1) RiskProof Bank's 10-year corporate bond expected return equals that of 10-year US Treasuries. Which of the following statements is true? A. Riskproof's probability of default is 0. B. Riskproof's bond has the same credit risk as the Treasuries. C. Riskproof's bond expected return is lower than its yield. D. Both A and B are correct. 2) Consider three risk-free bonds in your portfolio, bonds E, F and G with par value of $1000. You can only keep one bond in the portfolio, Bond E presently is selling at par value and pays annual interest of $90. Bond F pays interest of $100 annually, while bond G is a zero-coupon bond. Bond E will mature in 15 years while bond F will mature in 13 years. Bond G has 15 years to maturity. Your forecasting model predicts that the interest rate will increase by 1%, which bond would you keep? A. Bond E B. Bond F. C. Bond G. D. There is not enough information. 3) BacktoSchool (B2S) produces chocolate bars for kids. The firm's most recent earnings before interests and taxes (EBIT) is $10 million. Analysts expect the earnings to grow at a constant rate of 5% indefinitely. The firm has an optimal debt to equity ratio of 50%. The tax rate is 30%. For the last 5 years, the firm has maintained the 50% dividend payout ratio, yet analysts expect the payout ratio to increase to 60% in future years. The equity beta is 1.5, the market risk premium is 6%, and the risk free rate is 3.5%. Since most of the fim's investors prefer dividends, B2S's CFO announces that they will increase the dividend payout ratio to 80% with the aim to increase the firm market value. Which of the following statements is correct? A. The share value will increase because the majority of the investors prefers dividends, therefore charge a lower cost of capital. B. The share value will increase because high dividend paying firms have lower cost of capital. C. The share value will decrease because high dividend paying firms have lower growth. D. The share value will remain unchanged because the higher dividends are accompanied by lower future growth. E None of the above. 4) Book-to-market ratios across industries are usually below one. This observation implies that A. The market values are too high and therefore stocks are overpriced. B. Value strategies such as buying high book-to-market (value) stocks and selling low book-to- market (growth) stocks are profitable. C. Market sentiment drives prices to grow faster than book values. D. Conservative accounting principles downward bias the asset values. 5) You run a time series regression of future equity market excess returns on market variance. The regression result is below: Intercept 0.01 t-stat: 5.44 Coefficient -0.17 t-stat: -0.61 R2 0.03 Which of the following statements is plausible? A. The coefficient is negative and the intercept is high. Therefore, the positive risk-retum trade- off is a myth. B. The negative coefficient indicates a negative risk-retur relationship and implies that the stock market is inefficient C. The stock market is efficient and therefore we cannot predict future returns using past information such as stock realised variance. D. Stock market variance has two components: the average of pairwise correlations and the average of individual variances. The two components have different and potentially opposite impact on future market returns. As a result, we cannot reject the positive risk-return trade-off. E. Both C and D are correct. 6) The "Fed model" advocates the following logic: "Let Y represent the yield on 10-year Treasuries and E/P represent aggregate earnings to price ratio or earnings yield adjusted for risk premiums. Then stocks and bonds are competing investments. As a result, stocks are cheap when E/P exceeds Y, expensive when Y exceeds E/P, and fairly value when Y and E/P are equal". Which of the following statements is mostly correct? A. Stocks and bonds are not competing investments due to different preferences for risk. While investors in equity markets are a mixture of retail and institutional, investors in bond markets are mostly institutional B. Y should be the yield of perpetual bonds to be comparable with equity, which has indefinite claims in the future C. Y should be the yield of inflation-adjusted bonds (TIPS) as aggregate E/P is a real quantity. D. Y should be the yield of shorter-term bonds because long-term bonds are much less liquid than equity. 7) Which of the following combinations will result in a sharply-increasing yield curve? A. Increasing future expected short rates and increasing liquidity premiums, B. Decreasing future expected short rates and increasing liquidity premiums, C. Increasing future expected short rates and decreasing liquidity premiums. D. Increasing future expected short rates and constant liquidity premiums. E. Constant future expected short rates and increasing liquidity premiums. 8) You expect DM Corporation to generate the following free cash flows (FCF) over the next five years: Year 1 2 3 4 5 FCF (5 millions) 75 84 96 111 120 Beginning with year six, you estimate that DM's free cash flows will grow at 6% per year and that DM's costs of debt and equity are 10% and 23%, respectively. DM's share price is currently trading at $50 per share. DM has $700 million of debt and 14 million shares of stock outstanding. Assume the corporate tax rate is 30%. What is the firm's share price closest to? A. $22. B. $42. C. 562 D. 582. 9) You aim to immunize a portfolio of Simil in today's term, with a target duration of 10 years, using a zero-coupon bond with maturity of 4 years and a perpetuity, each currently yields 6%. How much of the zero-coupon bond and the perpetuity will you hold in your portfolio? A. $560,000 and $440,000 for zeros and perpetuity, respectively. B. $330,000 and $670,000 for zeros and perpetuity, respectively. C. $700,000 and $300,000 for zeros and perpetuity, respectively. D. $500,000 and $500,000 for zeros and perpetuity, respectively. 10) Profitable momentum trading strategy is a direct evidence against the notion of: A. Weak-form market efficiency. B. Semi-strong form market efficiency. C. Strong-form market efficiency. D. All of the above. 11) Consider two strategies from options, which have the same maturities and are written on the same stock. The firm does not pay dividends. Strategy A: Long a call with X = $20 and long a put with X; = $30 Strategy B: Long a put with X; = $20 and long a call with X2 - $30 Which strategy is more expensive? Hint: Draw the payoff diagrams for both strategies A. Strategy A is more expensive. B. Strategy B is more expensive. C. Both strategies are equally costly. D. There is insufficient information to conclude. 12) Which of the following statements is true? A. Empirically, the market implied volatility is higher than the market realised volatility. B. Empirically, the market implied volatility is lower than the market realised volatility. C. Empirically, the market implied volatility is higher (lower) than the market realised volatility during normal (bad) times. D. None of the above. 13) The profitability of momentum trading strategy can be economically explained by A. Disposition effect. B. Fama-French-Cahart four-factor models. C. Limits to arbitrage. D. None of the above. I 14) The low-beta-bias phenomenon can be explained by A. Market sentiment. B. Market risk. C. Limits to arbitrage. D. All of the above. 15) Which of the following statements is correct? A. Investor returns are generally lower than reported fund returns due to transaction costs and management fees. B. Investor returns are generally lower than reported fund returns because fund performances are not persistent and suffer from decreasing return to scale. C. Investor returns are generally lower than reported fund returns because funds generate negative alphas after accounting for risk. D. A and B are correct. E. All of the above are correct. 16) A bond's yield to call will receive more attention if A. the bond's yield to maturity is insufficient B. the firm has called some of its bonds in the past. C. the investor only plans to hold the bond until its first call date. D. interest rates are expected to rise. E. interest rates are expected to fall. 17) In a CAPM economy, investors should search for assets with a high Sharpe ratio. TRUE or FALSE? A. TRUE - The higher the Sharpe Ratio, the better. Also, investors search for lower correlation assets. B. TRUE - The higher the Sharpe Ratio, the better. Investors will only invest in the individual assets with the highest Sharpe Ratio. C. FALSE - All investors will invest in the market portfolio and the risk-free asset in some proportion. There is nothing to be gained by selecting individual stocks according to any criteria. D. FALSE - Investors in the CAPM economy only care about systematic risks. Therefore, they do not care about Sharpe Ratios in assessing investments. E. None of the above is correct. 18) A bond is selling at par with modified duration of 11 years. The bond convexity is 400. According to the duration-with-convexity rule, what would be the percentage change in price if there is an increase by 2% in yield? A. Greater than-11%. B. Less than -11% but greater than -22%. C. Great than 11%. D. Less than -22%. 19) Which of the following challenges does mean-variance optimisation framework face? A. The inputs are estimated with substantial errors. B. Estimating volatilities and covariances is imprecise and needs long history of data. C. Costly to obtain more observations through higher frequency data e.g. intraday prices to improve estimation precision for means, volatilities, and covariances. D. The computational cost is high due to a large number of inputs. E. All of the above. 20) A list of prices for zero-coupon bonds with different maturities and par values of $1,000 is provided below: Maturity (Years) 1 2 Price $ 943.40 881.68 808.88 742.09 4 What is the price of a 4-year maturity bond with annual 12% coupon rate and par value of $1,000? A. $742.09 B. $1,222.09 C. $1,000.00 D. $1,147.92 E. None of the options is correct