b.

Calculate the value of the expected return for the risky portfolio based on a 50-50 mix
of stocks and bonds. Show your work.

c. Calculate the value of the expected SD for the risky portfolio for that same 50-50 mix.
Show your work.

U S^O?) 4 /Qo)

16%
\

d. Consider the complete portfolio of pension fund with a target rate of return of 6%. Will
it have more than 0% in each of the three assets? For which asset will it have more than
50%? Check the appropriate boxes:
More than 0%?
Yes
No

Risk-free asset
Bonds
Stocks

More than 50%?

Yes
No

V*

e. Suppose the pension fund could not choose a mix of stocks and bonds, but had to
choose a risky portfolio of either all stocks or all bonds. In terms of the model of portfolio
optimization, which is the better choice, all stocks or all bonds? Explain.

A\\ idtxte. fyvyu Cu*- W*ac ^ h^ f*U^ <L_l* it W$U ffckuuK, Jjuj

11

24. Portfolio Optimization. Consider these expected returns, standard deviations

and correlations for the world bond and stock markets. (Five questions, four points
each, 20 pts. in all)

Expected Return
SD

Stocks
11%
20%

Bonds
6%
10%

Risk-free asset
1%
0%

Correlation, p(stocks, bonds) = 0.0

The graph below shows the minimum-variance frontier for different mixes of stocks and
bonds based on these assumptions. The diamonds () on the line show the expected
return (y-axis) and SD (x-axis) for weights at 10%-point intervals (0% stocks, 10%
stocks, 20% stocks, etc.)

6AL

o.ooo

0.050

0.100

0.150

0.200

0.250

a. In the diagram above, (A) mark and label the risk-free rate, (B) draw and label the
Capital Allocation Line (CAL), and (C) mark and label the optimal risky portfolio.

10

d. For the fund in the previous question, what is the drawback to using the same
formula if the applicable yield changes by a large amount, say decreasing from
5.0% to 4.0%? Would your estimate be an over- or under-estimate of the
percentage change resulting from that decline in yield? Explain.

{,* M\%
U 6?

-".0-57

-5/7*
U w c $ P v ^ U l y - M v o o * * f c t k s ^ ^ W. U q W ^
e. A 4% coupon treasury will pay semi-annual interest of $2 per $100 face value
on July 15. If the quoted (or clean) price on April 16 (90 days earlier) is $100,
what will be its sale (or dirty) price on that date?

[00 f(

Answer: blO(

f. Consider a two-year bond paying annual coupons of $3 per $100 face value. If
its current price is $106. what is its yield? Show your work or explain.

not

, JS-.Mob

"2

jo3
(Wo$' * Ci+of>"
rU fe >*V ^v tv/(lwj ^

Answer

-CfZ

23. Show your work or explain as necessary. (4 pts. each. 24 pts. in all)
a. A fifty-year bond with a coupon rate of 5% trades at par or face value. What fraction of its
value today is due to the promised return of coupon payments?
\

so " odnx

(U5fV

Answer: O. '& o
b. A zero-coupon bond returning $1,000 in ten years currently has a price of 700.
What is its yield to maturity?

\ OOO 4-0 __,

(UOv T 0+O
\,ooo

-jJEThT

.o"it>"S ^ C Answer: 5>.l/S/,

c. A fixed-income fund has a duration of 6 years. If the yield applicable to the
fund's assets increases from 5.0% to 5.1%, what is the percentage change in the
value of the fund?

-t* M
us;

- -006714

Answer: ~~,^ ' 'o

22. Which of the following is worth more? (2 pts. each, 10 pts. in all)

Alternative A

Alternative B

A call option on Twitter stock with a

strike price of $40

A call option on Twitter stock with

a strike price of $45

A call option on Twitter stock with a

strike price of $45 expiring in March
2014

A call option on Twitter stock with

a strike price of $45 expiring in July
2014

A corporate bond paying a 5%

coupon on an annual basis (once a
year).

A bond from the same corporation

paying a 5% coupon on a semi
annual basis (2.5% twice a year).

A ten-year corporate bond with a 5%

coupon.
y

A ten-year US treasury bond with a

5% coupon. \/

A December 2013 call option on

Twitter with a strike price of $30
when the current price is $40.

A December 2013 put option on

Twitter with the same strike price of
$30 when the current stock is worth
$40.

i-. HO- ^o/ur +P

The
alternative
worth
more:
AorB

A
B
5

A3

Part II. Answer the following questions.

21. Write in the correct answer, A or B. for each question below. (5 at 2 pts. each, 10
points)
AorB
a. The delta or hedge ratio of a call option is bounded (A) on the interval [0,
+ 1] or (B) on the interval [-1,0].

b. The SPDR S&P 500 (Symbol SPY) is trading at 123. The January 2013
call on SPY with a strike price of 120 is (A) in the money or (B) out of the
money.

c. The most recently issued Treasury securities are (A) more liquid or (B)
less liquid than seasoned issues that have been trading for a while.
? U~ltn~.X
d. Small investors have a tendency to (A) hold on to winners and sell losers
(B) sell winners and hold on to losers.
e. Consider a two-year bond with a face value of $100 and an annual coupon
of $3. If its yield is 4% it is selling at (A) a premium or (B) a discount.

3,4
3
1

A$

po//i4(c

general level of interest rates increases, what statement about duration is

The duration of high-coupon bonds will increase more than the duration of
low-coupon bonds.
The duration of low-coupon bonds will increase more than the duration of
high-coupon bonds.
yf The duration of all bonds with the same maturity will increase the same
/df The duration of zero-coupon bonds will not change. /*,'"1fc < u** r> u^ U^X\
15. About which input for the Black-Scholes options pricing model is there the most^*.
uncertainty?
a. The current stock price (So)
b. The strike price (X).
The volatility (a),
c)a. The
term to maturity (T).
16. If the correlation between two assets is , it is possible to construct a portfolio
with zero risk.
a. Infinite
b. +1
. zero

(3)-'

17. The net work of a bank with long-term assets and short-term liabilities will
decline if
a.. the general level of interest rates declines
a
b) the general level of interest rates increases
the yield curve has a positive slope
$S the spread between CDs and treasuries narrows.
18. Using "adjusted beta" (ADJ BETA = 0.67*BETA + 0.33) rather than estimated
"raw beta" (BETA) makes sense if
a. Estimated betas are biased toward zero
b. Estimated betas are biased toward one
(oy Estimated betas exhibit regression toward the mean
; -. d. The estimated beta is less than zero or greater than two. &{(aM* r^o L L
n9j Which of the following instruments has a region of "negative convexity"? r^*v fc**^
a. A ten-year US treasury with a coupon of 3%
s b. A straight or "bullet" corporate bond with a coupon of 5%
/ ^pr A callable corporate bond with a coupon of 7%
^" d. A zero-coupon bond constructed from the principal-only portion of a US
treasury.
20. If you wrote call options on 100 shares of Twitter, which of the following actions
would provide a hedge against your liability as the option writer?
a. Selling short shares of Twitter
b^ Buying shares of Twitter
c. Buying a put option on 100 shares with the strike price equal to the current
stock price
d. Selling a put option on 100 shares with a strike price equal to the current
stock price.
5

term
structure
rates,
marketto
participants
expect
future short-term
0 If the
yield
curve of
is interest
flat, then
according
the liquidity
preference
theory of rates
the
to be
a. Higher than today's short-term rates
b. Equal to today's short-term rates
(c) Lower than today's short-term rates
if Zero.
8. If a stock has a large estimated alpha over the last three years, according to the CAPM,
then
it is risky
it is safe
it has a high expected return
adjusting for market movements, it did better than the market.
iTch statement about beta is true?
a. High beta stocks have high alphas.
b. High beta stocks have high correlations with the market.
/c.yA beta can be equal to zero.
^ti: None of these statements is true.
(nfl Consider the stock price series Pt (t = 1,.. .n,), where Pt represents the price at
end of period t. This series does not follow a random walk if

?b. Corr(Pt+r
SSW"
pli - o *ww w w w
Pt, Pt-p"
Pt-i) -p"
0
jef If the stock's beta is greater than one Cfr*Y***
Jl If the stock's beta is less than one
11. The actual, realized return for a portfolio of high-yield (or "junk") bonds depends
on
a. the price originally paid for the bonds
b. the fraction of bonds that default
c. the recovery rate in the event of default
/cy all of the above.
/12j For a bond paying a coupon C with a yield of r, the expression ]jjj^
equal to
a

C/(l+r)~

X,c-o+rr
/Ct

A
"C

C~
r

(l+r)'

is

ur
"

13. Consider a bond with a maturity of five years, a face value of $1,000 and an
annual coupon rate of 2%, and a yield to maturity of 4%. The quoted price of the
bond will
a. decrease on average over the next five years
Jk" be the same five years from now as it is today
y^T^ncrease on average over the next five years Cu/Aaa J V^tfVx
l^e^equal
$1000/(6%
-4%).

'r

Part I. Multiple Choice. Four points each, twenty questions. Use the answer sheet to fill
in the correct letter for the questions that follow. (Twenty questions, 2 points each, 40
points in all)
The risk that cannot eliminated by building diversified portfolios is called
a. Market risk
b. Systematic risk
Non-diversifiable risk
All of the above,
number of assets in a portfolio increases, the number of correlations
for portfolio optimization k> alf*o v~vl*l.-L,
Declines
b." Increases linearly (in constant proportion to the number of assets)
^ . . . . < " > W.
f c/Jhcreases exponentially
d. Goes to zero
Which statement represents an inference that is not valid?
If the stock market is efficient, then stock prices follow a random walk.
If the stock market is efficient, then the autocorrelation of monthly returns
will be zero.
c. If the stock market is not efficient, it may still be hard to make money in
>^7\the
stock
market.
f
\
r\
\sC~$*^ stock prices follow a random walk, then the stock market is efficient. I *5r tvK.
jffl Consider the results of an event study of target firm returns around merger
'^^announcements. Which result would contradict the "efficient markets
hypothesis"?
a. Target firm stock prices increase 5% in the five days leading up to the
^-^announcement.
faUt
i*^r,
Wok,
Sy/.Wt*
(Jsff Target firm stock prices decrease 5% in the five days after the P^-WulL * ef^i.
|VU^
v
announcement.
'
/^5?STarget firm stock prices decline 5% in the twelve to six months ahead of
^""the announcement.
d. Target firm stock prices are unchanged on average after the
announcement.
plfejRffMCW Pr**--lo>
With a rising yield curve, which bond has the highest yield to maturity?
A five-year treasury with a 3% coupon
A five-year treasury with a 6% coupon .
ten-year treasury with a 3% coupon (fyUrVT"M- lofruyf-p^ 1 r^i a
ten-year
treasury
with
a
6%
coupon
V\
of the same set of bonds has the shortest duration?
A five-year treasury with a 3% coupon*) u
A five-year treasury with a 6% coupon
A ten-year treasury with a 3% coupon fjn*^ - - * U - f r i * M * ^
A ten-year treasury with a 6% coupon

K-X

ir-tl
University of Kansas
School of Business
FIN 410
Investment Theory and Applications
Instructor: G. Bittlingmayer

Fall 2013
EXAM II

Name

j!m j>m

Student ID 7J^M>lO

V-

(PLEASE PRINT - LEGIBLY)

Student ID <7/>\3c\i'}
1. Place all books, notebooks and other materials not authorized on the floor.
2. Formulas appear at the end of this exam. You may detach the formula sheets.
3. You may use a calculator. Use of a calculator to store formulas or other
information will be viewed as a violation of the honor code.
4. Do all your work on the exam. Clear demonstrations of how you arrived at your
answer make it easier to award partial credit.
5. Be sure to write your name in the space above and sign the honor pledge below
before handing in your exam.
University of Kansas, School of Business, Honor Pledge:
On my honor, I have neither given nor received any unauthorized aid on this
exam. Nor am I aware of anyone giving or receiving unauthorized aid.

This exam has a total of 125 points.