Sharpe ratio.
C. the individual risky security with the minimum variance.
D. the individual risky security with the highest Sharpe ratio.
E. none of the above.
36.
[1]
When two securities in a portfolio are not perfectly positively correlated, the portfolio standard
deviation will:
A. be greater than the weighted average of the individual securities’ standard deviation.
B. be equal to the weighted average of the individual securities’ standard deviation.
C. be less than the weighted average of the individual securities’ standard deviation.
D. always be equal to the covariance between the two individual securities.
E. be none of the above.
37.
[1]
According to the Separation Property,
investors choose the same risky portfo-
lio.
A. no
B. some
C. sophisticated
Page 8
D. all
E. unsophisticated
38.
[1]
If you are especially sensitive to the likelihood of
extremely
high and
extremely
low returns,
what characteristic of the return distribution most concerns you?
A. Expected return
B. Variance
C. Kurtosis
D. Skewness
39.
[1]
A zero-coupon bond with par value of
$
1000 maturing in 9 months is available today for
$
900.
What is its EAR?
A. 8.2%
B. 11.1%
C. 22.2%
D. 15.1%
E. None of the above
40.
[1]
You have
$
100,000 to invest. Based on your personal preferences, you decide to invest
$
130,000
in risky securities. This means that your personal risky asset allocation (
y
) is
,
which makes you a net
.
A. 0.3; lender
B. 0.3; borrower
C. 1.3; lender
D. 1.3; borrower
Short answer
41.
[8]
You intend to purchase shares in ABC stock, which is currently priced at
$
50/share. You have
assessed that the value of ABC in 3 months will fit into one of the three scenarios described
in the following table. If you purchase ABC stock, what is your expected return given your
assessment of its future value? What is the variance of these returns?
Scenario
Likelihood (%)
Dividend (
$
)
Price (
$
)
High
30
4
60
Medium
40
2
50
Low
30
0
40
After calculating the expected return and variance of the returns, you decide that the minimum
risk premium you would be willing to accept for this stock is 5% over the 3 months.
If the
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3-month T-bill rate is 1%, will you purchase ABC stock at the current price? If so, are you
receiving any additional return over your risk premium?
If not, what is the highest current
price at which you would purchase ABC?
42.
[2]
Bob is a mean-variance optimizing risk-averse investor with a coefficient of risk aversion of
4. His investment team offers him a risky portfolio with expected return of 8% and standard
deviation of 17%.
T-bills offer a 2% rate of return.
Individuals can borrow money at a 3%
interest rate. How much of his wealth should Bob invest in the risky portfolio? In the risk-free
asset?
43.
[3]
There exist two risky securities, X and Y. X has a risk premium of 10% and a standard
deviation of 18%.
Y has an risk premium of 6% and a standard deviation of 12%.
Their
correlation coefficient is 0.4. What are the weights in X and Y for the optimal risky portfolio?
What is the risk premium and standard deviation of the optimal risky portfolio?
Page 10
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