Question

Multiple Choice

26. Assuming the correlation coefficient between stocks in a portfolio is less than 1.0, the standard deviation of a portfolio’s returns will be:

A. greater than the weighted average standard deviation.

B. equal to the weighted average standard deviation.

C. less than the weighted average standard deviation.

Multiple Choice Problems (5 points each) Choose the best answer

27. The value of a common stock that just paid a $3.00 dividend will be ________________ if investors require a 12% return and dividends and earnings are expected to grow at 8% per year.

A. $66.67

B. $72.00

C. $81.00

D. $125.00

28.      A speculator purchases a call option for a premium of $3, with an exercise price of $32. The stock is presently priced at $30, and falls to $28 before the expiration date. What is the net gain or loss to the purchaser?

A. loss $1

B. loss $3

C. gain $1

D. gain $3

29. You forecast that James Inc. will pay dividends of $4 one year from today, $4.50 the next and $5.00 at the end of the third year. You expect earnings per share to be $8 at the end of the third year and based on the industry average as well as your own forecasts relative to the firm, you are willing to pay 12 times earnings at that point (i.e. the P/E in year 3 is 12). How much are you willing to pay for the stock today if you require a 14% return on the investment? NOTE: this is a TVM problem combined with a relative valuation (to find the selling price) problem.

A. $75.14

B. $85.66

C. $109.50

D. none of the above

30. What is the duration of a 9% coupon bond, $1,000 par value that has 3 years left to maturity if the discount rate is 8%?

A. 3 years.

B. 2.76 years.

C. 2.82 years.

D. 3.24 years.

31. You are buying a callable bond, $1,000 par value that currently is priced at $1025, pays a 6% annual coupon and has 20 years to maturity. The bond is callable in 4 years at a call premium of 1 year’s interest. The yield to maturity and the yield to call are, respectively:

A. 5.78%, 6.63%

B. 5.78%, 5.78%

C. 6.63%, 6.00%

D. 6.00%, 5.78%.

32.   What is the MONTHLY payment on a $260,000 mortgage loan that has a 12% annual interest rate if you pay it off in 30 years?

A. $1,028.61

B. $2,400.34

C. $2,674.39

D. $3,120.44

33. The risk free rate is 4%, Blackbeard Stock returned 11%. The stock’s beta is 1.2 and the standard deviation of returns is 14%. The stock’s Sharpe ratio is closest to:

A. 0.50

B. 0.79

B. 1.00

C. 5.83

34. The risk free rate is 4%, the market return is 11% and Blackbeard stock has a beta of 1.2. The required rate of return on Blackbeard’s stock is closest to:

A. 11%.

B. 12.4%.

C. 17.2%

D. none of the above

Answer 1

26.

The standard deviation of a portfolio is given by

Where Wi is the weight of the security i,

is the standard deviation of returns of security i.

and is the correlation coefficient between returns of security i and security j

So, if the correlation coefficient between the stocks is less than 1, then the standard deviation is less than the weighted average standard deviation of the stocks. (option C)

27. From Gordon's Constant growth model

Price P0 = D1/(r-g)

where D1 is the expected dividend in the next year , r is the required rate and g is the constant growth rate

P0 = D0*(1+g)/(r-g)

=3*(1+0.08)/(0.12-0.08)

=$81 (option C)

28. Net payoff to the purchaser of a call option at maturity is equal to the intrinsic value of the option

Intrinsic value = max (S-K, 0) = max (28-32 , 0) = 0

As the intrinsic value is 0, payoff is 0 and the purchaser loses the premium paid ie.. $3 (option B)

29. Price of the stock at the end of 3rd year = Earnings in 3rd year * P/E ratio at the end of 3rd year

P3 =$8* 12 =$96

So, Price of stock today = D1/(1+r) + D2/(1+r)^2+ D3/(1+r)^3+ P3/(1+r)^3

= 4/1.14 + 4.5/1.14^2+ 5/1.14^3+96/1.14^3

=$75.1435 (option A)