Exam 2 – FIN 4504 Investments, Spring 2022

Open book, notes, etc., but do not discuss or share this exam with any other person.

READ CAREFULLY: This exam is due to me via email on Tuesday 3/29 at 9:00pm
EST. Email me (dautore@business.fsu.edu) an excel file with your answer choices and
name the file “YourLastName.FirstName.Exam2”. Please follow the example excel file
that is posted in Canvas under the Exam Module. I will confirm receipt of your exam
submission no later than Tuesday morning. Submit only one excel file. Before you send it
to me, please make sure it is complete and final. Do not resend me your exam with
corrections.

The exam consists of 33 multiple choice questions (3 points each); everyone gets one
free point. There is only one correct answer to each question. Be sure to read the question
and all possible alternatives before you choose your answer.

1. Assume Stock ABC has a P/E ratio of 45. Analysts forecast its growth over the next
five years to be 45%. The industry average P/E ratio is 30 and the industry average
growth over the next five years is forecasted to be 20%. Is ABC a good buy (compared to
its industry peers) according to the PEG ratio?

A) No, because it is overvalued given that its price is 45 times earnings

B) Yes, because its PEG ratio is above the industry PEG ratio
C) Yes, because its PEG ratio is below the industry PEG ratio
D) No, because its PEG ratio is below the industry PEG ratio

2. Consider two perfectly negatively correlated risky securities A and B (the

correlation = –1). A has an expected rate of return of 10% and a standard
deviation of 15%. B has an expected rate of return of 13% and a standard
deviation of 25%. The risk-free portfolio that can be formed with the two
securities will earn a _____ rate of return.

A) 0%
B) 8.9%
C) 10.5%
D) 11.1%
E) Somewhere between 0% and 8%
3. Stock A has an expected return of 10% and standard deviation of 20%. Stock B has an
expected return of 15% and standard deviation of 25%. The minimum variance portfolio
(MVP) consisting of Stocks A and B has an expected return of 12% and a standard
deviation of 5%. The risk-free rate equals 3%. The correlation between Stocks A and B
equals________
A) +1
B) –1
C) Less than +1 and greater than –1
D) Cannot determine without more data

4. In one year from now your company is expected to pay a dividend of $2 per share. The
growth rate of the dividend is expected to be constant at 10% per year. The required
return is 12%. What is your firm’s stock currently worth?
A) $0.40
B) $13.33
C) $20
D) $100
E) $110

5. The covariance of returns of Stock 1 with Stock 2 is 150. The covariance of Stock
3 with Stock 4 is 200. The covariance of Stock 5 with Stock 6 is –100. Which of
the following statements is (are) definitely true?
I. The correlation coefficient between Stock 1 and Stock 2 does not equal
the correlation coefficient between stock 5 and 6.
II. The correlation coefficient between Stock 1 and Stock 2 does not equal
the correlation coefficient between stock 3 and 4.
III. The correlation coefficient between Stock 3 and Stock 4 does not
equal the correlation coefficient between stock 5 and 6.
IV. The correlation coefficient between Stock 1 and Stock 2 is positive
A) only II
B) I and III only
C) I, III, and IV only
D) All are definitely true
E) None are definitely true

6. Suppose you plot an investment opportunity set between two stocks. In the special case
in which the correlation equals +1, the investment opportunity set is represented by
__________ connecting the location of the two stocks on the graph.

A) A straight line
B) A curved line (with the curve out to the left)
C) A curved line (with the curve out to the right)

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Use the following information for Questions 7 and 8:

Stock A has an expected return of 10% and standard deviation of 15%. Stock B has an
expected return of 13% and standard deviation of 20%. The correlation between the two
stocks equals 0.4.

7. What is the expected return of the minimum variance portfolio (MVP) consisting of
stocks A and B (to the nearest whole percent)?

A) 9%
B) 11%
C) 13%
D) 18%
E) Need to know the risk-free rate to determine

8. What is the standard deviation of the minimum variance portfolio (MVP) consisting of
stocks A and B (to the nearest whole percent)?

A) 9%
B) 11%
C) 13%
D) 14%
E) Need to know the risk-free rate to determine

9. Stock A has an expected return of 14% and standard deviation 35%, and stock B
has an expected return of 9% and a standard deviation of 15%. The correlation
coefficient between A and B is +1. Assume no short selling is allowed. What is
the expected return and standard deviation on the minimum variance portfolio
consisting of A and B?
A) 11.5%; 0%
B) 9%; 15%
C) 11.5%; 25%
D) 7%; 12%
E) None of the above

10. Let’s assume you hold a portfolio consisting of two stocks (A and B). The standard
deviation of Stock A is 15%. The standard deviation of stock B is 25%. You have
positive weights in each stock. The standard deviation of the portfolio consisting of
stocks A and B can equal which of the following:

A) a value over 25%

B) a value under 15%
C) a value between 15% and 25%
D) B and C are both correct.

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11. In the phenomenon known as post-earnings announcement drift, abnormal returns in
the weeks after earnings news continue to appear in the same direction as the news.
According to this phenomenon, investors ________ to favorable earnings surprises and
_________ to unfavorable earnings surprises.
A) underreact; overreact
B) underreact; underreact
C) overreact; overreact
D) overreact; underreact

12. Consider two stocks, 1 and 2. The slope of the Security Characteristic Line (SCL) is
positive for both stocks, and is steeper for Stock 1 than for stock 2. This implies that
systematic risk is greater for _________, and firm-specific risk is greater for
___________.
A) Stock 1 ; Stock 1
B) Stock 2 ; Stock 2
C) Stock 1 ; Stock 2
D) Stock 2 ; Stock 1
E) Stock 1 ; Impossible to know without more information

For questions 13 through 15 use the following information

Today your company paid a dividend (D0) of $3 per share. The growth rate of the
dividend is expected to be 15% for the next two years, and then 6% thereafter. The cost
of capital is 10%. For each question, choose the closest answer.

13. What do you expect the dividend to be in three years from now (D3) (to the nearest
cent)?

a) $3.63
b) $3.85
c) $3.97
d) $4.21

14. What is your estimate of your firm’s stock price two years from now (P2)?

a) $96.20
b) $79.50
c) $105.10
d) $86.90
e) $93.30

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15. What is your estimate of your firm’s current stock price (P0)?

a) $96.20
b) $79.50
c) $105.10
d) $85.10
e) $93.30

16. Suppose the risk-free return is 2% and the return on the market is 10%. The beta of a
managed portfolio is 1.5, and the average realized return is 13%. According to the
CAPM, Jensen’s alpha of the managed portfolio is:
A) –1%
B) 0%
C) 1%
D) 2%
E) none of the above

17. Assume that markets are semi-strong form efficient. Suppose that during a trading day
important new information is released by a firm indicating that one of the firm's oil
fields, previously thought to be very promising, just came up dry. How would you
expect the price of a share of stock to react to this information?

A) The price will fall over an extended period of time as investors begin to sell shares
in the company.
B) The value of a share will drop immediately to a price that reflects the value of the
new information.
C) The value of a share will fall below what is considered appropriate because of the
decreased demand for shares, but eventually the price will rise to the correct level.
D) The value of a share will rise over a long period of time as investors sell the stock.
E) The stock price will not change since this type of information has no impact in
markets that are semi-strong form efficient.

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 18. Your friend’s portfolio consistently plots above the Security Market Line. As a result,
your friend claims to know how to earn abnormal returns. Thus, your friend tries to
convince you that the market is not efficient. How should you respond?

A) You should totally agree; this is direct evidence against market efficiency
B) Tell your friend that this should be expected due to the Momentum effect
C) Tell your friend that it is hard to measure risk (Joint Hypothesis Problem); maybe
the market is efficient, or maybe risk is being measured improperly

19. Below are two SCL lines for two separate managed portfolios. Which of the
graphs indicates good market timing by the portfolio manager?

A) The curved SCL on the left

B) The straight SCL on the right
C) They both exhibit market timing
D) Neither exhibits market timing

20. After several years of trying to develop trading strategies that use past price and volume
data to earn superior abnormal returns, you discover that it is possible. You conclude
that past data can be used to predict future price movements. Based on this analysis
alone, you would argue that the stock market is:

A) weak form efficient.

B) not weak form efficient.
C) semi-strong form efficient.
D) strong form efficient.

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 21. Brady Cosmetics just announced that earnings for the first quarter of the current year
grew at an annualized rate of 3%, well above the forecasted rate. Upon the
announcement, the stock price rose sharply. Which of the following is most likely
correct?

A) Brady’s price rose because the market is inefficient (semi-strong form)

B) Interest rates in the economy must have increased
C) Brady’s price rose because investors likely anticipated this news
D) Brady’s price rose because the market was surprised by the announcement
E) Brady must have a beta coefficient equal to 1

22. To calculate the variance of a portfolio consisting of 5 stocks, you would need to
calculate _________ variance terms and ___________ covariance terms.
A) 5; 5
B) 5; 10
C) 25; 25
D) 25; 10
E) 10; 10

23. Which one of the following portfolios cannot lie on the efficient frontier?

Portfolio Expected Return Standard Deviation

W 9% 11%
X 5% 7%
Y 15% 27%
Z 12% 35%

A) Only portfolio W cannot lie on the efficient frontier.

B) Only portfolio X cannot lie on the efficient frontier.
C) Only portfolio Y cannot lie on the efficient frontier.
D) Only portfolio Z cannot lie on the efficient frontier.
E) Cannot tell from the information given.

24. Consider two perfectly negatively correlated risky securities A and B (the
correlation = –1). A portfolio consisting of stocks A and B has a standard
deviation equal to ________.

A) 0
B) 1
C) -1
D) Need more information to determine

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25. Under prospect theory, the shape of the utility function implies that investors
are____________.
A) Always risk averse
B) Risk seeking when it comes to losses
C) Always risk seeking

26) Assume the CAPM is correct and also that markets are efficient. You are looking at two
different stocks. IBX has a beta of 1.25 and Microsquish has a beta of 1.95. Which
statement is true about these investments?
A) IBX is always a better addition to your portfolio.
B) Microsquish is always a better addition to your portfolio.
C) The expected return on IBX will be the higher of the two.
D) You cannot tell which of the two will have the higher expected return without
further information.
E) The IBX stock has the same Security Market Line (SML) slope as does the
Microsquish stock.

Use the following information for Questions 27 and 28

You invest $1000 in security A with a beta of 2 and $500 in security B with a beta of 1.
The expected market return is 10% and the risk free rate is 3%.

27. The beta of your portfolio equals ________.

A) 1
B) 1.50
C) 1.67
D) 1.75

28. According to the CAPM, your portfolio should have an expected return of
___________.
A) 12.2%
B) 13.5%
C) 14.7%
D) 15.2%
E) 20%

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29. Let’s assume you are studying a portfolio that consists of two risky assets. Do you
need to know the risk-free rate to determine: (i) the minimum variance portfolio? (ii) the
optimal risky portfolio?

A) Yes; Yes
B) Yes; No
C) No; Yes
D) No; No
E) Impossible to know either answer without more information

30. If the CAPM is valid, which of the following situations is possible:

1) Portfolio Expected return Standard deviation

A 30 35
B 40 25

2) Portfolio Expected return Standard deviation

Risk-free 10 0
Market 18 24
A 16 12

3) Portfolio Expected return Beta

Risk-free 10 0
Market 18 1.0
A 20 1.5

4) Portfolio Expected return Standard deviation

Risk-free 10 0
Market 18 24
A 16 22

A) 1 and 3 only
B) 1 and 4 only
C) 2, 3, and 4 only
D) 1, 3, and 4 only
E) 1, 2, 3, and 4

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31. The Fama-French 3-factor model is a multi-factor models that includes two additional
risk factors beyond the market risk factor in the CAPM model. These additional factors
account for__________.

A) Firm-specific risk that the CAPM does not measure.

B) Sensitivities of an asset’s return related to its size and its ratio of book-to-market
value.
C) A and B are both correct

32. According to the constant growth dividend discount model the price of a stock whose
dividend is growing at a rate g will:
A) Remain unchanged
B) Decrease over time at the rate of g percent
C) Increase over time at the rate of g percent
D Increase over time at the required return (r)
E) None of the above

33. Suppose you estimate the Fama and French 3-factor model for your portfolio using
monthly returns (using % form) during a five year period. You use the following model:
RPortfolio – Rf = BM*(Mkt – Rf) + BSMB*SMB + BHML*HML

Your estimates indicate the following: BM = 2; BSMB = 0.6; BHML = 1. Using these
coefficient estimates, calculate the expected return for next month on your portfolio.
Let’s assume the expected monthly market risk premium (Mkt-Rf) equals 1%, the
expected size premium (SMB) equals 0.5%, and the expected book-to-market (HML)
premium equals 0.2%. The expected monthly risk-free rate equals 0.2%.

Based on this data and analysis, what is the expected return next month for your
portfolio?

A) 1%
B) 1.5%
C) 2%
D) 2.3%
E) 2.7%