Financial Economics (University Carlos III)

MULTIPLE CHOICE QUIZ TOPIC 4: Characteristics of individual assets and portfolios: Return
and Risk

1. Determine the market price of a share at time t, given the following dividends per share expected for the next 4 years : (t+1) 0.5, (t+2) 0.6, (t+3) 0.7, (t+4) 0.9, and the share price at time t+5 is expected to be equal to 21. The required rate of return for firms with the same level of risk is 12%. a. 1.99 b. 21.16 c. 13.92 d. None of the above 2. Determine the discount rate that is consistent with the following situation: the current share price of a firm that has promised to pay a constant perpetual dividend per share of 1.2 is 150. a. 0.0109% b. 1.09% c. Higher than 2% d. None of the above. 3. Which a. b. c. d. of the following assets has the least risk? Long term Treasury bonds Long term corporate bonds Firms shares Treasury Bills

4. Compute the expected return of a portfolio that includes 30% of asset A and the remainder of asset B. Individual assets returns are equal to E[RA]=10% and E[RB]=15%. a. 13.50% b. 11.50% c. 12.50% d. None of the above 5. Compute the expected return and volatility of returns of a portfolio that includes 45% of asset A and 55% of asset B. Use the following information: E[RA]=10%, E[RB]=15%, A=11%, B=22% and cov(RA,RB)=0.02. a. 12.75% and 8.91% b. 12.75% and 16.43% c. 12.75% and 13.6% d. None of the above. 6. Choose the correct sentence: a. Portfolio theory assumes b. Portfolio theory assumes c. Portfolio theory assumes d. Portfolio theory does not towards risk. that investors are risk-lovers. that investors are risk-neutral. that investors are risk-averse. make assumptions the behavior of investors

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.

Financial Economics (University Carlos III)

7. The market portfolio expected return id equal to 15% and the T-bill rate of return is equal to 4.5%. Compute the market risk premium. a. 11% b. 15% c. 19.5% d. 11.5% 8. The part of portfolio risk that can be eliminated by diversification is called: a. Speficic or unique risk b. Systematic or market risk c. Systematic risk d. None of the above 9. The correlation between the return of two assets is equal to 0.5, and the individual assets standard deviations are 0.1 and 0.2. Determine the covariance between the returns of the two assets: a. 10% b. 0.01 c. 25% d. 25.0 10. Suppose you have the following information based on historical data. Determine the return and risk (volatility) obtained by a fund manager with a portfolio that includes 25% of asset A and 75% of asset B. Asset A B E[R] 9% 10% Standard Deviation 15% 25% Correlation -0.1

a. b. c. d.

9.75% and 18.75% 9.75% and 38.54% 9.75% and volatility lower than 18% None of the above.

Solutions TOPIC 4: 1.c, 2.b, 3.d, 4.a, 5.c, 6.c, 7.d, 8.a, 9.b, 10.a

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.

Financial Economics (University Carlos III)

MULTIPLE CHOICE QUIZ TOPIC 5: Investment Management: Portfolio Theory

1. If the covariance of returns between assets A and B is 0.025, the covariance of returns between B and A is: a. -0.025 b. 0.25 c. 0.025 d. Impossible to compute without the standard deviation of returns of A and B. 2. In the a. b. c. mean-variance model we assume that: Investors are risk-averse. Investors maximize expected return at the lowest possible risk. The optimal risky portfolio (tangent portfolio) is the same to every investor regardless of her behavior towards risk. d. All of the above are correct.

3. An efficient portfolio is: a. A portfolio that maximizes the level of risk required by investors. b. A portfolio that minimizes the level of risk required by investors. c. All the portfolios that maximize the return expected by investors. d. All the portfolio that maximize expected return for any given level of risk required by investors. 4. Choose the correct sentence: a. The efficient frontier includes all the dominated portfolios. b. The efficient frontier includes all the efficient portfolios. c. The efficient frontier includes the risk-free asset. d. None of the above is correct. 5. Two portfolios on the efficient frontier have the following expected returns and standard deviations of returns: E[Rp1]=10%, E[Rp2]=18%, p1=20% and p2=24%. The t-bill rate of return is equal to 4%. Compute the portfolio that a portfolio manager should choose to her client. a. Portfolio P2 as it offers the highest expected return. b. Portfolio P1. Since investors are risk-averse they want to invest in the portfolio that minimizes risk. In this way, the portfolio manager maximizes the expected utility of her clients. c. Portfolio P1 because it has the highest Sharpe ratio (0.6) d. Portfolio P2 because it has the lowest Sharpe ratio (0.583)

6. To diversify a portfolio that includes two risk assets (shares) it is necessary that:

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.

Financial Economics (University Carlos III)

a. The correlation coefficient between the returns of both assets is equal to 1. b. The correlation coefficient between the returns of both assets is equal to -1. c. The correlation coefficient between the returns of both assets is equal to 0. d. None of the above is correct. 7. A portfolio is formed with two shares (1 y 2) whose returns are perfectly and positively correlated. Then: a. we can form a riskless portfolio with W1>0 and W2>0. b. we can form a portfolio with low very risk, but not riskless. c. we can form a riskless portfolio if short-selling is allowed. d. None of the above is correct. 8. To select an efficient portfolio in the portfolio frontier a portfolio manager should: a. Look for the portfolio among the efficient portfolios that maximizes expected return. b. Look for the portfolio among the efficient portfolios that minimizes risk. c. Look for the portfolio that minimizes the slope of the Capital Market Line. d. Look for the portfolio that maximizes the slope of the Capital Market Line. 9. Determine the risk (volatility) of a portfolio that includes 30% of the S&P500 index (E[RS&P500]=9%; S&P500=16%) and the remainder in Treasury-bills (tbills). a. 16% b. Need the correlation coefficient between the returns of both assets. c. 0.048 d. 4.8%

Solutions TOPIC 5: 1.c, 2.d, 3.d, 4.b, 5.c, 6.d, 7.c, 8.d, 9.d

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.

Financial Economics (University Carlos III)

MULTIPLE CHOICE QUIZ TOPIC 6: The Capital Asset Pricing Model (CAPM)

1. The beta of a portfolio of T-bills is: a. 1 b. 0 c. -1 d. None of the above 2. The beta of a index that reflects the market (e.g. IGBM) is a. 1 b. 0 c. -1 d. None of the above 3. Which of the following defines market risk Premium? a. It is the difference between the return on an index that reflects the market and the return on corporate bonds with long maturity. b. It is the return on a market index. c. It is the difference between the return on an index that reflects the market and the return on bonds with long maturity. d. It is the difference between the return on a market index and the return on T-bills. 4. Which of following is correct with respect to the SML (Security Market Line)? a. Every asset can be plotted in the SML as a function of its risk (volatility) and its expected return. b. Assets with the same systematic risk should have the same expected rate of return. c. Most assets can be plotted in the SML although some assets can remain either above or below the line. 5. Choose the one that does NOT constitute a assumption behind the CAPM: a. Investors are risk-free. b. The CAPM is an equilibrium model in which supply equals demand. c. The expected rate of return on an asset can be different between investors such that transactions can take place. d. Every investor holds the same tangency portfolio (with equal weights within that tangency portfolio). 6. Determine the beta of asset j in the American market knowing that the correlation coefficient of the returns on this asset with the returns on the S&P500 is 0.4, the variance of returns of the S&P500 is 0.52 and the variance of returns of asset j is 0.12. a. 19.22% b. 0.1922

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.

Financial Economics (University Carlos III)

c. 0.048 d. 4.8% 7. Compute the expected rate of return on asset Z whose beta is 1.5 when the market risk premium is 7.5% and the expected rate of return on the market index is 9%. a. 21.75% b. 15% c. Less than 14% d. More than 15% 8. At a certain point in time a manager identifies a share which is overvalued. Its market price is Pt and being overvalued means that it is traded at Pt-, with >0. a. This share plots on the SML. b. This share plots below the SML. c. This share plots above the SML. d. None of the above. 9. The beta of a portfolio of bonds is equal to: a. The weighted average of the betas of each bond that is included in the portfolio. The weights are equal to the contribution of each bond to the total value of the portfolio. b. The sum of the betas of each bond that is included in the portfolio. c. The portfolio beta cannot be calculated without knowing the correlations. d. The beta of a portfolio of bonds does not exist. The beta only exists for shares or for the risk-free asset. 10. A manager wishes to obtain a portfolio beta of 1.5 combining two assets. Asset A has a beta of 0.9 and asset B has a beta of 0.5. Compute the portfolio weights. a. It is impossible to obtain a portfolio beta of 1.5 combining these two assets. b. 100% invested in asset A. c. Go long in asset A (WA=2.5) and go short in asset B (WB=-1.5). d. Go long in asset B (WB=2.5) and go short in asset A (WA=-1.5).

Solutions TOPIC 6: 1.b, 2.a, 3.d, 4.b, 5.c, 6.b, 7.c, 8.b, 9.a, 10.c

Copyright of Spanish version from David Moreno and Mara Gutirrez. Translation into English by Beatriz Mariano.