Royal Melbourne Institute of Technology

BAFI 1045

Topic 3

1)Which of the following is not an assumption of the Capital Market Theory?

 

1. 2. The rate of return on a risk free asset should equal the

 

 

1. 3. Which of the following statements about the risk-free asset is correct?

 

1. What does Wrf= -0.50 mean?

 

1. 4. The market portfolio consists of all

 

1. 5. The separation theorem divides decisions on                  from decisions on            .

 

1. 6. When identifying undervalued and overvalued assets, which of the following statements is false?

 

1. 7. The line of best fit for a scatter diagram showing the rates of an individual risky asset and the market portfolio of risky assets over time is called the

 

1. 8. Utilizing the security market line an investor owning a stock with a beta of -2 would expect the stock’s return to          in a market that was expected to decline 15 percent.

 

1. 9. All of the following questions remain to be answered in the real world except

 

1. 10. The correlation coefficient between the market return and a risk-free asset would

 

1. 11. As the number of securities in a portfolio increases, the amount of systematic risk

 

1. 12. Theoretically, the correlation coefficient between a completely diversified portfolio and the market portfolio should be

 

1. 13. All portfolio on the capital market line are

1. 14. The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a

 

1. 15. If the assumption that there are no transaction costs is relaxed, the SML will be a

 

1. 16. Which of the following is not a relaxation of the assumptions for the CAPM?

 

1. 17. Which of the following variables were found to be important in explaining return based upon a study of Fama and French ( covering the period of 1963 to 1990)?

 

1. 18. Which of the following would most closely resemble the true market portfolio?

 

1. 19. The error caused by not using the true market portfolio has become known as the

 

1. 20. The       the number of stocks in a portfolio and the    the time period the     the portfolio area.

 

1. 21. A completely diversified portfolio would have a correlation with the market portfolio that is

 

1. 22. In the presence of transactions costs, the SML will be

 

1. 23. If the wrong benchmark ( or market portfolio ) is selected then

 

1. 24. All of the following are assumptions of the Capital Asset Pricing Model (CAPM) except

 

1. 25. Beta is a measure of:

 

1. 26. The Efficient Frontier refers to a set of portfolios that

 

1. 27. If an individual owns only one security the most appropriate measure of risk is:

 

1. 28. The betas for the market portfolio and risk-free security are:

 

1. 29. Calculate the expected return for A Industries which has a beta of 1.75 when the risk free rate is . 03 and you expect the market return to be 0.11

1. 30. Calculate the expected return for B services which has a beta of 0.83 when the risk free rate is

0.05 and you expect the market return to be 0.12.

 

1. 31. Calculate the expected return for C Inc. which has a beta of 0.8 when the risk free rate is 0.04 and you expect the market return to be 0.12.

 

1. 32. Calculate the expected for D industries which has a beta of 1.0 when the risk free rate is 0.03 and you expect the market return to be 0.13.
   33. Calculate the expected return for E services which has a beta of 1.5 when the risk free rate is 0.05 and you expect the market return to be 0.11.
   34. Calculate the expected for F Inc which has a beta of 1.3 when the risk free rate is 0.06 and you expect the market return to be 0.125.

 

 

1. 35. Refer to exhibit 8-1, compute beta for RA Computer using the historic returns presented above.

 

 

1. 36. Refer to exhibit 8-1, compute the correlation coefficient between RA Computer and the Market Index.

 

 

 

1. 37. Refer to exhibit 8-1, compute the intercept of characteristic line for RA Computer.

 

 

1. 38. Refer to exhibit 8-1. The equation of the characteristic line for RA is

 

 

1. 39. Refer to exhibit 8-1, if you expected return on the Market Index to be 12%, what would you expect the return on RA Computer to be?

 

 

1. 40. Refer to exhibit 8-2, what are the expected (required) rates of return for the three stocks (in the order X,Y,Z)?

 

 

 

1. 41. Refer to exhibit 8-2, what are the estimated rates of return for the three stocks (in the order X,Y,Z)?

 

 

 

1. 42. Refer to exhibit 8-2, what is your investment strategy concerning the three stocks?

 

1. 43. Recently, you have received a tip that the stock of Bubbly Incorporated is going to rise from $57 to $61 per share over the next year. You know that the annual return on the S&P 500 has been 9.25% and the 90-day T-bill rate has been yielding 3.75% per year over the past 10 years. If beta for Bubbly is 0.85, will you purchase the stock?

 

 

1. 44. Your broker has advised you that he believes that the stock of Brat Inc. is going to rise from $20 to $22.15 per share over the next year. You know that the annual return on the S&P 500 has been 11.25% and the 90-T bill rate has been yielding 4.75% per year over the past 10 years. If beta for Brat is 1.25, will you purchase the stock?

 

 

1. 45. Recently, you have received a tip that the stock of Buttercup Industries is going to rise from

$76.00 to $85.00 per share over the next year. You know that the annual return on the S&P 500 has been 13% and the 90-day T-bill rate has been yielding 3% per year over the past 10 years. If beta for Buttercup is 1, will you purchase the stock?

 

 

1. 46. A friend has some reliable information that the stock of Puddles Company is going to rise from

$43.00to $50.00 per share over the next year. You know that the annual return on the S&P 500 has been 11 % and the 90-day T-bill rate has been yielding 5% per year over the past 10 years. If beta for Puddles is 1.5, will you purchase the stock?

 

 

1. 47. Recently, your broker has advised you that he believes that the stock of Casey Incorporated is going to rise from $55.00 to $70.00 per share over the next year. You know that the annual return on the S&P 500 has been 12.5 % and the 90-day T-bill rate has been yielding 6% per year over the past 10 years. If beta for Casey is 1.3, will you purchase the stock?

 

 

1. 48. A friend has information that the stock of Zip Incorporated is going to rise from $62to $65 per share over the next year. You know that the annual return on the S&P 500 has been 10% and the 90-day T-bill rate has been yielding 6% per year over the past 10 years. If beta for Zip is 0.9, will you purchase the stock?

 

 

1. 49. Assume that as a portfolio manager the beta of your portfolio is 0.85 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.0475, Rm(proxy) = 0.0975

ii. Rk = 0.0325, Rm (true) = 0.0845

 

 

1. 50. Assume that as a portfolio manager the beta of your portfolio is 1.15 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.0625, Rm(proxy) = 0.12

ii. Rk = 0.078, Rm (true) = 0.10

 

1. 51. Assume that as a portfolio manager the beta of your portfolio is 1.3 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.08, Rm(proxy) = 0.11

ii. Rk = 0.07, Rm (true) = 0.14

 

1. 52. Assume that as a portfolio manager the beta of your portfolio is 1.2 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.09, Rm(proxy) = 0.12

ii. Rk = 0.10, Rm (true) = 0.13

 

1. 53. Assume that as a portfolio manager the beta of your portfolio is 1.1 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.07, Rm(proxy) = 0.15

ii. Rk = 0.06, Rm (true) = 0.12

 

1. 54. Assume that as a portfolio manager the beta of your portfolio is 1.4 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

i. RFR = 0.06, Rm(proxy) = 0.12

ii. Rk = 0.05, Rm (true) = 0.11

 

 

1. 55. Refer to exhibit 8-3, the average true return is

 

 

1. 56. Refer to exhibit 8-3, the average proxy return is

 

 

1. 57. Refer to exhibit 8-3, the average return for Radtron is

 

 

1. 58. Refer to exhibit 8-3, the covariance between Radtron and the proxy index is

 

1. 59. Refer to exhibit 8-3, the covariance between Radtron and the true index is

 

 

1. 60. Refer to exhibit 8-3, what is the beta for Radtron using the proxy index?

 

1. 61. Refer to exhibit 8-3, what is the beta for Radtron using the true index?

 

 

1. 62. Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5% and the expected return on the stock index is 15%. The estimated return on the asset is 20%. Calculate the alpha for the asset.
   63. The variance of returns for a risky asset is 25%. The variance of the error term, Var(e) is 8%. What portion of the total risk of the asset, as measured by variance, is systematic?

1. 64. An investor wishes to construct a portfolio consisting of a 70% allocation to a stock index and a 30% allocation to a risk free asset. The return on the risk-free asset is 4.5% and the expected return on the stock index is 12%. The standard deviation of returns on the stock index is 12%. The standard deviation of returns on the stock index is 6%. Calculate the expected standard deviation of the portfolio.
   65. An investor wishes to construct a portfolio by borrowing 35% of his original wealth and investing all the money in a stock index. The return on the risk-free asset is 4.0% and the expected return on the stock index is 15%. Calculate the expected return on the portfolio.
   66. An investor wishes to construct a portfolio consisting of 70% allocation to stock index and a 30% allocation to a risk free asset. The return on the risk-free asset is 4.5% and the expected return on the stock index is 12%. Calculate the expected return on the portfolio.
   67. A stock has a beta of the stock is 1.25. The risk free rate is 5% and the return on the market is 6%.

The estimated return for the stock is 14%. According to CAPM you should

1. 68. Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk free asset.

 

 

1. 69. The expected return for a stock, calculated using the CAPM, is 10.5%. The market return is 9.5% and the beta of the stock is 1.50. Calculate the implied risk-free rate.

 

 

1. 70. The expected return for a stock, calculated using the CAP, is 25%. The risk free rate is 7.5% and the beta of the stock is 0.80. Calculate the implied return on the market.

 

 

1. 71. The expected return for Zbrite stock calculated using the CAPM is 15.5%. The risk fre rate is 3.5% and the beta of the stock is 1.2. Calculate the implied market risk premium.

 

 

NARRBEGIN: Exhibit 08-04

 

Exhibit 8-4

 

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Stock	Beta	Current Price	Expected Price	Expected Dividend
X	0.8	$12.50	$13.10	$0.80
Y	1.1	$ 8.25	$ 9.76	$0.20
Z	2.1	$25.70	$30.03	$0.00

 

 

 

1. 72. Refer to Exhibit 8-4. What are the expected returns for stocks X,Y, and Z for the next period based on the above prices and dividends?

 

	X	Y	Z
I	4.8%	18.3%	16.9%
II	10.7%	17.5%	14.4%
III	11.2%	20.7%	16.9%
IV	12.3%	22.5%	22.3%
V	13.1%	24.3%	18.2%

 

 

3. III

 

 

 

 

 

 

 

 

1. 73. Refer to Exhibit 8-4. If the expected return on the market is 11.5% and the risk-free rate of return is 4.5%, then what are the required rates of return for stocks X,Y, and Z based on the CAPM?

 

	X	Y	Z
I	4.8%	18.3%	16.9%
II	7.2%	20.7%	22.3%
III	10.7%	17.5%	14.4%
IV	10.1%	12.2%	19.2%
V	11.1%	12.2%	21.3%

 

4. IV

 

 

1. 74. Refer to Exhibit 8-4. Which of the following statements is correct?

 

 

 

NARRBEGIN: Exhibit 08-05

Exhibit 8-5

 

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

 

Portfolio	Expected Return	Standard Deviation
A	9.8%	14.0%
B	6.7%	9.8%
C	11.2%	18.5%

 

 

1. 75. Refer to Exhibit 8-5. Calculate the risk premium per unit of risk for the three portfolios above assuming the risk-free rate is 4.0%.

 

Portfolio:	A	B	C
I.	0.068	0.027	0.072
II.	0.414	0.276	0.389
III.	0.700	0.680	0.605
IV.	0.300	0.280	0.205
V.	0.650	0.580	0.480

 

(b) II

 

 

1. 76. Refer to Exhibit 8-5. Which of the three portfolios are most likely to be the market portfolios?

 

 

 

1. 77. Assume that the risk-free rate of return is 3% and the market portfolio on the Capital Market Line (CML) has an expected return of 11$ and a standard deviation of 14%. How should you invest $100,000 if you are only willing to accept a total portfolio risk of 8%?

 

 

HARRBEGIN: Exhibit 08-06

 

Exhibit 8-6

 

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

 

Jonathan Crowley is a portfolio manager for a large pension fund. Last year his portfolio had an actual return of 12.6% with a standard deviation of 13% and a beta of 1.3. the market risk premium for this period of time was 6% and the risk-free rate of return was 5%.