FIN 421/FIN 421 PRACTICE MIDTERM PRACTICE EXAM QUESTIONS AND ANSWERS
1. Stock prices (Pt) and Dividends (Dt) for assets A and B are given below. All
... [Show More] dividends
are paid out at the end of the year, 12/31/2016. Asset B performed a 3:1 stock split at
the beginning of the year, 01/01/2016. What is the equally-weighted net portfolio return
if you invested on 12/31/2015 and liquidated on 12/31/2016?
Date Asset A Asset B
Pt Dt Pt Dt
12/31/2015 (t) 20 100
12/31/2016 (t+1) 10 0 45 5
Asset B performed a 3:1 stock split on 01/01/2015.
A) 100%
B) 1%
C) -50%
D) 0%
E) 50%
Answer: D
Gross returns are RA = (10 + 0)=20 = 0:5; RB = 3(45 + 5)=100 = 1:5:
The net portfolio return is rP = 1=2 × 0:5 + 1=2 × 1:5 − 1 = 0 = 0%.
2. You have $1,000,000 available to invest. The risk-free rate as well as your borrowing rate
is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you
should .
A) invest $750,000 in the risk-free asset
B) borrow $750,000
C) invest $375,000 in the risk-free asset
D) borrow $125,000
E) borrow $375,000
Answer: B
w × :16 + (1 − w) × :08 = 0:22
w × :08 = 0:14
w = 0:14=0:08 = 1:75
Therefore, borrow 75% of your wealth.
33. To predict stock market returns for next year, you regress stock market returns on the
market’s dividend yield Dt=Pt, i.e. you run
Rt+1 = α + β(Dt=Pt) + "t+1:
The parameter estimates you obtain are ^ α = 0:01 and β^ = 3:8. If the current dividend
yield is 0.03, what is the expected return next year?
A) 0.124
B) 0.114
C) 0.04
D) 3.8003
E) 0.104
Answer: A
R^t+1 = ^ α + β^ × (Dt=Pt) = 0:01 + 3:8 × 0:03 = 0:124
4. Suppose the CAPM is true. The risk-free rate is 5% and the expected return on the
market is 15%. What is the beta on a stock with an expected return of 12%?
A) .5
B) 1.2
C) 1.4
D) .7
E) None of the above
Answer: D
:12 − :05 = β × (:15 − :05); or β = 0:7
45. Consider the following two stocks, A and B. Stock A has an expected return of 10% and
a beta of 1.25. Stock B has an expected return of 14% and a beta of 1.80. The expected
market rate of return is 9% and the risk-free rate is 5%. If the CAPM is a good description
of the real world, then security would be considered a good buy because
.
A) A, it offers an alpha of 0.8%
B) B, it offers an alpha of 1.8%
C) A, it offers an alpha of 2.2%
D) A, it offers an alpha of -0.8%
E) B, it offers an alpha of 2.4%
Answer: B
A : 10% − 5% − 1:25 (9% − 5%) = 0%
B : 14% − 5% − 1:8 (9% − 5%) = 1:8%
6. A risk parity portfolio is composed of $5,000 invested in stock A, $2,500 in stock B, and
$2,500 in stock C. Stock A has a variance of 0.04, while stocks B and C each have a
variance of 0.08. After some bad news is revealed about stock A, it’s variance increases
to 0.08. In order to rebalance your portfolio, you need to...
A) Buy $3,333.33 of each stock
B) Buy $1666.67 of A and sell $833.33 of each B and C
C) Sell $2,500 of A and buy $1,250 of each B and C
D) Sell $1666.67 of A and buy $833.33 of each B and C
E) Buy $2,500 of A and sell $1,250 of each B and C
Answer: D
• After the change in A’s variance, all stocks have a variance of σi2 = 0:08, so the risk
parity portfolio should have a weight of 1=0:08+11= =0 0: :08 08+1=0:08 = 1=3 in each stock, which
amounts to $3,333.33 in each stock
• To rebalance, you thus need to sell 5,000-3,333.33=1,666.67 of A and buy 3,333.33-
2,500=833.33 of each B and C
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