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# RSM 330

Winter 2016
Practice Midterm
Your Name

_______________________,
Last

________________________
First

## Your Student ID number ___________________________

Notes:
1, The total is 100 points.
2, Problems 1 through 28 are multiple choices. Each correct
answer gives you 1.5 point. Clearly indicate your choice.
No partial credit for multiple choices.
3, For the True/False and Short Essay questions, hit the key
points/be succinct. Partial credit will be given.
4, For the Calculation problems, you need to write down
the details/all the steps in arriving at your answers as
clearly/eligible as possible. Partial credit will be given. If
you can not find the final answer, at least write down the
equations you need to solve.

1.

## Which of the following is not a money market instrument? ____________

A) treasury bill
B) commercial paper
C) preferred stock
D) certificate of deposite

2.

A) liquidity
B) marketability
C) low risk
D) long maturity

3.

## Preferred stock is like long-term debt in that _____.

A) it gives the holder voting power regarding the firm's management
B) it promises to pay to its holder a fixed stream of income each year
C) the dividend is a tax-deductible expense for the firm
D) all of the above

4.

## Which of the following are not characteristic of common stock ownership?

_________
A) residual claimant
B) unlimited liability
C) voting rights
D) all of the above are characteristics of stock ownership

5.

6.

Under SEC rules, the managers of certain funds are allowed to deduct charges for
advertising, brokerage commissions, and other sales expenses, directly from the
fund assets rather than billing investors. These fees are known as ____________.
A) direct operating expenses
B) back-end loads
C) 12b-1 charges
D) None of the above
Mutual funds perform the function of __________ for their shareholders.
A) diversification
B) professional management
C) record keeping and administration
D) all of the above

7.

Assume that you have just purchased some shares in an investment company
reporting \$300 million in assets, \$20 million in liabilities, and 30 million shares
outstanding. What is the Net Asset Value (NAV) of these shares? __________
A) \$10
B) \$9.33
C) \$15
D) \$1.50

8.

The price at which you can sell a liquid stock using market order is closest to best
_________ price for the stock.
A) bid
B) ask
C) limit
D) none of the above

9.

The difference between balanced funds and asset allocation funds is that _____.
A) balanced funds invest in bonds while asset allocation funds do not
B) asset allocation funds invest in bonds while balanced funds do not
C) balanced funds have relatively stable proportions of stocks and bonds while
the proportions may vary dramatically for asset allocation funds
D) none of the above

10.

You short-sell 200 shares of Tuckerton Trading Co., now selling for \$50 per
share. What is your maximum possible loss? __________
A) \$50
B) \$150
C) \$10,000
D) unlimited

## 11. A contingent deferred sales charge is commonly called a ____.

A) Front-end load
B) Back-end load
C) 12b-1 charge
D) Top end sales commission

12. The Vanguard 500 Index Fund tracks the performance of the S&P 500. To do so the
fund buys shares in each S&P 500 company _______________
A) In proportion to the market value weight of the firm's equity in the S&P 500
B) In proportion to the price weight of the stock in the S&P 500
C) By purchasing an equal number of shares of each stock in the S&P 500
D) By purchasing an equal dollar amount of shares of each stock in the S&P 500

13. Investors who wish to liquidate their holdings in a closed-end fund may
___________________.
A) Sell their shares back to the fund at a discount if they wish
B) Sell their shares back to the fund at net asset value
C) Sell their shares on the open market
D) Sell their shares at a premium to net asset value if they wish
14. Consider the following two investment alternatives. First, a risky portfolio that pays
20% rate of return with a probability of 60% or 5% with a probability of 40%. Second, a
treasury that pays 6%. If you invest \$50,000 in the risky portfolio, your expected dollar
profit would be __________.
A) \$3,000
B) \$7,000
C) \$7,500
D) \$10,000

## 15. The excess return is the _________.

A. rate of return that can be earned with certainty
B. rate of return in excess of the Treasury bill rate
C. rate of return to risk aversion
D. index return

16. Historically the best asset for the long term investor wanting to fend off the threats of
inflation and taxes while making his money grow has been ____.
A. stocks
B. bonds
C. money market funds
D. Treasury bills

17. You invest \$100 in a portfolio that is composed of a risky asset with an expected
rate of return of 12% and a standard deviation of 15% and a treasury bill with a rate of
return of 5%. __________ of your money should be invested in the risky asset to form a
portfolio with an expected rate of return of 9%.
A)
87%
B)
77%
C)
67%
D)
57%
18. The complete portfolio refers to the investment in _________.
A. the risk-free asset
B. the risky portfolio
C. the risk-free asset and the risky portfolio combined
D. the risky portfolio and the index
19. A portfolio with a 25% standard deviation generated a return of 15% last year when
T-bills were paying 4.5%. This portfolio had a Sharpe measure of ____.
A. 0.22
B. 0.60
C. 0.42
D. 0.25
20. Based on the outcomes in the table below choose which of the statements is/are
correct:

## I. The covariance of Security A and Security B is zero

II. The correlation coefficient between Security A and C is negative
III. The correlation coefficient between Security B and C is positive
A. I only
B. I and II only
C. II and III only
D. I, II and III

## 21. The variance of a portfolio of risky securities _____________

A. is a weighted sum of the securities' variances.
B. is the sum of the securities' variances.
C. is the weighted sum of the securities' variances and covariances.
D. is the sum of the securities' covariances.

## 22. The risk premium for common stocks ___________________

A. cannot be zero, for investors would be unwilling to invest in common stocks.
B. must always be positive, in theory.
C. is negative, as common stocks are risky.
D. A and B.
E. A and C.

## 23. The equity market risk premium is defined as ___________.

A) the difference between the return on an index fund and the return on Treasury
bills
B) the difference between the return on a small firm mutual fund and the return
on the Standard and Poor's 500 index
C) the difference between the return on the risky asset with the lowest returns
and the return on Treasury bills
D) the difference between the return on the highest yielding asset and the lowest
yielding asset.
24.

## The capital allocation line is the __________.

A) investment opportunity set formed with a risky asset and a risk-free asset
B) investment opportunity set formed with two risky assets
C) line on which lie all portfolios that offer the same utility to a particular
investor
D) line on which lie all portfolios with the same expected rate of return and
different standard deviations

25.

## The optimal risky portfolio can be identified by finding _____________.

A) the minimum variance point on the efficient frontier
B) the maximum return point on the efficient frontier
C) the tangency point of the capital market line and the efficient frontier
D) None of the above answers is correct

## 26. __________ is a true statement.

A) Risk-averse investors reject investments that have zero expected returns
B) Risk-averse investors judge risky investments only by their expected returns
C) both a and b
D) neither a nor b

## 27. The reward-to-variability ratio is computed as __________.

A) standard deviation of returns
B) risk premium divided by standard deviation
C) the point at which the second derivative of the investor's indifference curve
reaches zero
D) the market risk premium divided by standard deviation
28.

## A portfolio is composed of two stocks, A and B. Stock A has a standard deviation

of return of 5% while stock B has a standard deviation of return of 15%. The
correlation coefficient between the returns on A and B is .5. Stock A comprises
40% of the portfolio while stock B comprises 60% of the portfolio. The variance
of return on the portfolio is __________.
A) .0035
B) .0085
C) .0094
D) .0103

## True or False (briefly explain why): 5 points for each question

1, In July 1993, the Walt Disney Company issued corporate bond that matures one
hundred years after the date of issue. Not long after, Coca-Cola Co. went to market with
its own 100-year bond. Since the longest U.S. government bond maturity is only 30
years, Walt Disney and Coca-Cola has lower risk than the U.S. government.

2, Close-end mutual funds are usually priced at a discount to their NAV. Thus, they are a
bargain and offer investors higher rates of returns.

## Short Essay Questions [5 points for each question]

1. Discuss the costs associated with trading a stock.

2. What are the costs (fees) investors usually pay for investing in mutual funds

3. What are the differences between open-end and close-end mutual funds?

4. Starting with a random portfolio, describe intuitively the steps you would take to find
the optimal risky portfolio.

Calculation Problems:
#1. [8 points]
You sold short 100 shares of ABC common stock at \$50 per share. Assume the initial
margin is 50% and the maintenance margin is 40%. What is the stock price P that would
trigger a margin call? Assume the stock pays no dividend and ignore interest.

#2. [8 points]
Suppose the standard deviation of a bond portfolio is 12%, and that of a stock portfolio is
25%. If you invest 50% of your portfolio in bonds and 50% in stocks, which results in a
standard deviation of 15% for your portfolio, then what must be the correlation
coefficient between the stock and bond portfolio?

## #3. [12 points]

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an
expected return of 18% and a standard deviation of return of 20%. Stock B has an
expected return of 12% and a standard deviation of return of 5%. The correlation
coefficient between the returns of A and B is 50%. The risk-free rate of return is 10%.
a), What is the proportion of the optimal risky portfolio that should be invested in stock
B?
b), What is the expected return and standard deviation of return on the optimal risky
portfolio?