SECURITY ANALYSIS & PORTFOLIO MANAGEMENT

FIN 411
April 2016
Sample Final Exam1

You must show the solution of problems to earn credits.

Good Luck!

Use the following data in answering questions 1, 2, and 3.

Investment
1
2
3
4

E(R)

0.12
0.15
0.21
0.24

0.30
0.50
0.16
0.21

U = E(R) 1/2 A 2
1.

(4 points)Based on the utility formula above, which investment would you select if you
were risk averse with A = 4?

2.

(4 points)Based on the utility formula above, which investment would you select if you
were risk neutral?

3.

(4 points) What does the Variable A in the utility formula represent?

Use the following data in answering questions 4, 5, 6, 7, and 8.

Assume that you manage a risky portfolio with E(R) = 0.17 and = 0.27. The risk-free rate
is 0.07.
4.

(6 points) Your client chooses to invest 70 percent of a portfolio in your fund and 30
percent at the risk free rate. What is the expected return and standard deviation of your
clients portfolio?

5. (4 points) Suppose your risky portfolio includes the following investments in the given
proportions:
Stock A:
27 percent
Stock B:
33 percent
Stock C
40 percent
What are the investment proportions of your clients overall portfolio in A, B, C and RF?

6.

(4 points) What is the reward-to-variability ratio of your clients overall portfolio?

7. (6 points) Suppose the same client prefers to invest in your risky portfolio a proportion
WP of his total investment so that his overall portfolio will have an expected return of 15
percent. What is the proportion WP?

8. (8 points) Suppose the same client prefers to invest in your risky portfolio a proportion
WP of his total investment that maximizes the expected return on his overall portfolio
subject to the constraint that the overall portfolios standard deviation will not exceed 20
percent.
a. What is the proportion WP?
b. What is the expected return on his overall portfolio?

9. (10 points) Suppose the following two stocks are traded in the market and that it is
possible to borrow at the risk-free rate.
Stock

E(R)

A
B

0.08
0.13

0.40
0.60

Coefficient of correlation between A and B is -1.

Could you construct a portfolio that has a zero risk? What is the rate of return of this riskless portfolio? Explain in details how.

10.

(10 points)
Assume the following two stocks:
Stock X
E(R) = 20 percent.
Standard Deviation = 50%.

Stock Y
E(R) = 16 percent.
Standard Deviation =35%.

Coefficient of Correlation Between X and Y = -40 percent.

As a risk-averse investor, would you invest in a portfolio that contains 30 percent in X
and 70 percent in Y? Explain in details.

11. (8 points) Consider the following two investment alternatives. First, a risky portfolio, P,
which earns 30 percent rate of return with a probability of 70 percent or 8 percent with a
probability of 30 percent. Second, a treasury bill that pays 4 percent.
If you invest $100,000 in the risky portfolio and $80,000 in the treasury-bill, what
would your expected profit (in dollars) be?

12.

(6 points) A treasury bill pays 5 percent. Which of the following investments would
not definitely be chosen by a risk-averse investor? (You must explain).
a.
b.
c.
d.

13.

An asset that pays 10 percent with a probability of 60 percent or 2 percent with a

probability of 40 percent.
An asset that pays 10 percent with a probability of 40 percent or 2 percent with a
probability of 60 percent.
An asset that pays 10 percent with a probability of 20 percent or 3.75 percent with
a probability of 80 percent.
An asset that pays 10 percent with a probability of 30 percent or 3.75 percent with
a probability of 70 percent.

(6 points) Cynthia is a risk-averse investor. She is investing in a risky portfolio X, which

has an expected rate of return of 15 percent and a standard deviation of 15 percent and
which is located on her indifference curve IC. Which one(s), if any, of the following
portfolios might be located lie on her indifference curve graphed in a return-standard
deviation scale? (You must explain).

Portfolio

Expected Return

15%

Variance of
returns
20%

15%

10%

10%

10%

20%

15%

14.

(20 points)
Assume the following two stocks:
Stock X

Stock Y

E(R) = 15 percent.
Standard Deviation = 25%.

E(R) = 10 percent.
Standard Deviation =15%.

Coefficient of Correlation Between X and Y = 20 percent.

a. The risk-free rate is 5 percent. Draw a tangent from the risk-free rate to
the opportunity set formed with X and Y. Call the tangency point "P". Assume that
P is constructed with 40 percent in X and 60 percent in Y.
What is the name of this portfolio?
What is the name of the line?
Find the equation of the line.
What is the slope of the line called?
c. Assume that your utility function is
U = E(R) 1/2 (A ); where A = 5.
2

Construct your optimal portfolio, C. (i.e. what are the weights of the risk-free security, X,
and Y in your optimal portfolio?).