Why is beta a measure of market risk for a security?
> When is the expected return equal to the required return?
> 1. What is the expected return and standard deviation of a portfolio consisting of $7,500 invested in a risk free asset with an 8‐percent rate of return, and $2,500 invested in a risky security with a 20‐percent rate of return and a 25‐percent standard d
> Four risk factors, F 1 , F 2 , F 3 , and F 4 , have been identified to determine the required rate of return, as follows: ERi a0 bi1 F1 bi2 F2 bi3 F3 bi4 F4, where a0 , is the expected return on a security with zero systematic risk. Calculate the require
> You invested $100,000 in the following stocks: If the risk‐free rate is 5 percent and the market risk premium is 8 percent, what is the expected return on your portfolio? Stock Amount Beta АВС $20,000 0.8 DEF $30,000 1.2 GHI $15,000
> The variance of the market returns is 0.0576, and the covariance of the returns on ABC stock and the market is 0.09504. If the risk‐free rate is 5 percent and the market risk premium is 8 percent, what is the required rate of return of ABC?
> The expected return on stock A is 15 percent. The expected return on stock B is 9 percent. Assuming CAPM holds, if the beta of stock A is higher than the beta of stock B by 0.4, what should the risk premium be?
> Stock A has a beta of 1.8 and an expected return of 20 percent. Stock B has a beta of 1.2 and an expected return of 14 percent. If CAPM holds, what should the return on the market and the risk‐free rate be?
> Assuming CAPM is valid, can we have a situation where stock A has a required rate of return of 15 percent and a beta of 1.4, and stock B has a required rate of return of 20 percent and beta of 1.2?
> Determine the beta of QTax based on the following information: • Market expected return is 9 percent; standard deviation is 12 percent • R isk‐free rate is 3 percent • Current dividend is $4 • Dividend growth rate is 4 percent • Current stock price is $3
> Data on the daily performance of Carraway Corporation have been partially completed in the following table. Fill in the missing data. The closing price on one day is assumed to be the opening price for the next day. Carraway Corporation Performance T
> Which of the following are examples of systematic (market) risks? Which are examples of unsystematic (unique) risks? a. Inflation risk b. CFO’ s fraudulent activities c. Changes in interest rates d. Product tampering e. Political risk f. CEO’ s aversion
> You are valuing the Vancouver Rain‐Making Company (VRM) and need to calculate the following: a. Required rate of return (assume the market risk premium is 8 percent, the risk‐free rate is 3 percent, and the beta is 1.28) b. Price of VRM based on the curr
> Estimate the beta of the following stock: market risk premium = 25 percent, RF = 6 percent, P0 = $10, expected dividend at the end of the year = $2.50, P = $12.50 . Assume the market is in equilibrium.
> Stock FM has a standard deviation of 28 percent and a correlation coefficient of 0.7 with market returns. The standard deviation of market return is 16 percent, and the expected return is 13.5 percent. The risk‐free rate is 4.5 percent. a. What is the be
> TrenStar Inc. obtained the following incomplete information from ABC Company and has given you the task of completing the table. Security 1 Security 2 Weight in Beta Beta Security 1 Portfolio Beta Case 1 0.5 1.5 0.4 Case 2 0.65 0.5 1.3 Case 3 1.1 1.9
> Calculate the missing values for the following five efficient portfolios. The expected return on the market is 8 percent, with a standard deviation of 5 percent, and the risk‐free rate is 2 percent. Еxpected Portfolio Return Standar
> Jackie borrowed $1,000 at the risk‐free rate of 6 percent. She invested the borrowed money and her own money of $2,500 in a portfolio with a 15‐percent rate of return and a 25‐percent standard deviation. What is the expected return and standard deviation
> Why is the CAPM called a single-factor model?
> Briefly describe the strengths and weaknesses of the Fama-French model and the APT.
> Describe some of the criticisms of the CAPM, including Roll’s critique.
> To achieve a zero standard deviation for a portfolio, calculate the weights of stock A and stock B, assuming the correlation coefficient is −1. Expected Expected Return on Return on Probability Stock A in Stock B in of Occurrence Th
> You are forecasting the returns for PVC Company, a plumbing supply company, which pays a current dividend of $10. The dividend is expected to grow at a rate of 3 percent. You have identified two public companies, ABC and VJK, which appear to be comparabl
> Your client is confused. He owns shares in the Whistler Snow‐Making Company (WSMC) and wants you to explain your recommendation. Both of you agree on the following: WSMC has an expected return of 12 percent, a standard deviation of 9 percent, and a beta
> Obtain monthly returns for BlackBerry, the Royal Bank of Canada, and the S&P/TSX Composite Index for January to December 2015. (Note: Monthly historical prices, adjusted for dividends, are available from http:// ca.finance.yahoo.com. To obtain the data,
> Three of your friends (Jean, Evan, and Lee) are having an argument about investments and, because you have taken this course, have come to you for advice. The possible investments are set out in the following table. (Assume you cannot mix risky investmen
> A lawyer prosecuting a lawsuit against The Brokerage Company has hired you to conduct an investigation into the advice the company has been giving its clients. You observe that clients have invested in the following portfolios: Evaluate the advice The Br
> TrenStar Inc. has five clients with different risk and return preferences. The market portfolio has an expected return of 12 percent, with a standard deviation of 16 percent. The risk‐free rate is 4 percent. Each client has $2,500 to in
> TrenStar Inc. is planning to offer several investments to investors and is in the process of designing its marketing materials. Each investment’ s value in the future will be related to the return on the S&P/TSX Composite Index over
> Portfolio A has a beta of 0.82. Portfolio B has a beta of 1.05. RF is 3 percent and the market risk premium is 6 percent. Calculate the required rate of return of A and B. If the expected rate of return for both portfolio A and B is 8.5 percent, what inv
> Suppose you have a portfolio that has $100 in stock A with a beta of 0.9, $400 in stock B with a beta of 1.2, and $300 in the risk‐free asset. You have another $200 to invest. You wish to achieve a beta for your whole portfolio to be the same as the mark
> You are following five different stocks and need to issue a recommendation (buy, hold, or sell) to your customers. The market return is 10 percent, with a standard deviation of 15 percent. The risk‐free rate is 3 percent. The CAPM is as
> On Monday you invested $182 in Dettall Ltd. Dettall has earned daily returns of −8 percent, 18 percent, −30 percent, 6 percent, 7 percent, and −5 percent. What is the value of your investment at the end of the six days?
> State Roll’ s critique concerning the CAPM.
> The risk‐free rate is 5 percent, the risk premium is 6 percent, and stock A has an expected return of 15.5 percent. What is the beta of stock A?
> The idea behind CAPM is that investors should not be compensated for diversifiable risk. Why not?
> The current price of a stock is $20. It is expected to rise to $22 in one year and pay an annual dividend of $1 during the year. The RF is 4 percent, the ER M is 10 percent, and the stock’s beta is 1.6. Determine whether the stock is overvalued, underval
> Which security, A, B, or C, will provide the greatest return per unit of risk when combined with the risk free asset with a 5 percent rate of return? ERA = 20 percent, σA = 5 percent ERB = 25 percent, σB = 10 percent ERC = 30 percent, σC = 15 percent
> If a security’ s total risk (variance) increases, does that mean the beta must have increased? Explain.
> What is the beta of the following? a. Risk‐free asset b. Market portfolio
> How do you determine if a portfolio or security is undervalued, correctly valued, or overvalued?
> State three of the assumptions underlying the capital asset pricing model (CAPM).
> Today, you observe the market portfolio has an expected return of 13 percent, with a standard deviation of 7 percent. The risk‐free rate is 2 percent. If only the risk‐free rate increases (i.e., there are no changes to the expected risk and returns of th
> FinCorp Inc. conducted an extensive analysis of the economy and concluded that the probability of a recession next year is 30 percent, the probability of a boom is 45 percent, and the probability of a stable economy is 25 percent. Your boss has estimated
> For the following decisions, indicate if they are consistent with risk aversion or risk loving. a. Buying a lottery ticket b. Buying fire insurance on your house c. Jaywalking on St. Catherine Street in Montreal d. Backing up your computer
> If the market risk premium increases will securities become over or under valued?
> If a security’s correlation with the market return increases, will its beta get larger or smaller?
> What is the slope of the CML, and why can it be reviewed as the market price of risk for efficient portfolios according to the CML?
> What is a characteristic line, and why is it useful?
> Assuming the CAPM holds, if the expected return on a diversified portfolio lies above the CML, should an investor buy or sell the portfolio?
> Why is the GM return a better estimate of long run investment performance than the AM return?
> What is the difference between ex ante and ex post returns?
> Why do the income and capital gains component of the total return differ between common shares and bonds?
> State three of the most important assumptions underlying Markowitz’s notion of efficient portfolios.
> 1. Calculate the capital gain return for a stock that was purchased at $32 one year ago and is now worth $34. It paid four quarterly dividends of $1.50 per share each throughout the year. a. 9.75 percent b. 6.25 percent c. 13.50 percent d. 11.00 percent
> Why would we sometimes want to use scenario based risk measures rather than the standard deviation of actual returns over a long time period?
> What is the difference between estimating a scenario-based (probability) estimate of risk versus a historic data-based estimate of risk?
> Why is the range sometimes a poor measure of risk?
> What is the difference between diversifiable and non-diversifiable risk?
> What is naïve diversification?
> Five years ago, your dad bought 250 shares of ABC for $6 each and 300 shares of DEF for $7.50 each. He has now given you all his shares, when both stocks are trading at $8. What are the weights of the two stocks in your portfolio?
> Using the following information, calculate the expected return and the standard deviation of ABC. State of the Economy Probability ABC Stock Return (%) Depression 0.15 -5 Recession 0.2 1 Normal 0.4 6 Вoom 0.25 18
> Calculate the covariance and correlation coefficient between the two securities of a portfolio that has 60 percent in stock X (with an expected return of 40 percent and a standard deviation of 12 percent) and 40 percent in stock Y (with an expected retur
> Why is it logical to believe that international diversification will provide benefits to investors?
> You wish to combine two stocks, Encor and Maestro, into a portfolio with an expected return of 16 percent. The expected return of Encor is 2 percent with a standard deviation of 1 percent. The expected return of Maestro is 25 percent with a standard devi
> FinCorp Inc. has been using the services of San Bernadino Brokerage Company (SBBC) for the past six months. SBBC has informed FinCorp Inc. that the geometric mean monthly return was 6 percent and that over the past six months FinCorp Inc. earned 16 perce
> As an analyst for FinCorp Inc., you are responsible for many firms, including ADFC. Currently you have a “hold” recommendation on ADFC. 19 The current price of ADFC is $140. You have conducted an extensive analysis of the industry and you feel that the p
> An investor owns a portfolio of $60,000 that contains $15,000 in stock A, with an expected return of 12 percent; $20,000 in bonds, with an expected return of 8 percent; and the rest in stock B, with an expected return of 20 percent. Calculate the expect
> Calculate the ex post standard deviation of returns for the following: 50 percent, 30 percent, 20 percent, 35 percent, 55 percent.
> Calculate the annual arithmetic mean and geometric mean return on the following security, and state which method is more appropriate for the situation: purchase price = $30; first‐year dividend = $5; price after one year = $35; second‐year dividend = $5;
> At the beginning of last year you invested $24,000 in 1,500 shares of Goran Products Inc. During the year you received $3,750 as a dividend. At the end of the year you sold the shares for $15 each. Calculate your total dollar return, capital gain, percen
> At the beginning of the year you bought 300 shares of Lycel Ltd. at $84 each. During the year you received dividends of $780. At the end of the year the stock is trading for $87 and you decide to sell all your shares. Calculate your capital gain, total d
> The expected return of ABC is 16 percent, and the expected return of DEF is 27 percent. Their standard deviations are 10 percent and 23 percent, respectively. If a portfolio is composed of 40 percent ABC and the remainder DEF, calculate the expected retu
> You wish to combine two stocks, Peledon and Mexcor, into a portfolio with a standard deviation of 6 percent. The expected return of Peledon is 2 percent with a standard deviation of 1 percent. The expected return of Mexcor is 25 percent with a standard d
> Is the zero-risk portfolio described in Question 4 generally equally weighted in both securities? Explain.
> On January 1, FinCorp Inc. completed its analysis of the prospects for the Geriatric Toy Store and concluded that there was a 25‐percent chance the stock price would be $150 in one year and a 75‐percent chance the stock price would be $200. Six months la
> On January 1, FinCorp Inc. published the following forecasts for the economy: During the year you observed quarterly returns of 2 percent, −5 percent, 3 percent, and 8 percent. a. Calculate the ex ante expected quarterly return. b. Calc
> You have the following return data on six stocks: a. Graph the returns of each stock (ABC, DEF, GHI, JKL, and MNO) against the returns of XYZ. b. Based on the five graphs, which stocks are positively correlated with XYZ? c. Based on the five graphs, whic
> FinCorp Inc. is exploring the risk of different portfolio allocations between two stocks. Complete the following table. Case 1 Case 2 Weight in stock 1 15% Weight in stock 2 25% Standard deviation of stock 1 15% 2% Standard deviation of stock 2 3% 10
> Your portfolio consists of two securities: Transcomm and MidCap. The expected return for Transcomm is 15 percent, while for MidCap it is 5 percent. The standard deviation is 6 percent for Transcomm and 20 percent for MidCap. If 55 percent of the portfoli
> FinCorp Inc. is exploring different portfolio allocations between two stocks. Complete the following table. Case 1 Case 2 Case 3 Case 4 Case 5 S invested in stock 1 S invested in stock 2 $500 $200 $500 $5,000 Total $ invested $2,000 $5,000 $1,000 Wei
> You observed the following daily returns for two companies, ABC and DEF. a. Calculate the following for each stock: i. Five‐day cumulative return ii. Geometric mean daily return iii. Arithmetic mean daily return iv. Standard deviation
> You have observed the following returns: 18 percent, −15 percent, 8 percent, 6 percent, and −12 percent. a. Calculate the geometric mean return. b. Calculate the arithmetic mean return. c. Calculate the variance and standard deviation of returns.
> Why might a scenario-based estimate be more accurate for a short-run expected return estimate than a historical AM estimate?
> What assumptions about investors underlie Markowitz’s theories regarding efficient portfolios?
> Why is all risk removed in a two-security portfolio if the securities are perfectly negatively correlated?
> What is an unattainable portfolio, and what is a dominated portfolio?
> Why is the efficient frontier bowed?
> How do you form the minimum variance frontier in the two-security case?
> You have received the following incomplete information about a set of currency forwards. All the forwards are for C$1,000 in one year. Complete the following table. Today In One Year Number Spot Cost Spot Profit of (CS/ Today Forward (C$/ Payoff (Los
> Simon manages a large bond portfolio and wishes to hedge against interest rate risk. His portfolio includes Government of Canada bonds and high‐grade Canadian corporate bonds. The correlation between the returns on his fund and the Government of Canada 6
> Why does it make sense that interest rate swaps involve an exchange of net payments, while currency swaps exchange all cash flows?
> Explain how currency swaps are structured and how they can be used for hedging purposes.
> Explain how plain vanilla interest rate swaps are structured and what purpose they serve.
> 1. Which of the following statements concerning Government of Canada bond futures is false? a. The contract price is quoted per $100. b. A maximum position limit is set to prevent a single dominant holding. c. Basis risk exists when the underlying asset
> 1. Which of the following statements is false? a. A spot price is a price today for immediate delivery. b. If a Canadian firm has to pay U.S. dollars in the future, it worries about the potential depreciation of the U.S. dollar. c. The forward price is a
> Why is portfolio standard deviation not a weighted average of the standard deviations of the underlying securities?
> Compare and contrast forwards and futures.
> What is basis risk? Why is it important for hedgers?
> Explain what is meant by “marked to market”.
> Define initial margin, maintenance margin, margin call, open interest, and notional amount.
