Investment Online Class

UCLA Extension Midterm Self-Evaluation

PART I: MULTIPLE CHOICE / SHORT ANSWER QUESTIONS
1. According to the efficient market hypothesis, there should be __________ overpriced and __________
underpriced securities.
A) no, no
B) no, some
C) some, no
D) some, some
2. The material wealth of society is determined by the economy's __________, which is a function of the
economy's __________.
A) investment bankers, financial assets
B) investment bankers, real assets
C) productive capacity, financial assets
D) productive capacity, real assets
3. According to the Flow of Funds Accounts of the United States, the largest financial asset of U. S.
households is _____.
A)
mutual fund shares
B)
corporate equity
C)
pension reserves
D)
personal trusts
4. Financial intermediaries exist because small investors cannot efficiently __________.
A)
diversify their portfolios
B)
gather information
C)
monitor their portfolios
D)
all of the above
5. Which of the following statements is most correct?
a. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is
completely described by a listing of the likelihood of unfavorable events.
b. Portfolio diversification reduces the variability of returns on an individual stock.
c. When company-specific risk has been diversified the inherent risk that remains is market risk, which is
constant for all securities in the market.
d. The CAPM / SML relates required returns to firms' market risk. The slope and intercept of this line
cannot be controlled by the investment manager.
6. Beta and standard deviation differ as risk measures in that beta measures:
A).
unsystematic risk, whereas standard deviation measures total risk.
B).
total risk, whereas standard deviation measures systematic risk.
C).
systematic risk, whereas standard deviation measures total risk.
D).
firm-specific risk, whereas standard deviation measures total risk.
7. Security Market Line (SML) implies that portfolio returns are best explained by:
A).
firm-specific risk
B).
currency risk
C).
total risk
D).
market risk

8. The standard deviation of Stock A is 0.2, and the standard deviation of stock B 0.12. The covariance
between Stock A and B is 0.0096. Whats the correlation between Stock A and Stock B? Show your
calculations.
0.4
(COV = 1,2 1 2)
9. An equity investment has a required return of 12 percent. The beta of the stock is 1.2 and the risk-free
rate is 5 percent. What is the market risk premium?
A).
6.5%
B).
8.0%
C).
6.3%
D).
5.8% [R = R f + Beta (R m R f)]
Risk premium
E).
5.3 %
10. An investment analyst estimates the following regression between the return on a stock (R) and the
return on S&P 500 index (RSP):
R = 5% + 1.1 RSP + error term
Assuming error term is zero. Estimate the change in the return on the stock when the return on the S&P 500
index changes from 16% to 12% (assuming error term 0).
-4.4% (= 4% x 1.1)
11. You have developed the following data on three stocks:
Stock
A
B
C

Standard Deviation
0.15
0.25
0.20

Beta
0.79
0.61
1.29

If you are a risk minimizer, you should choose Stock __________ if it is to be held in isolation and Stock
__________ if it is to be held as part of a well-diversified portfolio.
b. A; B
12. The correlation between the Freedom Equity Fund and the S&P 500 index is 1. The expected return on
the S&P 500 index is 10%, and the required return on the Freedom Equity Fund is 8%. The risk free return
in the U.S. is 3%. Based on this information, the implied beta of the Freedom Equity Fund is:
A).
0.8
B).
0.7
C).
0.6
D).
0.5
E).
0.9
[R = R f + Beta (R m R f)]
13. Stars Technologies is considering two potential projects, X and Y. In assessing the
projects' risk, the company has estimated the beta of each project and has also
conducted a simulation analysis.
Expected NPV
Standard deviation (NPV)
Estimated project beta

Project X
$300,000
$180,000
0.8

Project Y
$300,000
$150,000
1.2

Which of the following statements is most correct?

a. Project X has a higher level of total risk relative to Project Y.
b. Project Y has a higher level of market risk relative to Project X.
c. Statements a and b are correct.
d. Statement a only
2

14. Given a data series that is normally distributed with a mean of 100 and a standard deviation of 10,
about 95% of the numbers in the series will fall within:
a. 60 to 140
b. 90-110
c. 70-130
d. 80-120 (100 +/- 2 (10) = 80-120)
According to the empirical/Normal Distribution rule in Business Statistics, 95% of the observations in a
bell-shaped, symmetrical frequency distribution lie within 2 standard deviations of the mean.
15. James Smith, CFA, has developed the following data on stock X and the market:
Return on the market
12%
Covariance between the return on stock X and the
0.0288
return on the market
Correlation coefficient of the return on stock X and the 0.8
return on the market
Standard deviation of the return on stock X
0.18
Standard deviation of the return on the market
0.20
Based on these data, whats the beta of stock x? Show your calculations.
0.72
( = COV (ri, rm) / m2)
16. An analyst estimates the following return distribution for a stock:
Probability
0.3
0.5
0.2

Rate of Return
0.05
0.1
0.2

The standard deviation of the expected return is closest to:

A).
2%
B).
3%
C).
4%
D).
5%
E).
6%
n

k = k i Pi
i =1

(k
i 1

k) 2 Pi .

17. The primary goal of a publicly-owned firm interested in serving its stockholders should be to:
a. Maximize expected total corporate profit.
b. Maximize expected EPS.
c. Minimize the chances of losses.
d. Maximize expected net income.
e. Maximize the shareholder equity.
18. Risk in a revenue-producing investment project can best be adjusted for by
a.
Ignoring it.
b.
Adjusting the discount rate upward for increasing risk.
c.
Adjusting the discount rate downward for increasing risk.
d.
Picking a risk factor equal to the average discount rate.
e.
Reducing the NPV by 10 percent for risky projects.
19. A dollar denominated deposit at a London bank is called ______.
a. Eurodollars
3

b. LIBOR
c. Fed funds
d. Banker's acceptance
20. Which of the following is not a money market instrument?
a. Treasury bill
b. Commercial paper
c. Preferred stock
d. Banker's acceptance
PART II: MINI-CASE QUESTIONS
Question 1
A price-linked investment pays $300 if the oil price over the next year increases by more than 8%, an event
that can happen with a 60% probability. Otherwise, it pays $50. If the expected return on the security is
14%, how much does the security cost?
$175

Question #2:
Chile Monthly Returns
Mean
Median
Standard Deviation
Sample Variance
Range
Minimum
Maximum
Count

1.95%
0.62%
10.50%
1.10%
90.11%
-28.24%
61.87%
285

You are given the information above regarding monthly returns on investing in the Chilean Stock Market
from January 1976 through Sept. 1999. For comparison, the monthly average return on an essentially riskfree 3-month US Treasury Bill over this period was .53%. How would you characterize an investment in
the Chilean stock market over this time period? Be sure to indicate what measures of return and risk
you are using and why you are using them.
The answers vary; you get full credits as long as you can justify your answers. Please include discussions
of mean / median, standard deviations, range, max / min. Here is an example from your classmate (for
demo purpose).

Question 3 The following information describes he expected return and risk relationships for to stocks.
Expected Return
12%
9%
9%
4%

Stock A
Stock B
Market Index
Risk free rate

Standard Deviation
18%
14%
10%

Beta
1.2
0.8
1

Draw and label a graph showing the Security Market Line (SML) and position stocks A and B on the chart.
See attached Excel file
Question 4
You are given the following information regarding the historical returns on two assets:

Year
1

Investment X
5%

Investment Y
-3%

-10%

6%

3%

12%

16%

-6%

4%

2%

Calculate the Covariance of Investment X and Investment Y

Calculate the Standard Deviation of Investment X and Investment Y
Calculate the correlation of Investment X and Investment Y
Calculate the expected return and standard deviation of a portfolio consisting of 30% Investment X and
70% Investment Y.
Explain why a portfolio consisting of 30% investment X and 70% investment Y produces a lower
standard deviation than a portfolio consisting of 70% Y and 30% risk-free asset.

See attached Excel file

BONUS QUESTION (CHALLENGING)

Bartman Industries and Reynolds Incs stock prices and dividends, along with Wilshire 5000 Index,
are shown below for the periods 1995-2000. The Wilshire data are adjusted to include dividends.

a).Use the data given, calculate the annual returns for Barman, Reynolds, the Wilshire index. Calculate
average returns over the 5-year holding period.
b). Calculate the standard deviation of the returns for Barman, Reynolds, the Wilshire index.
c). Calculate coefficients of variation for Bartman, Reynolds, Wilshire index [CV = Std dev / Mean].
d). Construct a scatter diagram graph showing the returns for Bartman and Reynolds on the vertical axis,
the Wilshire index on the horizontal axis.
e). Calculate the correlations & covariance between Bartman Industries returns & Wilshire returns.
f). Draw a Security Market Line using the information provided above, assuming 4% risk free rate.