Fin380: Investments
Final Exam Spring 2017 (Form A)
Please read the following before you start answering questions:
Question 1: Multiple Choices (10 points)
A. 
technical analysis cannot; fundamental analysis can 
B. 
technical analysis can; fundamental analysis can 
C. 
technical analysis can; fundamental analysis cannot 
D. 
technical analysis cannot; fundamental analysis cannot 
A. 
an abnormal price change immediately after the announcement 
B. 
an abnormal price increase before the announcement 
C. 
an abnormal price decrease after the announcement 
D. 
no abnormal price change before or after the announcement 
A. 
stock price changes that are random but predictable 
B. 
stock prices that respond slowly to both old and new information 
C. 
stock price changes that are random and unpredictable 
D. 
stock prices changes that follow the pattern of past price changes 
A. 
stock prices do not rapidly adjust to new information 
B. 
future changes in stock prices cannot be predicted from any information that is publicly available 
C. 
corporate insiders should have no better investment performance than other investors even if allowed to trade freely 
D. 
arbitrage between futures and cash markets should not produce extraordinary profits *NOTE WE DIDN”T TALK ABOUT THIS, YOU WILL NOT BE RESPONSIBLE FOR KNOWING ABOUT FUTURES AND CASH MARKETS 
A. 
all past information, including security price and volume data 
B. 
all publicly available information 
C. 
all information, including inside information 
D. 
all costless information 
A. 
semistrong 
B. 
strong 
C. 
weak 
D. perfect 
A. 
the covariance between the security and market returns divided by the variance of the market's returns *NOTE WE DIDN’T EMPHASIZE THIS SO I WILL NOT ASK THIS QUESTION ON THE FINAL. 
B. 
the covariance between the security and market returns divided by the standard deviation of the market's returns 
C. 
the variance of the security's returns divided by the covariance between the security and market returns 
D. 
the variance of the security's returns divided by the variance of the market's returns 
A. 
I, II, and III only 
B. 
II, III, and IV only 
C. 
I, III, and IV only 
D. 
I, II, III, and IV 
*Note, III is poorly worded, it should say “per unit of risk (Beta)”
A. 
unique risk 
B. 
beta 
C. 
the standard deviation of returns 
D. 
the variance of returns 
A. 
negative alpha is considered a good buy 
B. 
positive alpha is considered overpriced 
C. 
positive alpha is considered underpriced 
D. 
zero alpha is considered a good buy 
Question 2 (9 points)
.05 + Beta * .10 = .17, beta = 1.2
(28 + 1.5) / 25 = 1.18, 6% + 1.1*10% = 17, alpha is 1%
The project’s beta is 1.8. Assuming that r_{f} = 8% and E(r_{M}) = 16%, what is the required rate of return (cost of capital) based on CAPM? Suppose that you estimate that the internal rate of return (IRR) of the project is 20%. Should you recommend investing in the project?
.08 + 1.8*(.16.08) = 22.4. No you should not invest.
Question 3 (9 points)
20 – .05 – 1.5*(.13.05) = .03
15  .05 – 1.2*(.13.05) = .004
Adviser 1 was a better stock picker
What is the expected return for a portfolio with a beta of 0.5?
.05 + .5*(.5) = .075%
E[R] = 6% + 1.2*.1 = 18%
= (X + 6) /50  1, X = 53
Question 4 (10 points)
Portfolio 
E(r) 
Beta 
A 
15% 
1.5 
F 
6% 
0.0 
Suppose that another portfolio E is well diversified with a beta of 0.5 and expected return of 8%. Construct an arbitrage strategy by investing $1 in the long position and $1 in the short position. What is the profit for the arbitrage strategy?
A portfolio of 1/3 A and 2/3 F has a beta of 0.5 and an expected return of (1/3*(1.5) + 2/3*(.06)) =.09
Go long this portfolio $1 and short $1 of Portfolio E. Make 1.09 – 1.08 = .01
Portfolio 
β on F_{1} 
β on F_{2} 
Expected Return 
A 
0.5 
2.0 
19% 
B 
2.0 
0.5 
12% 
Assuming no arbitrage opportunities exist, what is the risk premium on the factor F_{2} portfolio?
.19  = .06 + .5 RP_{1} + 2 RP_{2}
.12 = .06 + 2 RP_{1} + 0.5 RP_{2}
Multiply first equation by 2, divide second by 2 to get
.26 = RP_{1} +4 RP_{2}
.03 = RP_{1} + 0.25 RP_{2}
Subtract equation 2 from equation 1 to get .23 = 3.75 RP2, RP2 = .06133
Question 5 (10 points)
.07 + .5*.01 + 1.25*.07 = 16.25%
.1625 + .5*(.01) + 1.25*(.02) = .1425
Expected return on this day was 0.2% + 1.5 (4%), 6.2%. Company likely lost the lawsuit.
Question 6. (15 points)
An investor can design a risky portfolio based on one stock fund (S) and one bond fund (B). The Stock fund has an expected return of 21% and a standard deviation of return of 39%. The bond fund has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of two funds is 0.4. The riskfree rate of return is 5%. ***NOTE*** THIS QUESTION WHERE YOU HAVE TO SOLVE FOR THE OPTIMAL SHARPE RATIO WILL NOT BE ASKED (THE FORMULA IS COMPLICATED) REFER TO THE QUESTION ON THE MIDTERM FOR THE TYPE OF QUESTION I MIGHT ASK INVOLVING ALLOCATING TO TWO RISKY ASSETS.
Question 7 (8 points)
Investors expect the market rate of return in the coming year to be 13%. The riskfree rate is 3%. QQAG has a beta of 1.7. The market value of its outstanding equity is $200 million.
.03 + 1.7*.10 = 20%
Market disappoints by 3%, so 20% + 1.7*(.03) = 14.9%
The stock disappoints by 4.9%, 4.9% * 200 Million = 9.8 Million
Question 8 (9 points)
Consider the following excel output from a FamaFrench threefactor model regression for a stock:
Coefficients 
Standard Error 
Tstat 
Pvalue 

Intercept 
0.685 
0.993 
0.690 
0.493 
Market 
1.578 
0.224 
7.056 
0.000 
SMB 
0.209 
0.446 
0.468 
0.642 
HML 
1.383 
0.378 
3.657 
0.001 
0.685 (no Tstat is less than 2)
Market Beta and HML are both positively significant (tstats of 7 and 3.65). SMB beta is not statistically significant
The stock is highly cyclical (its beta is 2.5 SE greater than 1) , and is likely a value stock (it loads on the value factor). We can not tell if it is large or small (it does not load on SMB).
Question 9 (12 points)
The index model has been estimated for stocks A and B with the following results:
R_{A}= 0.01 + 0.8R_{M}+ e_{A}
R_{B}= 0.02 + 1.2R_{M}+ e_{B}
s_{M}= 20%, s(e_{A}) = 20%, s (e_{B}) = 10%
Sqrt( .8^2*.2^2 + .2^2) = 0.256
Sqrt(1.2^2*.2^2 + .1^2) = 0.26
Covariance is .8*1.2*.2*.2 = .0384. .0384 / .256/.26 = .58 (correlation)
Total variance is .5^2*.256^2 + .5^2*.26^2 + 2 .5*.5* .0384 = .0525, STDEV = .229
Beta is 1 of this portfolio, so systematic standard deviation is 20%
Nonsystematic variance is 0.5^2*.2^2 + .05^2*.1^2 = .0125, sqrt(.0125) = 11.1%
Question 10: Short discussions (8 points)
On April 9^{th}, 2017, United Airlines forcibly removed passenger David Dao from United Express Flight 3411 due to overbooking. Video of the incident recorded by passengers went viral on social media, resulting in outrage over the violent incident. Design an event study (using daily stock returns) to examine the price impact of this incident on United Airlines stock over the one week period following the incident. Please be specific about each step, clearly define the notation, and provide interpretation for all estimations.
Step 1) Calculate the beta of UA stock with respect to relative indexes. (Probably an airline industry index, could also include the market), using data prior to the law suit.
This gets us an expected return to the UA on a given day of
Alpha + Beta_A *ReturnAirlineIndex + Beta_M ReturnMarket
Step 2) Calculate the return to the airline index and market return over the week of the event, as well as the return to UA
The abnormal return to UA is
Return_UA – alpha – Beta_A * ReturnAirlineIndex – Beta_M Return Market
If this return is significantly negative then it appears that the incident may have negatively impacted UA.
Step 3) To get a sense for the value impact, could multiple this abnormal return times the value of UA at the beginning of the week.
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