Fundamentals Of Investments 2nd Edition Charles J. Corrado, Bradford Jordan - Solutions

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22.Year Returns Return deviations Squared deviations Product of deviations Security Market Security Market Security Market 1995 12 6 3 2 9 4 6 1996 -9 -12 -18 -16 324 256 288 1997 -6 0 -15 -4 225 16 60 1998 30 -4 21 -8 441 64 -168 1999 18 30 9 26 81 676 234 Totals 45 20 0 0 1,080 1,016 420 Average
21. From the chapter, $i = CORR(Ri, RM) × Fi / FM. Also, CORR(Ri, RM) = COV(Ri, RM)/ Fi×FM. Substituting this second result into the expression for $i produces the desired result.
20. The rule is always “buy low, sell high.” In this case, we buy the undervalued asset and sell(short) the overvalued one. It does not matter whether the two securities are misvalued with regard to some third security; all that matters is their relative value. In other words, the trade will be
19. Yes. It is possible, in theory, for a risky asset to have a beta of zero. Such an asset’s return is simply uncorrelated with the overall market. Based on the CAPM, this asset’s expected return would be equal to the risk-free rate. It is also possible to have a negative beta; the return
18. Earnings contain information about recent sales and costs. This information is useful for projecting future growth rates and cash flows. Thus, unexpectedly low earnings often lead market participants to reduce estimates of future growth rates and cash flows; price drops are the result. The
17. Here we have two equations in two unknowns:E[rOxy Co.] = .23 = rf + 1.35(rm - rf); E[rMore-On Co.] = .17 = rf + .9(rm - rf).23 = rf + 1.35rm - 1.35rf = 1.35rm - .35rf; .17 = r + .9(rm - rf) = rf + .9rm - .9rf rf = (1.35rm - .23)/.35 rm = (.17 - .1rf)/.9 = .18889 - .1111rf rf = [1.35(.18889 -
16. (E[rA] - rf)/ßA = (E[rB] - rf)/ßBßA/ßB = (E[rA] - rf)/(E[rB] - rf)
15. [.25 - rf]/1.59 = [.12 - rf]/0.44; rf = .0703
14. E[ri] = .06 + .113ßi.25 > E[rY] = .06 + .113(1.59) = .2397; Y plots above the SML and is undervalued..12 > E[rZ] = .06 + .113(0.44) = .1097; Z plots above the SML and is undervalued.
13. ßp = xW(1.6) + (1 - xW)(0) = 1.6xW E[rW] = .25 = .07 + MRP(1.60) ; MRP = .18/1.6 = .1125 E[rp] = .07 + .1125ßp; slope of line = MRP = .1125; E[rp] = .07 + .1125ßp = .07 + .18xW xW E[rp] ßp xW E[rp] ßp 0% .070 0.0 100% .358 1.6 25 .115 0.4 125 .430 2.0 50 .214 0.8 150 .502 2.4 75 .286 1.2
12. A. E[rp] = (.13 + .07)/2 = .1 B. ßp = 0.6 = xS(0.9) + (1 - xS)(0) ; xS = 0.6/0.9 = .6666 ; xrf = 1 - .6666 = .3333 C. E[rp] = .11 = .13xS + .07(1 - xS); xS = 2/3; ßp = 2/3(0.9) + 1/3(0) = 0.6 D. ßp = 1.8 = xS(0.9) + (1 - xS)(0) ; xS = 1.8/0.9 = 2; xrf = 1 - 2 = -1 The portfolio is invested
11. E[ri] = .22 = rf + (.16 - rf)(1.6); rf = .06
10. E[ri] = .17 = .075 + (E[rmkt] - .075)(.9); E[rmkt] = .1806
9. E[ri] = .13 = .07 + .08ßi ; ßi = .75
8. E[ri] = .08 + (.17 - .08)(1.2) = .188
7. ßp = 1.0 = 1/3(0) + 1/3(1.6) + 1/3(ßX) ; ßX = 1.4
6. ßp = .3(1.2) + .2(.6) + .1(1.5) + .4(.8) = .95
5. False. Expected returns depend on systematic risk, not total risk.
4. A. an unexpected, systematic event occurred; market prices in general will most likely decline.B. no unexpected event occurred; company price will most likely stay constant.C. no unexpected, systematic event occurred; market prices in general will most likely stay constant.D. an unexpected
3. A. systematic B. unsystematic C. both; probably mostly systematic D. unsystematic E. unsystematic F. systematic
2. If the market expected the growth rate in the coming year to be 2 percent, then there would be no change in security prices if this expectation had been fully anticipated and priced.However, if the market had been expecting a growth rate different than 2 percent and the expectation was
1. Some of the risk in holding any asset is unique to the asset in question. By investing in a variety of assets, this unique portion of the total risk can be eliminated at little cost. On the other hand, there are some risks that affect all investments. This portion of the total risk of an asset
22. Calculating Beta Fill in the following table, supplying all the missing information. Use this information to calculate the security’s beta. Year Retums Retum Deviations Squared Deviations Product Security Market Security Market Security Market of Deviations 1995 12% 6% 1996 -9 -12 1997 -6 0
21. Calculating Beta Show that another way to calculate beta is to take the covariance between the security and the market and divide by the variance of the market’s return.
20. Relative Valuation Suppose you identify a situation in which one security is overvalued relative to another. How would you go about exploiting this opportunity? Does it matter if the two securities are both overvalued relative to some third security? Are your profits certain in this case?
19. Beta Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does the CAPM predict about the expected return on such an asset? Can you give an
18. Announcements As indicated by examples in this chapter, earnings announcements by companies are closely followed by, and frequently result in, share price revisions. Two issues should come to mind. First, earnings announcements concern past periods. If the market values stocks based on
17. Relative Valuation Suppose you observe the following situation:Expected Security Beta Return Oxy Co. 1.35 23%More-On Co. .90 17 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate?
16. CAPM Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.
15. Relative Valuation In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?
14. Relative Valuation Stock Y has a beta of 1.59 and an expected return of 25 percent. Stock Z has a beta of .44 and an expected return of 12 percent. If the risk-free rate is 6 percent and the market risk premium is 11.3 percent, are these stocks correctly priced?
13. Portfolio Risk and Return Asset W has an expected return of 25 percent and a beta of 1.6.If the risk-free rate is 7 percent, complete the following table for portfolios of Asset W and a risk-free asset. Illustrate the relationship between portfolio expected return and portfolio beta by plotting
12. Portfolio Weights A stock has a beta of .9 and an expected return of 13 percent. A riskfree asset currently earns 7 percent.A. What is the expected return on a portfolio that is equally invested in the two assets?B. If a portfolio of the two assets has a beta of .6, what are the portfolio
11. Risk-free Rates A stock has an expected return of 22 percent, and a beta of 1.6, and the expected return on the market is 16 percent. What must the risk-free rate be?
10. Market Returns A stock has an expected return of 17 percent, its beta is .9, and the riskfree rate is 7.5 percent. What must the expected return on the market be?
9. Stock Betas A stock has an expected return of 13 percent, the risk-free rate is 7 percent, and the market risk premium is 8 percent. What must the beta of this stock be?
8. Expected Returns A stock has a beta of 1.2, the expected return on the market is 17 percent, and the risk-free rate is 8 percent. What must the expected return on this stock be?
7. Stock Betas You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.6 and the total portfolio is exactly as risky as the market, what must the beta be for the other stock in your portfolio?
6. Portfolio Betas You own a stock portfolio invested 30 percent in Stock Q, 20 percent in Stock R, 10 percent in Stock S, and 40 percent in Stock T. The betas for these four stocks are 1.2, .6, 1.5, and .8, respectively. What is the portfolio beta?
5. Diversification and Risk True or false: the most important characteristic in determining the expected return of a well-diversified portfolio is the variances of the individual assets in the portfolio. Explain.
4. Announcements and Risk Indicate whether the following events might cause stocks in general to change price, and whether they might cause Big Widget Corp.'s stock to change price.A. The government announces that inflation unexpectedly jumped by 2 percent last month.B. Big Widget's quarterly
3. Announcements and Risk Classify the following events as mostly systematic or mostly unsystematic. Is the distinction clear in every case?A. Short-term interest rates increase unexpectedly.B. The interest rate a company pays on its short-term debt borrowing is increased by its bank.C. Oil prices
2. Announcements and Prices Suppose the government announces that, based on a justcompleted survey, the growth rate in the economy is likely to be 2 percent in the coming year, as compared to 5 percent for the year just completed. Will security prices increase, decrease, or stay the same following
1. Diversifiable Risk In broad terms, why is some risk diversifiable? Why are some risks nondiversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk?
15. CAPM In the capital asset pricing model (CAPM), a security’s expected return isa. the return on the market portfoliob. the risk-free rate plus the return on the market portfolioc. the return on the market portfolio plus a market risk premiumd. the risk-free rate plus a market risk premium
14. CAPM A financial market’s security market line (SML) describesa. the relationship between systematic risk and expected returnsb. the relationship between unsystematic risk and expected returnsc. the relationship between systematic risk and unexpected returnsd. the relationship between
13. Security Risk The systematic risk of a stock is measured by itsa. beta coefficientb. correlation coefficientc. return standard deviationd. return variance
12. Security Risk The systematic risk principle has an important implication, which is thata. systematic risk is preferred to unsystematic riskb. systematic risk is the only risk that can be reduced by diversificationc. the expected return on an asset is independent of its systematic risk.d. the
11. Security Risk The systematic risk principle states thata. systematic risk doesn’t matter to investorsb. systematic risk can be essentially eliminated by diversificationc. the reward for bearing risk is independent of the systematic risk of an investment.d. the reward for bearing risk depends
10. Security Risk Which type of risk is essentially eliminated by diversification?a. perceived riskb. market riskc. systematic riskd. unsystematic risk
9. Security Risk The unsystematic risk of a security is also called itsa. perceived riskb. unique or asset-specific riskc. market riskd. fundamental risk
8. Security Risk The systematic risk of a security is also called itsa. perceived riskb. unique or asset-specific riskc. market riskd. fundamental risk
7. News Effects A company announces that its earnings have decreased 50 percent from the previous year, but analysts only expected a 25 percent decrease. What is the likely effect on the stock price?a. the stock price will increaseb. the stock price will decreasec. the stock price will rise and
6. News Effects A company announces that its earnings have increased 25 percent from the previous year, but analysts actually expected a 50 percent increase. What is the likely effect on the stock price?a. the stock price will increaseb. the stock price will decreasec. the stock price will rise and
5. News Effects A company announces that its earnings have decreased 25 percent from the previous year, but analysts only expected a small increase. What is the likely effect on the stock price?a. the stock price will increaseb. the stock price will decreasec. the stock price will rise and then
4. News Effects A company announces that its earnings have increased 50 percent over the previous year, which matches analysts’ expectations. What is the likely effect on the stock price?a. the stock price will increaseb. the stock price will decreasec. the stock price will rise and then fall
3. News Components A news announcement about a stock is said to have which two of the following parts?a. an expected part and a surpriseb. public information and private informationc. financial information and product informationd. a good part and a bad part
2. Stock Return The return on a stock is said to have which two of the following basic parts?a. an expected return and an unexpected returnb. a measurable return and an unmeasurable returnc. a predicted return and a forecast returnd. a total return and a partial return
1. Portfolio Return According to the CAPM, what is the rate of return of a portfolio with a beta of 1? (1994 CFA Exam)a. between RM and Rfb. the risk-free rate, Rfc. beta × (RM - Rf)d. the return on the market, RM
2. CAPM Suppose the risk-free rate is 8 percent. The expected return on the market is 16 percent. If a particular stock has a beta of .7, what is its expected return based on the CAPM?If another stock has an expected return of 24 percent, what must its beta be?
1. Risk and Return Suppose you observe the following situation:Security Beta Expected Return Sanders 1.8 22.00%Janicek 1.6 20.44 If the risk-free rate is 7 percent, are these two stocks correctly priced relative to each other?What must the risk-free rate be if they are correctly priced?
23. Portfolio Variance Derive our expression in the chapter for the portfolio weight in the minimum variance portfolio. (Danger! Calculus required!) (Hint: let x be the percentage in the first asset and (1 - x) the percentage in the second. Take the derivative with respect to x and set it to zero.
22. Portfolio Variance Suppose two assets have zero correlation and the same standard deviation. What is true about the minimum variance portfolio?
21. Portfolio Variance Using the result in Problem 20, show that whenever two assets have perfect negative correlation it is possible to find a portfolio with a zero standard deviation.What are the portfolio weights? (Hint: let x be the percentage in the first asset and (1 - x) be the percentage in
20. Portfolio Variance Suppose two assets have perfect negative correlation. Show that the standard deviation on a portfolio of the two assets is simply Fp = ± (xA × FA - xB × FB)(Hint: See previous problem.)
19. Portfolio Variance Suppose two assets have perfect positive correlation. Show that the standard deviation on a portfolio of the two assets is simply Fp = xA × FA + xB × FB(Hint: Look at the expression for the variance of a two-asset portfolio. If the correlation is+1, the expression is a
18. Portfolio Volatility True or false: If the two stocks have the same standard deviation of 45 percent, then any portfolio of the two stocks will also have a standard deviation of 45 percent.
17. Expected Returns True or false: If the two stocks have the same expected return of 12 percent, then any portfolio of the two stocks will also have an expected return of 12 percent.
16. Asset Allocation Fill in the missing information assuming a correlation of -.10.Portfolio Weights Expected Standard Stocks Bonds Return Deviation 1.00 14% 20%0.80 0.60 0.40 0.20 0.00 5% 8%
15. Minimum Variance Portfolio In Problem 13, what are the expected return and standard deviation on the minimum variance portfolio?
14. More Portfolio Variance In the previous question, what is the standard deviation if the correlation is +1? 0? -1? As the correlation declines from +1 to -1 here, what do you see happening to portfolio volatility? Why?
13. Portfolio Variance Use the following information to calculate the expected return and standard deviation of a portfolio that is 40 percent invested in Kuipers and 60 percent invested in SuCo:Kuipers SuCo Expected return, E(R) 30% 26%Standard deviation, F 65 45 Correlation .30
12. Portfolio Returns and Volatilities Given the following information, calculate the expected return and standard deviation for a portfolio that has 40 percent invested in Stock A, 30 percent in Stock B, and the balance in Stock C.State of Economy Probability of State of Economy Returns Stock A
11. Portfolio Returns and Volatilities Fill in the missing information in the following table.Assume that Portfolio AB is 40 percent invested in Stock A. Annual Returns Stock B Portfolio AB Year Stock A 1995 15% 55% 1996 35 -40 1997 -15 45 1998 20 0 1999 0 10 Average retums Standard deviations
10. Efficient Portfolios What is an efficient portfolio?
9. Interpreting Correlations If the returns on two stocks are highly correlated, what does this mean? If they have no correlation? If they are negatively correlated?
8. Diversification and Market History Based on market history, what is the average annual standard deviation of return for a single, randomly chosen stock? What is the average annual standard deviation for an equally weighted portfolio of many stocks?
7. Portfolio Volatility Calculate the volatility of a portfolio of 70 percent Roll and 30 percent Ross by filling in the following: (1) State of Economy (2) Probability of State of Economy (3) Portfolio Returns if State Occurs (4) Squared Deviation from Expected Return (5) Product (2) (4)
6. Portfolio Expected Returns Calculate the expected return on a portfolio of 40 percent Roll and 60 percent Ross by filling in the following: (1) State of the Economy (2) (3) Probability of Portfolio Return if State Occurs State of the Economy (4) Product (2) (3) E(Rp)=
5. Standard Deviations Calculate the standard deviations for Roll and Ross by filling in thefollowing: (1) State of Economy (2) Probability of State of (3) Return Deviation from Expected Return (4) Squared (5) Product Economy Return Deviation (2) (4) Roll Ross
4. Expected Returns Calculate the expected returns for Roll and Ross by filling in the following: (1) State of Economy (2) (3) Roll Probability of Return if State State of Economy Occurs E(R) = (4) Product (2) (3) (5) Ross Return if State Occurs E(R)= (6) Product (2) (5)
3. Expected Returns and Deviations Repeat Questions 1 and 2 assuming that all three states are equally likely.
2. Standard Deviations Using the information in the previous question, calculate the standard deviation of return.
1. Expected Returns Use the following information on states of the economy and stock returns to calculate the expected return for Dingaling Telephone:State of Economy Probability of State of Economy Security Return if State Occurs Recession .20 -10%Normal .50 20%Boom .30 30%1.00
12. Markowitz Efficient Frontier Which of the following portfolios cannot lie on the efficient frontier as described by Markowitz? (1994 CFA Exam)Portfolio Expected Return Standard Deviationa. W 9% 21%b. X 5 7c. Y 15 36d. Z 12 15
11. Minimum Variance Portfolio Stocks A, B, and C each have the same expected return and standard deviation. The following shows the correlations between returns on these stocks.Stock A Stock B Stock C Stock A +1.0 Stock B +0.9 +1.0 Stock C +0.1 -0.4 +1.0 Given these correlations, which of the
10. Minimum Variance Portfolio Both Netcap and Jmart have the same return standard deviation of 20 percent, and Netcap and Jmart returns have a correlation of -1. What is the minimum attainable return variance for a portfolio of Netcap and Jmart?a. 20 percentb. 14.14 percentc. 10 percentd. 0 percent
9. Minimum Variance Portfolio Both Netcap and Jmart have the same return standard deviation of 20 percent, and Netcap and Jmart returns have zero correlation. What is the minimum attainable return variance for a portfolio of Netcap and Jmart?a. 20 percentb. 14.14 percentc. 10 percentd. 0 percent
8. Return Standard Deviation Both Netcap and Jmart have the same return standard deviation of 20 percent, and Netcap and Jmart returns have a correlation of -1. You invest half your funds in Netcap and the other half in Jmart. What is the return standard deviation for your portfolio?a. 20 percentb.
7. Return Standard Deviation Both Netcap and Jmart have the same return standard deviation of 20 percent, and Netcap and Jmart returns have a correlation of +1. You invest half your funds in Netcap and the other half in Jmart. What is the return standard deviation for your portfolio?a. 20 percentb.
6. Return Standard Deviation Both Netcap and Jmart have the same return standard deviation of 20 percent, and Netcap and Jmart returns have zero correlation. You invest half your funds in Netcap and the other half in Jmart. What is the return standard deviation for your portfolio?a. 20 percentb.
5. Risk Premium Netcap has an expected return of 25 percent, Jmart has an expected return of 20 percent, and the risk-free rate is 5 percent. You invest half your funds in Netcap and the other half in Jmart. What is the risk premium for your portfolio?a. 20 percentb. 17.5 percentc. 15 percentd.
4. Expected Return An analyst estimates that a stock has the following return probabilities and returns, depending on the state of the economy:State of Economy Probability Return Good .1 15%Normal .6 13 Poor .3 7 What is the expected return of the stock? (1994 CFA Exam)a. 7.8 percentb. 11.4
3. Return Standard Deviation Jmart experiences returns of 0 percent, 25 percent, or 50 percent, each with a one-third probability. What is the approximate return standard deviation for Jmart?a. 30 percentb. 25 percentc. 20 percentd. 10 percent
2. Return Standard Deviation Netcap experiences returns of 5 percent or 45 percent, each with an equal probability. What is the return standard deviation for Netcap?a. 30 percentb. 25 percentc. 20 percentd. 10 percent
1. Diversification Netcap has an expected return of 25 percent and Jmart has an expected return of 20 percent. What is the likely investment decision for a risk-averse investor?a. invest all funds in Netcapb. invest all funds in Jmartc. do not invest any funds in Netcap and Jmartd. invest funds
20. Hedging Interest Rate Risk Suppose you want to hedge a $600 million bond portfolio with a duration of 6 years using 10-year Treasury note futures with a duration of 9 years, a futures price of 102, and 90 days to expiration. How many contracts do you buy or sell?
19. Spot-Futures Parity Suppose the 90-day S&P 500 futures price is 1200 while the cash price is 1,194. What is the implied difference between the risk-free interest rate and the dividend yield on the S&P 500?
18. Program Trading Program traders closely monitor relative futures and cash market prices, but program trades are not actually made on a fully mechanical basis. What are some of the complications that might make program trading using, for example, the S&P 500 contract more difficult than the
17. Cross-Hedging You have been assigned to implement a three-month hedge for a stock mutual fund portfolio that primarily invests in medium-sized companies. The mutual fund has a beta of 1.15 measured relative to the S&P Midcap 400, and the net asset value of the fund is $200 million. Should you

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Fundamentals Of Investments 2nd Edition Charles J. Corrado, Bradford Jordan - Solutions

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