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标题: Portfolio Management【Reading 45】Sample [打印本页]

作者: andytrader    时间: 2012-3-29 14:34     标题: [2012 L1] Portfolio Management【Session 12 - Reading 45】Sample

Which of the following statements about asset pricing models is most accurate?
A)
Assuming assets are not perfectly positively correlated, the systematic risk of a portfolio decreases as more assets are added.
B)
According to the Capital Asset Pricing Model (CAPM), the expected rate of return of a portfolio with a beta of 1.0 is the market expected return.
C)
Adding the risk-free asset to a portfolio will reduce return and total risk.



Diversification reduces unsystematic, or unique risk. With the risk-free asset and a portfolio of risky assets, the equation for the expected standard deviation is linear: wAsA .  A combination of the risk free asset and a portfolio always gives more return for a given level of risk.Risk tends to be reduced, but assuming that assets are not perfectly positively correlated, an investor can achieve the benefits of diversification by adding just one security (Markowitz). Studies have shown that approximately 18-30 stocks are needed for proper diversification. The main point is that the number of stocks required is small and is significantly less than all securities (and significantly less than 1,000 securities).
作者: andytrader    时间: 2012-3-29 14:35

An equally weighted portfolio of a risky asset and a risk-free asset will exhibit:
A)
more than half the returns standard deviation of the risky asset.
B)
less than half the returns standard deviation of the risky asset.
C)
half the returns standard deviation of the risky asset.



A risk free asset has a standard deviation of returns equal to zero and a correlation of returns with any risky asset also equal to zero. As a result, the standard deviation of returns of a portfolio of a risky asset and a risk-free asset is equal to the weight of the risky asset multiplied by its standard deviation of returns. For an equally weighted portfolio, the weight of the risky asset is 0.5 and the portfolio standard deviation is 0.5 × the standard deviation of returns of the risky asset.
作者: andytrader    时间: 2012-3-29 14:36

The slope of the capital market line (CML) is a measure of the level of:
A)
expected return over the level of inflation.
B)
risk over the level of excess return.
C)
excess return per unit of risk.



The slope of the CML indicates the excess return (expected return less the risk-free rate) per unit of risk.
作者: andytrader    时间: 2012-3-29 14:36

Which of the following is the vertical axis intercept for the Capital Market Line (CML)?
A)
Expected return on the market.
B)
Risk-free rate.
C)
Expected return on the portfolio.



The CML originates on the vertical axis from the point of the risk-free rate.
作者: andytrader    时间: 2012-3-29 14:37

According to capital market theory, which of the following represents the risky portfolio that should be held by all investors who desire to hold risky assets?
A)
The point of tangency between the capital market line (CML) and the efficient frontier.
B)
Any point on the efficient frontier and to the left of the point of tangency between the CML and the efficient frontier.
C)
Any point on the efficient frontier and to the right of the point of tangency between the CML and the efficient frontier.



Capital market theory suggests that all investors should invest in the same portfolio of risky assets, and this portfolio is located at the point of tangency of the CML and the efficient frontier of risky assets. Any point below the CML is suboptimal, and points above the CML are not feasible.
作者: andytrader    时间: 2012-3-29 14:38

All portfolios on the capital market line are:
A)
unrelated except that they all contain the risk-free asset.
B)
perfectly positively correlated.
C)
distinct from each other.



The introduction of a risk-free asset changes the Markowitz efficient frontier into a straight line. This straight efficient frontier line is called the capital market line (CML). Since the line is straight, the math implies that any two assets falling on this line will be perfectly, positively correlated with each other. Note: When ra,b = 1, then the equation for risk changes to sport = WAsA + WBsB, which is a straight line.
作者: andytrader    时间: 2012-3-29 14:38

The market portfolio in Capital Market Theory is determined by:
A)
a line tangent to the efficient frontier, drawn from any point on the expected return axis.
B)
the intersection of the efficient frontier and the investor's highest utility curve.
C)
a line tangent to the efficient frontier, drawn from the risk-free rate of return.



The Capital Market Line is a straight line drawn from the risk-free rate of return (on the Y axis) through the market portfolio. The market portfolio is determined as where that straight line is exactly tangent to the efficient frontier.
作者: andytrader    时间: 2012-3-29 14:39

The market portfolio in the Capital Market Theory contains which types of investments?
A)
All risky and risk-free assets in existence.
B)
All risky assets in existence.
C)
All stocks in existence.



The market portfolio contains all risky assets in existence. It does not contain any risk-free assets.
作者: andytrader    时间: 2012-3-29 14:39

A portfolio to the right of the market portfolio on the capital market line (CML) is created by:
A)
holding both the risk-free asset and the market portfolio.
B)
fully diversifying.
C)
holding more than 100% of the risky asset.


Portfolios that lie to the right of the market portfolio on the capital market line are created by borrowing funds to own more than 100% of the market portfolio (M).
The statement, "holding both the risk-free asset and the market portfolio" refers to portfolios that lie to the left of the market portfolio. Portfolios that lie to the left of  point M are created by lending funds (or buying the risk free-asset). These investors own less than 100% of both the market portfolio and more than 100% of the risk-free asset. The portfolio at point Rf (intersection of the CML and the y-axis) is created by holding 100% of the risk-free asset.  The statement, "fully diversifying" is incorrect because the market portfolio is fully diversified.
作者: andytrader    时间: 2012-3-29 14:39

Portfolios that represent combinations of the risk-free asset and the market portfolio are plotted on the:
A)
capital market line.
B)
capital asset pricing line.
C)
utility curve.


The introduction of a risk-free asset changes the Markowitz efficient frontier into a straight line. This straight efficient frontier line is called the capital market line (CML). Investors at point Rf have 100% of their funds invested in the risk-free asset. Investors at point M have 100% of their funds invested in market portfolio M. Between Rf and M, investors hold both the risk-free asset and portfolio M.  To the right of M, investors hold more than 100% of portfolio M. All investors have to do to get the risk and return combination that suits them is to simply vary the proportion of their investment in the risky portfolio M and the risk-free asset.
Utility curves reflect individual preferences.
作者: andytrader    时间: 2012-3-29 14:40

For an investor to move further up the Capital Market Line than the market portfolio, the investor must:
A)
diversify the portfolio even more.
B)
reduce the portfolio's risk below that of the market.
C)
borrow and invest in the market portfolio.


Portfolios that lie to the right of the market portfolio on the capital market line ("up" the capital market line) are created by borrowing funds to own more than 100% of the market portfolio (M).
The statement, "diversify the portfolio even more" is incorrect because the market portfolio is fully diversified.
作者: andytrader    时间: 2012-3-29 14:40

In the context of the CML, the market portfolio includes:
A)
12-18 stocks needed to provide maximum diversification.
B)
all existing risky assets.
C)
the risk-free asset.



The market portfolio has to contain all the stocks, bonds, and risky assets in existence. Because this portfolio has all risky assets in it, it represents the ultimate or completely diversified portfolio.
作者: andytrader    时间: 2012-3-29 14:40

What is the risk measure associated with the CML?
A)
Standard deviation.
B)
Beta.
C)
Market risk.



In the context of the CML, the measure of risk (x-axis) is total risk, or standard deviation. Beta (systematic risk) is used to measure risk for the security market line (SML).
作者: andytrader    时间: 2012-3-29 14:41

Based on Capital Market Theory, an investor should choose the:
A)
portfolio with the highest return on the Capital Market Line.
B)
portfolio that maximizes his utility on the Capital Market Line.
C)
market portfolio on the Capital Market Line.



Given the Capital Market Line, the investor chooses the portfolio that maximizes his utility. That portfolio may be exactly the market portfolio or it may be some combination of the risk-free asset and the market portfolio.
作者: andytrader    时间: 2012-3-29 14:41

Which of the following statements about the capital market line (CML) is least accurate?
A)
Investors choose a portfolio on the CML by varying their weightings of the risk-free asset and the market portfolio.
B)
The CML will not be a linear relationship if investors' borrowing and lending rates are not equal.
C)
The market portfolio lies on the CML and has only unsystematic risk.



The first part of this statement is true - the market portfolio does lie on the CML. However, the market portfolio is well diversified and thus has no unsystematic risk. The risk that remains is market risk, or nondiversifiable, or systematic risk.
The CML measures standard deviation (or total risk) against returns. The CML will “kink” if the borrowing rate and lending rate are not equal. Investors choose a portfolio on the CML by lending or borrowing at the risk-free rate to vary the weighting of their investments in the risk-free asset and the market portfolio.
作者: clearlycanadian    时间: 2012-3-29 14:44

Which of the following is the risk that disappears in the portfolio construction process?
A)
Unsystematic risk.
B)
Systematic risk.
C)
Interest rate risk.



Unsystematic risk (diversifiable risk) is the risk that is eliminated when the investor builds a well-diversified portfolio.
作者: clearlycanadian    时间: 2012-3-29 14:45

Which of the following statements about systematic and unsystematic risk is least accurate?
A)
Total risk equals market risk plus firm-specific risk.
B)
The unsystematic risk for a specific firm is similar to the unsystematic risk for other firms in the same industry.
C)
As an investor increases the number of stocks in a portfolio, the systematic risk will remain constant.



This statement should read, "The unsystematic risk for a specific firm is not similar to the unsystematic risk for other firms in the same industry." Thus, other terms for this risk are firm-specific, or unique, risk.
Systematic risk is not diversifiable. As an investor increases the number of stocks in a portfolio the unsystematic risk will decrease at a decreasing rate. Total risk equals systematic (market) plus unsystematic (firm-specific) risk.
作者: clearlycanadian    时间: 2012-3-29 14:46

In the context of the capital market line (CML), which of the following statements is CORRECT?
A)
The two classes of risk are market risk and systematic risk.
B)
Market risk can be reduced through diversification.
C)
Firm-specific risk can be reduced through diversification.



The other statements are false. Market risk cannot be reduced through diversification; market risk = systematic risk. The two classes of risk are unsystematic risk and systematic risk.
作者: clearlycanadian    时间: 2012-3-29 14:46

Which of the following is least likely considered a source of systematic risk for bonds?
A)
Purchasing power risk.
B)
Market risk.
C)
Default risk.



Default risk is based on company-specific or unsystematic risk.
作者: clearlycanadian    时间: 2012-3-29 14:47

Which of the following statements about portfolio management is most accurate?
A)
The security market line (SML) measures systematic and unsystematic risk versus expected return; the CML measures total risk.
B)
As an investor diversifies away the unsystematic portion of risk, the correlation between his portfolio return and that of the market approaches negative one.
C)
Combining the capital market line (CML) (risk-free rate and efficient frontier) with an investor's indifference curve map separates out the decision to invest from the decision of what to invest in.



Combining the CML (risk-free rate and efficient frontier) with an investor’s indifference curve map separates out the decision to invest from what to invest in and is called the separation theorem. The investment selection process is thus simplified from stock picking to efficient portfolio construction through diversification.
The other statements are false. As an investor diversifies away the unsystematic portion of risk, the correlation between his portfolio return and that of the market approaches positive one. (Remember that the market portfolio has no unsystematic risk). The SML measures systematic risk, or beta risk.
作者: clearlycanadian    时间: 2012-3-29 14:48

A model that estimates expected excess return on a security based on the ratio of the firm’s book value to its market value is best described as a:
A)
market model.
B)
single-factor model.
C)
multifactor model.



A model that estimates a stock’s expected excess return based only on the book-to-market ratio is a single-factor model. The market model is a single-factor model that estimates expected excess return based on a security’s sensitivity to the expected excess return of the market portfolio. A multifactor model would estimate expected excess return based on more than one factor.
作者: clearlycanadian    时间: 2012-3-29 14:48

Beta is a measure of:
A)
total risk.
B)
systematic risk.
C)
company-specific risk.



Beta is a measure of systematic risk.
作者: clearlycanadian    时间: 2012-3-29 14:48

Beta is least accurately described as:
A)
a standardized measure of the total risk of a security.
B)
a measure of the sensitivity of a security’s return to the market return.
C)
the covariance of a security’s returns with the market return, divided by the variance of market returns.



Beta is a standardized measure of the systematic risk of a security. β = Covr,mkt / σ2mkt. Beta is multiplied by the market risk premium in the CAPM: E(Ri) = RFR + β[E(Rmkt) – RFR].
作者: clearlycanadian    时间: 2012-3-29 14:49

An analyst has developed the following data for two companies, PNS Manufacturing (PNS) and InCharge Travel (InCharge). PNS has an expected return of 15% and a standard deviation of 18%. InCharge has an expected return of 11% and a standard deviation of 17%. PNS’s correlation with the market is 75%, while InCharge’s correlation with the market is 85%. If the market standard deviation is 22%, which of the following are the betas for PNS and InCharge?
Beta of PNSBeta of InCharge
A)
0.660.61
B)
0.610.66
C)
0.921.10



Betai = (si/sM) × rI, M
BetaPNS = (0.18/0.22) × 0.75 = 0.6136
BetaInCharge = (0.17/0.22) × 0.85 = 0.6568
作者: clearlycanadian    时间: 2012-3-29 14:49

If the standard deviation of the market’s returns is 5.8%, the standard deviation of a stock’s returns is 8.2%, and the covariance of the market’s returns with the stock’s returns is 0.003, what is the beta of the stock?
A)
0.05.
B)
0.89.
C)
1.07.



The formula for beta is: (Covstock,market)/(Varmarket), or (0.003)/(0.058)2 = 0.89.
作者: clearlycanadian    时间: 2012-3-29 14:50

Which of the following statements about a stock's beta is CORRECT? A beta greater than one is:
A)
riskier than the market, while a beta less than one is less risky than the market.
B)
risky, while a beta less than one is risk-free.
C)
undervalued, while a beta less than one is overvalued.



Beta is a measure of the volatility of a stock.  The overall market's beta is one. A stock with higher systematic risk than the market will have a beta greater than one, while a stock that has a lower systematic risk will have a beta less than one.
作者: clearlycanadian    时间: 2012-3-29 14:50

The expected rate of return is twice the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%?
A)
2.
B)
3.
C)
4.



24 = 6 + β (12 − 6)
18 = 6β
β = 3
作者: clearlycanadian    时间: 2012-3-29 14:50

Given the following data, what is the correlation coefficient between the two stocks and the Beta of stock A?
Correlation Coefficient Beta (stock A)
A)
0.5296 2.20
B)
0.6556 2.20
C)
0.5296 0.06



correlation coefficient = 0.00109 / (0.0205)(0.1004) = 0.5296.
beta of stock A = covariance between stock and the market / variance of the market
Beta = 0.002 / 0.03012 = 2.2
作者: clearlycanadian    时间: 2012-3-29 14:50

The expected rate of return is 2.5 times the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%?
A)
5.
B)
4.
C)
3.



30 = 6 + β (12 - 6)
24 = 6β
β = 4
作者: clearlycanadian    时间: 2012-3-29 14:51

The expected rate of return is 1.5 times the 16% expected rate of return from the market. What is the beta if the risk free rate is 8%?
A)
3.
B)
2.
C)
4.



24 = 8 + β (16 − 8)
24 = 8 + 8β
16 = 8β
16 / 8 = β
β = 2
作者: clearlycanadian    时间: 2012-3-29 14:51

Which of the following is NOT an assumption of capital market theory?
A)
The capital markets are in equilibrium.
B)
Investors can lend at the risk-free rate, but borrow at a higher rate.
C)
Interest rates never change from period to period.



Capital market theory assumes that investors can borrow or lend at the risk-free rate. The other statements are basic assumptions of capital market theory.
作者: clearlycanadian    时间: 2012-3-29 14:51

Which of the following is an assumption of capital market theory? All investors:
A)
select portfolios that lie above the efficient frontier to optimize the risk-return relationship.
B)
have multiple-period time horizons.
C)
see the same risk/return distribution for a given stock.



All investors select portfolios that lie along the efficient frontier, based on their utility functions. All investors have the same one-period time horizon, and have the same risk/return expectations.
作者: clearlycanadian    时间: 2012-3-29 14:52

Which is NOT an assumption of capital market theory?
A)
Investments are not divisible.
B)
There are no taxes or transaction costs.
C)
There is no inflation.



Capital market theory assumes that all investments are infinitely divisible. The other statements are basic assumptions of capital market theory.
作者: clearlycanadian    时间: 2012-3-29 14:52

Which of the following statements regarding the Capital Asset Pricing Model is least accurate?
A)
It is useful for determining an appropriate discount rate.
B)
It is when the security market line (SML) and capital market line (CML) converge.
C)
Its accuracy depends upon the accuracy of the beta estimates.



The CML plots expected return versus standard deviation risk. The SML plots expected return versus beta risk. Therefore, they are lines that are plotted in different two-dimensional spaces and will not converge.
作者: clearlycanadian    时间: 2012-3-29 14:53

When the market is in equilibrium:
A)
all assets plot on the CML.
B)
all assets plot on the SML.
C)
investors own 100% of the market portfolio.


When the market is in equilibrium, expected returns equal required returns. Since this means that all assets are correctly priced, all assets plot on the SML. By definition, all stocks and portfolios other than the market portfolio fall below the CML. (Only the market portfolio is efficient.
作者: clearlycanadian    时间: 2012-3-29 14:53

Given a beta of 1.10 and a risk-free rate of 5%, what is the expected rate of return assuming a 10% market return?
A)
10.5%.
B)
15.5%.
C)
5.5%.



k = 5 + 1.10 (10 - 5) = 10.5
作者: clearlycanadian    时间: 2012-3-29 14:53

The expected market premium is 8%, with the risk-free rate at 7%. What is the expected rate of return on a stock with a beta of 1.3?
A)
16.3%.
B)
10.4%.
C)
17.4%.



RRStock = Rf + (RMarket − Rf) × BetaStock, where RR = required return, R = return, and Rf = risk-free rate, and (RMarket − Rf) = market premium
Here, RRStock = 7 + (8 × 1.3) = 7 + 10.4 = 17.4%.
作者: clearlycanadian    时间: 2012-3-29 14:54

What is the required rate of return for a stock with a beta of 1.2, when the risk-free rate is 6% and the market is offering 12%?
A)
7.2%.
B)
6.0%.
C)
13.2%.


RRStock = Rf + (RMarket - Rf) × BetaStock, where RR= required return, R = return, and Rf = risk-free rate.  

Here, RRStock = 6 + (12 - 6) × 1.2 = 6 + 7.2 = 13.2%.


作者: clearlycanadian    时间: 2012-3-29 14:55

The beta of Stock A is 1.3. If the expected return of the market is 12%, and the risk-free rate of return is 6%, what is the expected return of Stock A?
A)
14.2%.
B)
15.6%.
C)
13.8%.


RRStock = Rf + (RMarket - Rf) × BetaStock, where RR= required return, R = return, and Rf = risk-free rate

Here, RRStock = 6 + (12 - 6) × 1.3  = 6 + 7.8 = 13.8%.


作者: clearlycanadian    时间: 2012-3-29 14:55

The beta of stock D is -0.5. If the expected return of Stock D is 8%, and the risk-free rate of return is 5%, what is the expected return of the market?
A)
+3.0%.
B)
-1.0%.
C)
+3.5%.



RRStock = Rf + (RMarket − Rf) × BetaStock, where RR = required return, R = return, and Rf = risk-free rate
A bit of algebraic manipulation results in:
RMarket = [RRStock − Rf − (BetaStock × Rf)] / BetaStock = [8 − 5 − (-0.5 × 5)] / -0.5 = 0.5 / -0.5 = -1%
作者: clearlycanadian    时间: 2012-3-29 14:55

What is the expected rate of return on a stock that has a beta of 1.4 if the market risk premium is 9% and the risk-free rate is 4%?
A)
13.0%.
B)
16.6%.
C)
11.0%.



Using the security market line (SML) equation:
4% + 1.4(9%) = 16.6%.
作者: clearlycanadian    时间: 2012-3-29 14:56

If the risk-free rate of return is 3.5%, the expected market return is 9.5%, and the beta of a stock is 1.3, what is the required return on the stock?
A)
7.8%.
B)
11.3%.
C)
12.4%.



The formula for the required return is: ERstock = Rf + (ERM – Rf) × Betastock,
or 0.035 + (0.095 – 0.035) × 1.3 = 0.113, or 11.3%.
作者: clearlycanadian    时间: 2012-3-29 14:57

Given a beta of 1.25 and a risk-free rate of 6%, what is the expected rate of return assuming a 12% market return?
A)
10%.
B)
31%.
C)
13.5%.



k = 6 + 1.25 (12 − 6)
= 6 + 1.25(6)
= 6 + 7.5
= 13.5
作者: clearlycanadian    时间: 2012-3-29 14:57

Given the following information, what is the required rate of return on Bin Co?

A)
7.6%.
B)
16.7%.
C)
10.2%.



Use the capital asset pricing model (CAPM) to find the required rate of return. The approximate risk-free rate of interest is 5% (2% real risk-free rate + 3% inflation premium).
k = 5% + 1.3(4%) = 10.2%.

作者: clearlycanadian    时间: 2012-3-29 14:57

Given a beta of 1.55 and a risk-ree rate of 8%, what is the expected rate of return, assuming a 14% market return?
A)
12.4%.
B)
17.3%.
C)
20.4%.



k = 8 + 1.55(14-8)
= 8 + 1.55(6)
= 8 + 9.3
= 17.3
作者: clearlycanadian    时间: 2012-3-29 14:58

The following information is available for the stock of Park Street Holdings:
Park Street Holdings stock is:
A)
overvalued by 1.1%.
B)
undervalued by 3.7%.
C)
undervalued by 1.1%.



To determine whether a stock is overvalued or undervalued, we need to compare the expected return (or holding period return) and the required return (from Capital Asset Pricing Model, or CAPM).
Step 1: Calculate Expected Return (Holding period return):
The formula for the (one-year) holding period return is:
Step 2: Calculate Required Return:
The formula for the required return is from the CAPM:
RR = Rf + (ERM – Rf) × Beta
RR = 4.25% + (12.5 – 4.25%) × 2.31 = 23.3%.

Step 3: Determine over/under valuation:
The required return is greater than the expected return, so the security is overvalued.
The amount = 23.3% − 22.2% = 1.1%.

作者: clearlycanadian    时间: 2012-3-29 14:59

A stock that plots below the Security Market Line most likely:
A)
has a beta less than one.
B)
is overvalued.
C)
is below the efficient frontier.



Since the equation of the SML is the capital asset pricing model, you can determine if a stock is over- or underpriced graphically or mathematically.  Your answers will always be the same.
Graphically: If you plot a stock’s expected return on the SML and it falls below the line, it indicates that the stock is currently overpriced, causing its expected return to be too low.  If the plot is above the line, it indicates that the stock is underpriced.  If the plot falls on the SML, it indicates the stock is properly priced.
Mathematically: In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.
作者: clearlycanadian    时间: 2012-3-29 15:00

Mason Snow, CFA, is an analyst with Polari Investments. Snow's manager has instructed him to put only securities that are undervalued on the buy list. Today, Snow is to make a recommendation on the following two stocks: Bahre (with an expected return of 10% and a beta of 1.4) and Cubb (with an expected return of 15% and a beta of 2.0). The risk-free rate is at 7% and the market premium is 4%.Snow places:
A)
only Cubb on the list.
B)
neither security on the list.
C)
only Bahre on the list.



In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.

Here, the holding period (or expected) return is calculated as: (ending price – beginning price + any cash flow or dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate - risk free rate).
作者: clearlycanadian    时间: 2012-3-29 15:00

Mason Snow, CFA, is an analyst with Polari Investments. Snow's manager has instructed him to put only securities that are undervalued on the buy list. Today, Snow is to make a recommendation on the following two stocks: Bahre (with an expected return of 10% and a beta of 1.4) and Cubb (with an expected return of 15% and a beta of 2.0). The risk-free rate is at 7% and the market premium is 4%.Snow places:
A)
only Cubb on the list.
B)
neither security on the list.
C)
only Bahre on the list.



In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.

Here, the holding period (or expected) return is calculated as: (ending price – beginning price + any cash flow or dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate - risk free rate).
作者: clearlycanadian    时间: 2012-3-29 15:01

An analyst wants to determine whether Dover Holdings is overvalued or undervalued, and by how much (expressed as percentage return). The analyst gathers the following information on the stock:
Dover Holdings stock is:
A)
overvalued by approximately 1.8%.
B)
undervalued by approximately 2.1%.
C)
undervalued by approximately 1.8%.



To determine whether a stock is overvalued or undervalued, we need to compare the expected return (or holding period return) and the required return (from Capital Asset Pricing Model, or CAPM).
Step 1: Calculate Expected Return (Holding period return)
The formula for the (one-year) holding period return is:
HPR = (D1 + S1 – S0) / S0, where D = dividend and S = stock price.
Here, HPR = (1.50 + 39 – 35) / 35 = 15.71%
Step 2: Calculate Required Return
The formula for the required return is from the CAPM: RR = Rf + (ERM – Rf) × Beta
Here, we are given the information we need except for Beta. Remember that Beta can be calculated with: Betastock = [covS,M] / [σ2M]. Here we are given the numerator and the denominator, so the calculation is: 0.85 / 0.702 = 1.73. RR = 4.50% + (12.0 – 4.50%) × 1.73 = 17.48%.
Step 3: Determine over/under valuation
The required return is greater than the expected return, so the security is overvalued.
The amount = 17.48% − 15.71% = 1.77%.
作者: clearlycanadian    时间: 2012-3-29 15:02

Luis Green is an investor who uses the security market line to determine whether securities are properly valued. He is evaluating the stocks of two companies, Mia Shoes and Video Systems. The stock of Mia Shoes is currently trading at $15 per share, and the stock of Video Systems is currently trading at $18 per share. Green expects the prices of both stocks to increase by $2 in a year. Neither company pays dividends. Mia Shoes has a beta of 0.9 and Video Systems has a beta of (-0.30). If the market return is 15% and the risk-free rate is 8%, which trading strategy will Green employ?
Mia ShoesVideo Systems
A)
BuySell
B)
SellBuy
C)
BuyBuy



The required return for Mia Shoes is 0.08 + 0.9 × (0.15-0.08) = 14.3%. The forecast return is $2/$15 = 13.3%. The stock is overvalued and the investor should sell it. The required return for Video Systems is 0.08 - 0.3 × (0.15-0.08) = 5.9%. The forecast return is $2/$18 = 11.1%. The stock is undervalued and the investor should buy it.
作者: clearlycanadian    时间: 2012-3-29 15:02

Consider the following graph of the Security Market Line (SML). The letters X, Y, and Z represent risky asset portfolios. The SML crosses the y-axis at the point 0.07. The expected market return equals 13.0%. Note: The graph is NOT drawn to scale.

Using the graph above and the information provided, which of the following statements is most accurate?
A)
The expected return (or holding period return) for Portfolio Z equals 14.8%.
B)
Portfolio Y is undervalued.
C)
Portfolio X's required return is greater than the market expected return.



At first, it appears that we are not given the information needed to calculate the holding period, or expected return (beginning price, ending price, or annual dividend). However, we are given the information required to calculate the required return (CAPM) and since Portfolio Z is on the SML, we know that the required return (RR) equals the expected return (ER). So, ER = RR = Rf + (ERM – Rf) × Beta = 7.0% + (13.0% − 7.0%) × 1.3 = 14.8%.
The SML plots beta (or systematic risk) versus expected return, the CML plots total risk (systematic plus unsystematic risk) versus expected return. Portfolio Y is overvalued – any portfolio located below the SML has an RR > ER and is thus overpriced. Since Portfolio X plots above the SML, it is undervalued and the statement should read, “Portfolio X’s required return is less than the market expected return.”
作者: clearlycanadian    时间: 2012-3-29 15:02

Charlie Smith holds two portfolios, Portfolio X and Portfolio Y. They are both liquid, well-diversified portfolios with approximately equal market values. He expects Portfolio X to return 13% and Portfolio Y to return 14% over the upcoming year. Because of an unexpected need for cash, Smith is forced to sell at least one of the portfolios. He uses the security market line to determine whether his portfolios are undervalued or overvalued. Portfolio X’s beta is 0.9 and Portfolio Y’s beta is 1.1. The expected return on the market is 12% and the risk-free rate is 5%. Smith should sell:
A)
both portfolios X and Y because they are both overvalued.
B)
portfolio Y only.
C)
either portfolio X or Y because they are both properly valued.



Portfolio X’s required return is 0.05 + 0.9 × (0.12-0.05) = 11.3%. It is expected to return 13%. The portfolio has an expected excess return of 1.7%
Portfolio Y’s required return is 0.05 + 1.1 × (0.12-0.05) = 12.7%. It is expected to return 14%. The portfolio has an expected excess return of 1.3%.
Since both portfolios are undervalued, the investor should sell the portfolio that offers less excess return. Sell Portfolio Y because its excess return is less than that of Portfolio X.
作者: clearlycanadian    时间: 2012-3-29 15:03

An investor believes Stock M will rise from a current price of $20 per share to a price of $26 per share over the next year. The company is not expected to pay a dividend. The following information pertains:
Should the investor purchase the stock?
A)
No, because it is undervalued.
B)
No, because it is overvalued.
C)
Yes, because it is undervalued.



In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.
Here, the holding period (or expected) return is calculated as: (ending price – beginning price + any cash flows/dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate − risk free rate).
ER = (26 − 20) / 20 = 0.30 or 30%, RR = 8 + (16 − 8) × 1.7 = 21.6%. The stock is underpriced therefore purchase.
作者: clearlycanadian    时间: 2012-3-29 15:04

A stock's abnormal rate of return is defined as the:
A)
rate of return during abnormal price movements.
B)
actual rate of return less the expected risk-adjusted rate of return.
C)
expected risk-adjusted rate of return minus the market rate of return.



Abnormal return = Actual return – expected risk-adjusted return




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