:Answer all questions.

1.

Which one of the following investments is likely to bring the highest average long-term returns to investors?

Group of answer choices

investment grade bonds

preferred stocks

common stocks

the above three choices generate similar long-term returns

.

2.

Suppose two stocks do not pay dividends. A return correlation coefficient of -0.5 means that the prices of the two stocks _____.

Group of answer choices

tend to move in the same direction

move independently of each other

tend to move in opposite directions

move in exactly the same way except in opposite directions

7. An investor is considering investing in only one of the following securities:

Security A B C

Expected return 10% 10% 15%

Standard deviation 5% 6% 9%

Which of the following statements is correct?

Group of answer choices

Securities A and B are equally desirable for a risk-averse investor.

Securities B and C are equally desirable for a risk-averse investor.

Security B is better than security C for a risk-averse investor.

Security C is better than security A for a risk-averse investor.

10. Which one of the following statements about a portfolio is FALSE?

Group of answer choices

The total risk of the portfolio can be decomposed into systematic risk and unsystematic risk.

As you add more risky assets into your portfolio, the total risk of the portfolio is reduced at an increasing rate.

No matter how many risky assets you include in your portfolio, you can never eliminate all the return volatility of the portfolio.

A portfolio that includes all the risky assets in the market is called the market portfolio.

11. Which one of the following stock portfolios is likely to be best diversified?

Group of answer choices

A portfolio of 15-20 randomly selected tech company stocks.

A portfolio of 15-20 randomly selected small company stocks.

A portfolio of 15-20 randomly selected US company stocks.

A portfolio of 15-20 randomly selected world stocks.

12. Which one of the followings violates the risk diversification rule in personal investment?

Group of answer choices

An employee of a public company should invest less in his/her company's stock than a nonemployee.

A stock broker should invest less in stocks and more in other asset classes such as bonds, commodities, etc.

A young investor with stable job should invest more aggressively .

As an investor with stable job grows older, he/she needs to be more aggressive in his/her financial portfolio by tilting more toward high-risk assets such as stocks.

13. _____ can be diversified away.

Group of answer choices

Total risk

Systematic risk

Unsystematic risk

All of the above three choices

14. In finance, the systematic risk of an asset is measured by _____.

Group of answer choices

return variance

return standard deviation

return covariance

beta

15. The capital asset pricing model describes the relationship _____ of an investment asset.

Group of answer choices

between expected return and total risk

between expected return and unsystematic risk

between expected return and systematic risk

between expected return and return standard deviation

16. In practice, how do financial analysts estimate the beta of a publicly traded stock?

Group of answer choices

Regress the stock's returns on S&P 500 index's returns, and the slope of the regression line is the stock's beta.

Regress the stock's returns on S&P 500 index's returns, and the intercept of the regression line is the stock's beta.

The yield to maturity of Treasury securities can be used as the stock's beta.

The expected return of the S&P 500 index can be used the stock's beta.

19. The capital asset pricing model is most readily applied to estimate investor's required rate of return on which of the following securities?

Group of answer choices

publicly traded stocks

private equity

Treasury bonds

corporate bonds

20. Which of the following pairs of securities are likely to have the highest return correlation coefficient?

Group of answer choices

Two US stocks from the same industry

Two US stocks from very different industries

One US stock and one Japanese stock

One Treasury bond and one US stock

21. If investors believe a public company's senior executives know substantial inside information, then the management's decision to issue additional shares signals ____ of the company's stock, and the management decision to repurchase existing shares signals _____ of the company's stock.

Group of answer choices

undervaluation, undervaluation

undervaluation, overvaluation

overvaluation, undervaluation

overvaluation, overvaluation

22. A German company's stock is traded in the US over-the-counter stock market in the form of American Depository Receipt. Most of this company's sales revenues come from the European market. Ceteris paribus, if euro depreciates relative to US dollar, then the dollar price of this company's ADR would _____.

Group of answer choices

increase

decrease

unchange

first increase and then decrease.

32. Fast Track, a local bus company providing direct service between New York and Boston, had after-tax earnings of $2.5 million in the past year (year 0) and expected the same earnings forever. An investment bank had valued Fast Track at $20 million. Now by allowing passengers to book online, Fast Track expects its after-tax earnings to grow at 2.5% per year, starting this year (year 1). How much would the value of Fast Track increase by this change? (Assume the cost of capital stays the same.) 33. Dragon and Tiger Island (DTI), an online game company, expects next year's after tax earnings to be $20 per share. Its business is still expanding. It plows back 80% of its earnings. The ROE on its new investments is 15%. Its cost of capital is 12.5%. (a) What is the share price of DTI? What is its PVGO? (b) Suppose that a new competitor comes in and cuts DTI's ROE to 12%. How would this impact DTI's investment decisions and its share price? Explain why. 34. The dividend yield for shares of the Union Pacific Railroad is 1.9%. Security analysts are forecasting rapid growth in Union Pacific's earnings per share (EPS), about 12.7% per year for the next three years. Does that imply an expected rate of return of 1.9 + 12.7 = 14.6%? Explain. 35. The Northern Company is a utility company with existing assets that generates an EPS (earnings per share) of $5. If the firm only maintains existing assets, EPS is expected to remain constant at $5 a year. However, next year, the Northern Company has the opportunity to invest $3 per share to develop a new electricity generator using solar energy. The development of the new generator will be completed next year. This investment is expected to generate a return (ROE) of 20% per year forever. The cost Fall 2008 Page 34 of 66 of capital is 10%. What will be the Northern Companys share price if it decides to develop the new generator? Use the back of this page if needed to complete your answer. 36. Beta Trend is an exact match for MetaTrend except for one thing: it generates a con- tinuous stream of earnings and dividends. Thus it generates earnings in a continuous stream at 12% per year, starting immediately, and pays out half of earnings as divi- dends. What is the present value of Beta Trend stock? The annually compounded cost of capital is 12%.Problem 12: ABC Company is an unlevered firm, meaning that it is financed with 100%% equity and has 0%% debt. ABC expects to cam EBIT (Famings before interest and tax) of $80,000 annually, forever, Its cost of equity is 25%% and tax rate is 35%%. i) What is the market value of ABC Company as an unlevered firm (Vu)? in) ABC wants to change its capital structure from being an unlevered company to a levered company. Suppose ABC borrows $50,000 at 14% interest rate and uses the proceeds to repurchase and replace $30,000 of equity by $50,000 of debt? Calculate the value of ABC Company as a levered firm and the value of value of equity. Remember that tax rate is 35% Value of levered firm - Vi = Value of equity - E-$ [Hint: Vo - Vu + Tax shield and Vi. = D + E] if Recall that for unlevered ABC, cost of equity is 25; Cost of Asset - Cost of Equity - 25% and Cost of Asset = WACC - Cost of equity 25% (because Debt = 0). Calculate the cost of equity and- WAGE of the levered ABC with $50,000 debt? Cost of equity % WACE iv) Modigliani and Miller Proposition II (with risk free debt) explains that as D/E increases, (Fill in one blank in each line) Debt holders demand higher lower Stock holders demand no change in interest rate higher lower no change in return Value of the firm should: Increase decrease no change2) Answer the following questions about Convergence in the Solow Model: i) ii) True or False: The Solow Model predicts that "rich\" and "poor\" countries will eventually reach the same equilibrium value of output per person. (5 points) Use one graph with Time on the horizontal axis and Output per Person on the vertical axis to show the growth path for a \"rich" and "pom\" country to the long-run equilibrium value of output per person. Which country would have the faster growth rate of output per person? (15 points) Redraw the graph from Question 2 Part (ii) but now assume that the \"rich\" country has low population growth rate and the \"poor\" country has high population growth rate. Do both countries still converge to the same long-run equilibrium of output per person? (15 points)