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Practice Exam

Name
FINANCE 3033
Fall 2005

Multiple choice -- Circle the letter of the BEST answer (3 points each)
1. If a stock increases in price from $20 to $30 in seven years, what annual compound rate of
return would it yield? (approximately)
a. 6.0%
b. 7.1%
c. 21.4%
d. 50.0%
e. none of the above
2. You called your broker and told him to buy XYZ stock if and when its price got as low as
$30.00 per share. It currently trades at a bid of $33.00 per share. This type of order is
known as a
a.
b.
c.
d.
e.

Market order
Sell order
Limit order
Block order
none of the above

3. Jimmy called his broker on 5-3-05 and asked the broker to loan him one-half of the funds
required to buy 500 shares of Bold Ventures, Inc. On 7-24-05 Jimmy called his broker and
told her to sell the 500 shares of Bold Venture, Inc., to pay off the loan and cover his
transaction on 5-3-05. Jimmy has just completed:
a.
b.
c.
d.
e.

margin purchase
short sale
call option exercise
put option exercise
none of the above

4. The stock of most U.S. companies is traded in the


a.
b.
c.
d.
e.

New York Stock Exchange


American Stock Exchange
Over-the-counter market
Money market
none of the above

5. You are considering investing some of your year-end bonus and are considering several

stocks from different industries. One of your primary concerns is lowering the risk of your
portfolio. Below are five industries in which you are considering an investment as well as
their correlations with your current portfolio. Which industry should you invest in?
a.
b.
c.
d.
e.

Steel, +1.0
Transportation, +0.8
Telecommunications, +0.5
Health care, +0.2
Paper products, 0.0

6. If a large corporation wants to issue new common stock, management will probably seek the
advice and counsel of:
a.
b.
c.
d.
e.

the SEC
the governors of the New York Stock Exchange
a commercial banker
an investment banker
a securities dealer

7. If the return to the market is a consistent 14% and the risk-free rate is 6%, what is the
expected return of a security with a beta of 1.5?
a.
b.
c.
d.
e.

9%
18%
21%
23%
none of the above

8. Inflation, recession, and high interest rates are economic events which are characterized as
a.
b.
c.
d.
e.

firm-specific risk that can be diversified away


market risk
unsystematic risk
diversifiable risk
none of the above

9. Diversification works because


a. systematic risk exists.
b. forming stocks into a portfolio guarantees a positive rate of return on investment.
c. individual assets may fluctuate in price due to company specific events but these
fluctuations tend to offset one another in a portfolio.
d. market risk can be dramatically reduced if not eliminated.
e. Diversification does not work

10. A firm has several classes of securities outstanding. Which of the following is the MOST
risky from an investor's viewpoint?

a.
b.
c.
d.
e.

mortgage bond
debenture
preferred stock
common stock
the risk is the same if issued by the same company

11. You invested a $20,000 inheritance in a diversified portfolio. The value of the portfolio over
the years has been the following:
Year

Value of
Portfolio

2000
2001
2002
2003
2004
2005

$20,000
$17,000
$15,300
$16,065
$18,475
$22,170

What average annual rate of return has your portfolio earned since 2000? (5 points)

2.1%

12. Identify the three forms of the Efficient Markets Hypothesis, how the versions differ from one
another, and what the evidence suggests about the validity of each. (15 points)

13. The current price of the stock of Exxon Mobil is $65.70 per share, a record high. You feel
that the market has overpriced the stock and that the effects of hurricanes Katrina and Rita
will slow the economy, reducing demand for oil and, hence, the price of oil which will in turn
result in a decrease in the price of Exxon Mobil stock. You have an initial cash account of
$50.00 with your broker and instruct her to sell Exxon Mobil short.
A. If the price of Exxon Mobil rises to $70.00 per share, what rate of return would you
realize? (5 points)

-8.6%

B. If the price of Exxon Mobil falls to $55.00 per share, what rate of return would you
realize? (5 points)

21.4%

C. If your broker's firm requires a maintenance margin of 30%, at what market price of
Exxon Mobil would you receive a margin call? (5 points)
$89.00

14. You're considering two potential stocks as investment opportunities. Below are the historical
returns on the stocks over the past few years:

2001
2002
2003
2004
2005
A.

Stock X

Stock Y

-10%
5%
12%
7%
10%

- 6%
4%
8%
4%
6%

What average (arithmetic) rates of return have Stock X and Stock Y earned? (5 points)
Stock X = 4.8%
Stock Y = 3.2%

B.

What is the standard deviation of returns for Stock X and Stock Y? (5 points)
Stock X = 8.7%
Stock Y = 5.4%

C. Which stock is more risky? (5 points)

D. Suppose you had owned both stocks with 70% of your money in Stock X and 30% in
Stock Y. What rate of return would your portfolio have earned? (5 points)
4.3%

E.

You've calculated the betas of Stock X and Stock Y to be as follows:


Beta
Stock X
Stock Y

0.50
0.75

Suppose the risk-free rate is 3% and the expected return to the market as a whole is
9%. What rate of return should you require for Stock X and what rate of return should
you require for Stock Y? (5 points)
Stock X = 6.0%
Stock Y = 7.5%

F.

Explain why the required rate of return that you calculated in Part E for the more risky
stock could be lower than the required rate of return for the less risky stock as answered
in Part D. (5 points)