125.241 Review of Problem Questions: Modules 1 To 3

Introduction to
Investments
School of Economics and Finance Introduction to

College of Business Investments
125.241
Review of Problem Questions
Modules 1 to 3
© Massey
Module 1 – Problem One

FQP Managed Fund states the following
average annual total returns
Past 1 yr Past 5 yrs Past 10 yrs
Fund return 11.63% 16.54% 15.31%
An investor placed $50 000 in this fund.
Based on the above returns, what would be
his or her final wealth after each period
© Massey
Problem One
(a) one year final wealth
50 000 x 1.1163 = $55 815
(b) five years

50 000 x (1.1654)5 = $107 484
(c) ten years?

50 000 x (1.1531)10 = $207 797
© Massey
Problem 2 – Margin Trading

Assume that an investor sells short 200
shares of stock at $7.50 per share.
At what price must the investor cover the
short sale to realise a gross profit of $500?
© Massey
Problem 2
To realise a gross profit of $500 on 200
shares sold short at $7.50, the investor must
cover at (ignoring transaction costs):
200 ($7.50) = $1500
$1500 – X = $ 500 profit
X is $1000, which must be divided by 200
shares.
Answer: $5 per share
© Massey
Problem 3 – Margin Loans

Assume that an investor buys 100 shares at
$5 per share and the share rises to $6.
What is the gross profit, assuming an initial
margin requirement of 40 percent?
© Massey
Problem 3
At 40% margin:
the investor must put up $200, resulting in a
gross profit percentage relative to equity of:
$100 / $200
= 50.00%
© Massey
Problem 4
Joey has $30 000 to invest. Being quite aggressive
in terms of risk, he borrows a further $30 000 &
invests the full amount in LMN shares. Assume
borrowings are at 8.85 per cent per annum & that
the total return on shares (capital growth &
dividends) is 10.7 per cent per annum over a five
year period.
Compare the net portfolio value of
using a margin loan versus the net portfolio value
of not utilising a margin© Massey
loan.
Without margin With 50% margin

loan loan
Own capital $30 000 $30 000
Margin loan Nil $30 000
Total investment $30 000 $60 000
Total value of portfolio $49 872 $99 745
end of year 5
Less borrowing costs @ Nil $13 275
8.85% p.a.
Less margin loan Nil $30 000
repayment
Net portfolio value at the $49 872 $56 470
end of year 5
© Massey
Problem 5
If security markets are totally efficient, the
best common stock strategy to take is:
a. An asset allocation approach
b. The modern portfolio theory approach
c. Value investing.
d. An active strategy.
e. A passive strategy.
© Massey
Problem 6
Which of the following regarding behavioural finance and investors is
NOT correct?
a. Overconfidence can lead to investors trading securities more
frequently.
b. Many investors avoid selling their losing stocks due to their
dislike of taking losses.
c. For investors, narrow framing means the tendency to analyse
a situation in isolation.
d. Investors make mistakes about the probability of events
happening to shares.
e. Investors have a tendency to decrease the amount invested in
a share after the share’s price has fallen.
© Massey
Problem 7
Calculate the TR & the RR for the following:
Ignore transaction costs
An ordinary share bought for $70 per share,
held for one year during which $5 per share
dividends are collected, & sold for $63
© Massey
Problem 7
TRps = [Dt + (PE – PB)] / PB
where Dt = the dividend, PE = ending price or sale price
PB = beginning price or purchase price
TR = (5 + –7) / 70 = –2.86%
(a) a TR of –2.86%
is equal to a RR of 0.9714 = (1.0+ [– 0.0286])
(b) a TR of 18.18%
is equal to a RR of 1.1818
© Massey
Problem 8
You are given the following three years for the ASX200
index:
Year TR RR
2002 –8.09% 0.9191
2003 13.92% 1.1362
2004 26.33% 1.2633
Calculate the Cumulative Wealth Index (CWI).
© Massey
Problem 8
CWI02-04 = 1.00 (0.9191)(1.1362)(1.2633)
= 1.3192
• Wealth has changed on an annual basis by –8.09%,

13.92% and 26.33%.
• Over the three year period return was 31.92%.
• So, $1 invested at the beginning of 2002 would have
been worth $1.32 by the end of 2004.
© Massey
Problem 9 - Equities
Indicate the likely direction of change, and
why, in a share’s P/E ratio if:
(a) the dividend payout increases
(b) the required rate of return rises
(c) the expected growth rate of dividends
rises
(d) the risk-free rate of return decreases
© Massey
Problem 9
– (a) decline1
– (b) decline
– (c) increase
– (d) increase2
– 1
if D/E increases, P/E will increase. But this is only if
'all other things are equal'. If dividends increase then
the firm will have less funds to invest (this is E - D) so
expected g will probably decrease.
– 2the riskless rate of return is a component of the
required rate of return, which has an inverse
relationship with the P/E.
© Massey
• ABC is currently paying a dividend of
$1.60 per year,
• This dividend is expected to grow at a
constant rate of 8 per cent a year.
• Investors require a 16 per cent rate if
return on ABC.
• What is its estimated price?
© Massey
• Q10) Inputs
• D0 = $1.60
• g = 8.00%
• k = 16.00%
D1
D1  D0 1  g  P0 
kg
 $1.601.08
$1.728
 $1.728 
0.16  0.08
 $21.60
© Massey
• The appropriate P/E ratio for ABC shares
are 23.
• Forecasted one-year earnings per share
(EPS) are $1.50,
• The required rate of return is 9.20%
• ABC has an estimated constant growth in
dividends at a rate of 6.30 per cent.
• Calculate the current dividend per share.
© Massey
• Q11) Inputs:
• g = 6.30%
• k = 9.20%
• P/E ratio = 23
• E1 = $1.50
• First, estimate the share’s current value.
P0  E1   P  E1 
 $1.50  23
 $34.50
© Massey
• Imply the dividend in one-year:

D1
P0 
kg
D1
$34.50 
0.0920  0.0630
D1  $1.0005
• Finally, imply the current dividend:
D1  D0 1  g 
$1.0005  D0 1.063
$1.0005
D0 
1.063
 $0.9412
© Massey
• DEF is currently paying a dividend of
$1.80.
• The dividend is expected to grow at a rate
of 6 per cent in the future.
• DEF 10 percent less risky than the market
as a whole.
• The market risk premium is 7 percent and
the risk-free rate is 5 per cent.
• What is the estimated price of this stock?
© Massey
• Q4) Inputs
• D0 = $1.80
• g = 6.00%
• RM = 12.00%
• RF = 5.00%
• Beta = 0.90
• Use CAPM: k  RF   i  E  RM   RF 
 5.00%  0.9012.00%  5.00%
 5.00%  0.90 7.00%
 5.00%  6.30%
 11 .30%
© Massey
• Calculate D1.
D1  D0 1  g 
 $1.801.06
 $1.908
• Calculate the estimated share price:
D1
P0 
kg
$1.908

0.113  0.06
 $36.00
© Massey
• Describe three active strategies
involving ordinary shares.
© Massey
Problem 13
• Three active strategies for ordinary shares include:
• share selection — searching for undervalued or
overvalued shares
• sector rotation — shifting the sector weights in a
portfolio to take advantage of those sectors expected to
do relatively better and avoid those expected to do
relatively worse
• market timing — the attempt to earn excess returns
by varying the percentage of portfolio assets in equity
securities.
© Massey
• If an investor can determine when
the bottoming out of the economy
will occur, when should shares be
purchased: before, during or after
the economy hits its bottom?
• Would share prices be expected to
continue to rise as the economy
recovers?
© Massey
Problem 14
• Shares should be purchased before a
bottoming of the economy occurs because
prices almost always rise before the
trough.
• As the economy recovers, be prepared for
a leveling off, or even a decline in share
prices.
© Massey
Assume the following information for the market:
Average dividend per share $0.63
Average earnings per share $0.89
Average required rate of return10.5%
Average growth rate 5.2%
(a) Compute the P/E ratio for the market, together with the
average price of the market
(b) what would happen to both the P/E ratio of the
market and the average price of the market if
the spread between k and g fell by 20%
© Massey
$0.63  1.052
• Q15) (a) P
0.105  0.052
 $12.50
$12.50
P/E  $0.63  1.052
$0.89 P
 14.04 0.0424
• (b) New spread  $15.63
= 0.0530.8 = 0.0424
$15.63
P/E 
$0.89
 17.56
© Massey
• Explain how growth industries,
defensive industries and cyclical
industries are affected by the
business cycle.
© Massey
• Growth industries operate autonomously to the business

cycle. Such industries are in a growth phase that is not
affected by setbacks in the business cycle. Such industries
do not remain growth industries, and will only temporarily
be unaffected by business cycles, until such a time as the
growth subsides. Defensive industries are perhaps the least
affected by business cycles. These industries accommodate
the necessities to people such as food. As a result,
consumption of such goods will continue regardless of the
cycle within the economy.
• Cyclical industries are those industries greatly affected by
movements in the business cycle. There performance is
enhanced during periods of economic prosperity and falls
during economic downfalls. Cyclical industries often
encompass luxury, or non-essential
© Massey
items.
• Holding everything else constant, what
effect would the following have on a
company’s P/E ratio?
– (a) An increase in the expected growth rate of
earnings
– (b) A decrease in the expected dividend payout
– (c) An increase in the risk-free rate of return
– (d) An increase in the risk premium
– (e) A decrease in the required rate of return
© Massey
• Q17)
• (a) Earnings and dividends are directly related; therefore,
an increase in the expected growth rate of earnings
would equate with an increase in g, which is
directly related to the P/E.
• (b) A decline in the expected payout will lead to a
decline in the P/E. Remember that this direct
relationship only holds if all other variables remain
constant.
• (c) An increase in the risk-free rate of return will result
in a rise in k and, therefore, a decline in the P/E.
• (d) An increase in the risk premium will result in a rise
in k and, therefore, a decline in the P/E.
• (e) A decrease in the required rate of return will
increase the P/E.
© Massey
• (a) Why would an investor want to
know the beta coefficient for a
particular company?
• (b) How would this information be
used?
© Massey
• Beta reflects the relative systematic risk for a share. Other

things being equal, the higher the beta, the higher the risk,
and the higher the required rate of return.
• Investors will want to know about a share’s beta in order
to estimate the volatility of the share’s returns. If a rise in
the market is expected, investors would prefer, other
things being equal, shares with higher betas. In this
instance, the share’s return will increase by a greater
proportion than the rise in the market. Likewise, with an
expected market decline, lower betas would be preferred if
shares are to be held. In this instance, the share’s returns
will not fall to the full extent as the fall in the market.
© Massey
• RB company has
– a net profit of $10,000,
– interest of $2000
– tax of $2000.
– 10 days’ sales in receivables.
– Average total assets are $100,000
– total receivables are $4000
– debt/equity ratio is 0.40.
• (a) What is RB’s profit margin?
• (b) What is Roadblock’s total asset turnover?
• (c) What is Roadblock’s ROE?
© Massey
365
Sales   $4000
• Q19) (a) 10
 $146000
EBIT
Profit margin 
Sales
$10000  $2000  $2000

$146000
 0.0960
• (b)
Sales
Total asset turn over 
Average total assets
$146000

$100000
 1.46
© Massey
EBIT Sales NPBT NPAT

ROA    
Sales Average total assets EBIT NPBT
NPAT
• (c) 
Average total assets
$10000

$100000
 0.10
Recalling the following relationsh ip : TA  D  E, then :

D TA - E

E E
D TA
 1
E E
TA D
 1
E E
 D
ROE  ROA  1  
 E
 0.10  1  0.4 
 0.10  1.40
 0.14 © Massey
• What is a relative strength analysis?
© Massey
• Q20)
• Relative strength is generally used to forecast
individual shares or industries.
• It is calculated as the ratio of a share’s price to a
market index, an industry index, or the average
price of the share itself over some previous
period.
• These ratios are plotted to form a graph of
relative price across time.
• A rising ratio indicates relative strength, and it is
often assumed that the trend will continue.
© Massey
2013 Sem 1 Test

• "A noncallable bond would be expected to have a higher yield to
maturity than a comparable callable bond." True or false. Explain.
• False. (1 mark)
• Callable bonds have call risk and would be expected to have a higher
yield to maturity. The call risk is that when market interest rates fall,
the bond issuers will call back callable bonds that were issued with
higher coupon rates and replace them by new lower coupon bonds,
whereby the bondholders of callable bonds will be deprived of the
higher return on these callable bonds that will be realised if the bonds
are not called back. (1 mark)
• P. 217
• Note: only mentioning that callable bonds have higher risk is not
enough.
2012 Sem 1 Exam

• You expect a fall in interest rates. Which of
the following bonds will you choose for
investment?
a. A 20-year, 9% bond
b. A 20-year, 12% bond
c. A 30-year, 9% bond
d. A 30-year, 12% bond
e. A 30-year, 0% bond
The Effects of Maturity

• As interest rates change, the prices of longer-
term bonds change more than the prices of
shorter-term bonds, everything else being
equal.
• Example of two bonds, one three-year with
coupon of 8% and the other a five-year with
coupon of 8% and interest rates increase, the
longer maturity coupon bond will have a greater
price change.
45
The Effects of Coupon

• Bond volatility and coupon rates are inversely
related.
• Example of two three-year bonds, one with
coupon of 8% and the other 5% and interest
rates decrease, the lower coupon bond will have
a greater price change. (Since for the lower
coupon bond, the contribution of the face value
to the bond value is larger and the present value
of more distant face value is affected by interest
rate changes more) 46
Implications of Bond Theorems

• To receive maximum price impact from a
change in interest rates (capital gain), bond
investors should purchase low-coupon, long-
maturity bonds.
• If a rise in interest rates is expected, bond
investors should purchase bonds with large
coupons or short maturities, or both.
47
2012 Sem 1 Exam

• You expect a fall in interest rates. Which of
investment?
a. A 20-year, 9% bond
b. A 20-year, 12% bond
c. A 30-year, 9% bond
d. A 30-year, 12% bond
e. A 30-year, 0% bond
2012 Sem 1 Exam

• You want to protect against interest rate risk. You
have an investment horizon of 20 years. Which of
investment?
a. Treasury bills
b. 10-year, 0% bonds
c. 20-year, 10% bonds
d. 20-year, 0% bonds
e. 30-year, 0% bonds
Immunisation
• Used to protect a bond portfolio against interest
rate risk.
– The portfolio is designed so that price risk and
reinvestment risk offset each other.
• Price risk results from the relationship between
bond prices and required rates of return.
• Reinvestment risk results from uncertainty
about the reinvestment rate for future coupon
income.
50
Immunisation
• Risk components move in opposite directions.
– Favourable results on one side can be used to offset
unfavourable results on the other.
– When interest rates rise (fall), reinvestment income
rises (fall) while bond prices fall (rise).
• The portfolio is immunised if the duration of the
portfolio is equal to the preselected investment
horizon for the portfolio.
• Usually require frequent rebalancing.
– Duration changes as time/interest rates change
51
2012 Sem 1 Exam

• You want to protect against interest rate risk. You
have an investment horizon of 20 years. Which of
investment?
a. Treasury bills
b. 10-year, 0% bonds
c. 20-year, 10% bonds
d. 20-year, 0% bonds
e. 30-year, 0% bonds
2012 Sem 1 Exam

• The duration of a bond is 4 years and its
price is $1020. If the yield of the bond
increases from 5.2 per cent to 5.32 per
cent, estimate the new price of the bond.
Estimating Price Changes

Using Duration
• Modified duration =D*=D/(1+ ytm)

• D* can be used to estimate the bond’s percentage
price change for a given change in yield.
• For small changes in yield:
D
% Δ in bond price  Δ r
(1  ytm )
54
2012 Sem 1 Exam

• Yield spreads generally __________ during
recession and _________ during times of economic
prosperity. One can thus claim that the yield spread
varies _________ to the business cycle.
a. Narrow, widen, directly
b. Narrow, narrow, inversely
c. Widen, widen, directly
d. Widen, narrow, inversely
e. Do not change, remain constant, not
Chapter 17, p.452

• It seems reasonable to assume that yield
spreads widen during recessions, when
investors become more risk-averse, and
narrow during times of economic
prosperity.
2012 Sem 1 Exam

• Yield spreads generally __________ during
recession and _________ during times of economic
prosperity. One can thus claim that the yield spread
varies _________ to the business cycle.
a. Narrow, widen, directly
b. Narrow, narrow, inversely
c. Widen, widen, directly
d. Widen, narrow, inversely
e. Do not change, remain constant, not
2012 Sem 1 Test

• Consider a 20-year, 9% bond priced to
yield at 10%. The bond pays semi-annual
coupons. Find the price of the bond. The
face value is $1000. Please use 2
decimal places. Do not include "$" in
your answer. Just enter your
numerical answer.
•
• =+
• =914.2046
2012 Sem 1 Test

• Suppose the yield of one-year zero coupon
bonds is 7 per cent and that of three-year
zero coupon bonds is 8.2 per cent. Find
the implied two-year forward rate in one
year time. Please use 4 decimal
places. For example, if your answer
is 10.12334%, please put "0.1012".
Do not include "%" in your answer.
Just enter your numerical answer.
2012 Sem 1 Test

• Calculate the realised compound yield for
a 6 per cent bond with twenty years to
maturity and a reinvestment rate of 8 per
cent p.a.. The bond pays annual coupons.
The initial bond investment is $1000.
Please use 4 decimal places. For
example, if your answer is
10.12334%, please enter "0.1012".
Do not inclue "%" in your answer.
Just enter your numerical answer.
2012 Sem 1 Test

Which of the following affect(s) the yield of a bond?
I. Investment opportunities of the economy
II. Prospects of the issuer
III. People's preference for current consumption over future consumption
IV. The expected rate of change in the general price level
Choose one answer.
a. I, II, III and IV
b. II, III and IV only
c. I, II and IV only
d. II only
e. II and IV only
• Yield to maturity (YTM) is defined as the indicated (promised) compounded rate of return an
investor will receive from a bond purchased at the current market price and held to maturity.
•
•
• One of the key determinants of bond yields is the default risk of the issuer. The greater the expected
chance of default, the higher will be yield demanded by investors in order to compensate them for the
extra risk associated with holding such bonds.
• Other factors include the level of economic activity which directly affects inflation and also the
probability of default (i.e. default is more likely when the economy is in a slump). The level of interest
rates in the economy as a whole is also a factor as these determine the ‘base’ prices for borrowing and
lending in the economy and form the foundation from which other debt instruments are priced. The
level of interest rates in overseas economies (especially the US) also influence yields due to the
influence they have over domestic interest rates.
• +++++
•
• where risk-free rate = real interest rate + expected inflation premium and the real interest rate
depends on available opportunities (+) to invest in the economy and how impatient to consume
(rather than to save) people are (+).
2012 Sem 1 Test

Which of the following theory/hypothesis (theories/hypotheses) explains (explain)
the relation between yield to maturity and time to maturity?
I. Expectation Theory
II. Market Segmentation Theory
III. Fisher Hypothesis
IV. Liquidity Preference Theory
Choose one answer.
a. I and IV only
b. I and II only
d. I, III and IV only
e. I, II, III and IV
Term Structure Theories

• Explanations of the shape of the yield
curve and why it changes shape over time.
• Major term structure theories include:
– Pure expectations theory
– Liquidity premium theory
(also known as liquidity preference theory)
– Market segmentation theory
65
Pure Expectations Theory

• Investors’ expectation completely determines the term
structure.
• Long-term rates of interest are an average of current
short-term rates (R) and those expected to prevail
over the long-term period (r).
• In effect, the term structure consists of a set of forward
rates (r) and a current known rate (R).
• Forward rates are rates expected to prevail in the
future.
• Forward rate = expected short-term rate
66
Liquidity Preference Theory

• Lenders prefer to lend for the short term while borrowers
prefer to borrow for the long term.
• Liquidity premium needed to induce long-term lending.
– Implies long-term bonds should offer higher yields.
• Interest rates reflect the sum of current and expected short
rates, plus liquidity (risk) premiums.
• Forward rate = expected short rate + liquidity premium
• Notes that interest rate expectations are uncertain (& more
risk for longer horizon).
67
Market Segmentation Theory

• Various institutional investors confine
themselves to specific maturity sectors.
• Investors do not move to other maturity
segments to take advantage of profitable
opportunities.
• Shape of the yield curve is determined by
supply and demand factors within each
maturity segment.
68
2012 Sem 1 Test

Which of the following theory/hypothesis (theories/hypotheses) explains (explain)
the relation between yield to maturity and time to maturity?
I. Expectation Theory
II. Market Segmentation Theory
III. Fisher Hypothesis
IV. Liquidity Preference Theory
Choose one answer.
a. I and IV only
b. I and II only
d. I, III and IV only
e. I, II, III and IV
2012 Sem 1 Test

If people expect that inflation will be __________ in the future, other things being
constant, then bond yields will be _________ and bond price will be __________.
Choose one answer.
a. higher; higher; higher

b. lower; lower; higher
c. lower; higher; lower
d. higher; lower; higher
e. lower; higher; higher
2009 Sem 2 Exam

• Consider two bonds, A and B. Both bonds presently are selling at their par value of
$1,000. Each pays annual interest of $120. Bond A will mature in 5 years while
bond B will mature in 6 years. If the yields to maturity on the two bonds change
from 12% to 14%, then:
•
• a. Both bonds will increase in value but bond A will increase more than
bond B.
• b. Both bonds will increase in value but bond B will increase more than
bond A.
• c. Both bonds will decrease in value but bond A will decrease more
than bond B.
• d. Both bonds will decrease in value but bond B will decrease more
than bond A.
• e. Bond A will increase in value whilst bond B will decrease in value.
•
2009 Sem 2 Exam

• If a bond is known as a premium bond then:
•
• a. its coupon rate is less than the yield to maturity .
• b. its current price is less than its face value, so the
discount gives the investor a greater capital gain.
• c. its yield to maturity is less than its coupon rate.
• d. the bond cannot be called by the issuer.
• e. the bond has a maturity greater than one year.
•
2009 Sem 2 Exam

• When discussing bonds, convexity relates to the:
•
• a. shape of the bond price curve with respect to
interest rates.
• b. shape of the yield curve with respect to maturity.
• c. slope of the yield curve with respect to liquidity
premiums.
• d. size of the bid-ask spread.
• e. how complex the marketing arrangements are.
•
Bond 2009 Sem

Years to 2 Exam
maturity Yield to maturity
A 1 6.00%
B 2 7.50%
C 3 7.99%
D 4 8.49%
Use the above table of zero coupon bonds with par value
$1,000. Assume zero liquidity premiums, the expected
one-year interest rate one year from now should be about:
a. 7%
b. 8%
c. 9%
d. 10%
e. 11%
2009 Sem 2 Exam

• Which one of the following does an issuer pay to
redeem a bond prior to maturity?
•
• a. par value
• b. face value
• c. put price
• d. call price
• e. discounted price
•
2009 Sem 2 Exam

• Which one of the following is the risk that market interest
rates may increase causing the price of a bond to decline?
•
• a. credit risk
• b. reinvestment risk
• c. interest rate risk
• d. firm specific risk
• e. default risk
•
2015 Sem 1 Exam

• All else equal, call option values are
________ if the ________ is lower.
•
a. higher; share price
b. higher; exercise price
c. lower; dividend payout
d. higher; share volatility
e. higher; interest rate
Effects of various variables on

options prices
78
2013 Sem 1 Test

• "If the price of the underlying stock equals the
strike price of a call option at maturity, the
buyer of the call option has a breakeven
transaction" True or false? Explain.
• The call option buyer has paid the premium
and has a loss although the payoff is zero. The
statement is false.
• Pages 410-412: Payoffs and profits from basic
option positions
2012 Sem 1 Exam

• NZMA stock is currently selling for $128. Which
of the following options is “out-of-the-money"?
•
a. February $130 call
b. March $130 call
c. February $125 call
d. March $125 put
e. February $100 put
2012 Sem 1 Exam

• Mary wrote a 40 call on ABC stock at a price of $275. The position has
•
• I. limited her losses to $275.
• II.unlimited loss potential.
• III. limited her gains to $275.
• IV. unlimited profit potential.
•
a. I and IV only
b. II and III only
c. I and III only
d. II and IV only
e. None of the given choices
2012 Sem 1 Exam

• Eric has just purchased a heating oil contract at $2.05 per
gallon. The contract size is 21,000 gallons. Initial margin is
$6,075; maintenance margin is $4,500. If the price of
heating oil is $2.15 when the contract expires, Eric's profit or
loss is ________
•
a. $(2,100) loss.
b. $2,100 profit.
c. $(3,975) loss.
d. $(2,400) loss
e. $45,150 profit.
2012 Sem 1 Test

• Joseph bought a contract for future delivery of 5000 bushels of
corns at $2.80 per bushel and sold a later contract at $2.90 a
bushel. A month later, corn prices were rising and Joseph sold
his long contract for $3.10 per bushel and covered his short
position by purchasing the same contract for $3.25 per bushel.
Ignoring trading costs, Joseph
• a. lost $250
• b. made $750
• c. made $500
• d. lost $750
• e. broke even
2012 Sem 1 Test

• With futures contracts, the price at which the
commodity must be delivered
• a. is set when the contract expires.
• b. changes frequently during the life of the contract.
• c. is equivalent to the price of the commodity in the
commodity market.
• d. is set when the futures contract is sold.
• e. is equivalent to the strike price for an option
contract.
2012 Sem 1 Test

• A farmer who grows soy beans can hedge against the risk that
bad weather will damage her crop by
• Select one:
• a. buying contracts in alternative crops for delivery near the
time of harvest.
• b. buying soy bean futures for delivery near the time of harvest.
• c. buying contracts in unrelated commodities for delivery near
the time of harvest.
• d. selling contracts in alternative crops for delivery near the
time of harvest.
• e. selling soy bean futures for delivery near the time of harvest.
2012 Sem 1 Test

• What is the intrinsic value of a put option with a
strike price of $25 when the option price is $1.50
and the underlying common stock sells for $26?
• a. -$1.0
• b. $1.0
• c. $1.5
• d. $0.0
• e. $25
2012 Sem 1 Test

• In January, JB stock was selling for $50 per share. When the calls and the puts,
written on JB stocks, with a strike price of $45 expired on March 20 was selling
at $46, which investors made a profit?
• I. the writer of the call

• II. the buyer of the call
• III. the writer of the put
• IV. the buyer of the put
• a. III only
• b. II and III
• c. I and IV
• d. I and III
• e. II and IV
2012 Sem 1 Test

• The strike price of a put option is the price
• a. of the underlying stock in the share market at the
time when the option contract is exercised.
• b. at which the underlying stock can be sold.
• c. of the underlying stock in the share market at the
end of the option contract.
• d. of the underlying stock at the time when the
option contract is purchased.
• e. an investor must pay for the option contract.
2009 Sem 2 Exam

• Which one of the following can protect a stock
portfolio in a bear market?
•
• a. Buy stock index calls.
• b. Buy stock index puts.
• c. Write stock index calls.
• d. Write stock index puts.
• e. Increase the convexity of the portfolio.
2009 Sem 2 Exam

• A call option written against stock owned by
the writer is said to be:
•
• a. naked.
• b. in the money.
• c. out of the money.
• d. covered.
• e. speculative
2009 Sem 2 Exam

• When trading futures, the margin requirement:
•
• a. is seldom used.
• b. indicates that credit is being extended.
• c. is a down payment.
• d. is, in effect, a performance bond.
• e. reduces investor risk
•
2013 Sem 1 Test

• On the other side of every futures
transaction is:
• a. the dealer.
• b. the commodity producer.
• c. the clearinghouse.
• d. the futures exchange.
2013 Sem 1 Test

• Which of the following is not a reason for
investors to participate in options?
• a. Options are a smaller investment than
stock investments.
• b. Options eliminate leverage.
• c. Options can reduce risk.
• d. Options allow investors to trade on the
overall market movements.
Introduction to
Investments

Mod 6 Workshop
2015 Sem 1 Exam

• In a well-diversified portfolio, ________
risk is negligible.
a. nondiversifiable
b. market
c. systematic
d. firm specific
e. total
2013 Sem 1 Test

• If investors become more pessimistic about the stock
market, then
• Select one:
• a. the SML will become steeper, but the intercept will
not change.
• b. the SML will shift downward parallelly.
• c. the SML will become flatter, the intercept will not
change.
• d. the security market line (SML) will shift upward
parallelly.
2012 Sem 1 Exam

• Which one of the following is the best example of a risk associated
with stock ownership?
•
a. The stock paid a regular quarterly dividend.
b. The firm's net income decreased by 4 percent for the quarter, as
had been expected.
c. One of the firm's patent applications was unexpectedly rejected.
d. The firm's cost of debt increased as the result of an expected tax
cut.
e. The firm's production costs increased in line with previous years.

2012 Sem 1 Exam

• Of the following, Stock _____ has the greatest level of
total risk and Stock _____ has the highest risk
premium.

a. A; B
b. B; E
c. C; D
d. D; C
e. C; E
2012 Sem 1 Exam

• You own three stocks which have betas of 1.16, 1.34, and
1.02. You would like to add a fourth security such that
your portfolio beta will match that of the market. Given
this situation, the new security:
•
a. must have a beta of 1.0.
b. must have a beta of zero.
c. could be a U.S. Treasury bill.
d. could have any beta greater than 1.0.
e. must have a portfolio weight of 50 percent or more.
2012 Sem 1 Test

• The common stock of Industrial Technologies has an
expected return of 15.6 percent. The expected market
return is 11.2 percent and the risk-free return is 4.6
percent. What is the stock's beta?
• Select one:
• a. 1.42
• b. 1.67
• c. 1.00
• d. 1.32
• e. 0.42
2012 Sem 1 Test

• The expected market return is 16 per cent. The risk-
free rate of return is 7 per cent, and BC Co. has a
beta of 1.1. BC Co.'s required rate of return is:
• Select one:
• a. 23.0 per cent.
• b. 17.6 per cent.
• c. 16.9 per cent.
• d. 16.0 per cent.
• e. 24.6 per cent.
2012 Sem 1 Test

• Wilson Farms' stock has a beta of 0.79 and an expected return
of 7.8 percent. The risk-free rate is 2.6 percent and the market
risk premium is 6 percent. This stock is _____________
because the CAPM return for the stock is ____________
percent.
• Select one:
• a. underpriced; 7.49
• b. underpriced; 7.59
• c. overpriced; 7.49
• d. underpriced; 7.34
• e. overpriced; 7.34
2012 Sem 1 Test

• Which of the following will affect the beta value of an individual
security?
• I. Interval of time frequency used for the data sample
• II. Length of the time period used for the data sample
• III. Particular time period selected for sampling
• IV. Choice of index used as the measure of the market
• Select one:
• a. I, II, III and IV
• b. I and II only
• c. I and III only
• d. II, III and IV only
• e. II and IV only
2012 Sem 1 Test

• The systematic risk level of a security
• Select one:
• a. is the slope of the capital market line.
• b. can be calculated as the ratio of the share's covariance
with the market portfoio to the variance of the market's
return.
• c. can be measured by standard deviation.
• d. is not related to the variability of the overall market
portfolio.
• e. is the slope of the security market line.
2009 Sem 2 Exam

• When identifying undervalued and overvalued assets, which of
the following statements are FALSE?
•
• a. An asset is properly valued if its estimated rate of return is
equal to its required rate of return.
• b. An asset is considered undervalued if its estimated rate of
return is above its required rate of return.
• c. An asset is considered overvalued if its required rate of
return is below its estimated rate of return.
• d. All of the above (that is, all are false statements)
• e. None of the above (that is, all are true statements)
2009 Sem 2 Exam

• Risk factors in the arbitrage pricing theory (APT) must
possess all EXCEPT which of the following characteristics?
•
• a. Factors must be readily observable in risk/return space.
• b. Each factor must have a pervasive influence on stock
returns.
• c. The factors must influence expected return.
• d. Factors must be unpredictable.
• e. Factors cannot be firm-specific events.
•
2009 Sem 2 Exam

• The security market line (SML) can be used to
analyse the relationship between risk and required
return for:
•
• a. all assets.
• b. inefficient portfolios.
• c. only efficient portfolios.
• d. only individual securities.
• e. only risk-free securities
2009 Sem 2 Exam

• Under the capital market theory, the relevant risk to
consider with any security is:
•
• a. its deviation from the risk-free rate of return.
• b. its covariance with the market portfolio.
• c. its deviation from the portfolio required rate of return.
• d. its variance from the risk-free rate of return.
• e. its covariance with the market indifference curve.
•
Mod 7 workshop
2015 Sem 1 Exam

• A market timing strategy is one where asset allocation
in the share market ________ when one forecasts the
share market will outperform treasury bonds.
•
a. decrease
b. increase
c. remains the same
d. may increase or decrease
•
2012 Sem 1 Exam

• Fred and Martha are in their seventies and retired. Which one of the
following sets of portfolio statistics might best suit their situation if
their primary investment goal is current income with limited risk?
•
a. beta of 0.83 and a dividend yield of 6.3%
b. beta of 0.86 and a dividend yield of 4.6%
c. beta of 1.6 and a dividend yield of 6.4%
d. beta of 1.1 and a dividend yield of 5.4%
e. beta of 1.2 and a dividend yield of 6.0%
•
2012 Sem 1 Exam

• Portfolio Y has an expected return of 22 per cent and a
standard deviation of 20 per cent. A risk-free asset has a
return of 8 per cent. The standard deviation of the portfolio
consisting of 50 per cent Y and 50 per cent risk-free asset is:
•
a. 8 per cent
b. 10 per cent
c. 12 per cent
d. 14 per cent
e. 15 per cent
2012 Sem 1 Exam

• The S & P 500 Index is an appropriate benchmark for
•
a. diversified portfolios of large company stocks.
b. portfolios diversified among several asset classes such as
stocks, bonds, and real estate.
c. diversified portfolios with a mix of large, small, and mid-cap
stocks.
d. diversified portfolios of mid-cap and small company stocks.
e. diversified portfolios of stocks and bonds.
•
2012 Sem 1 Exam

• Allison's portfolio has an expected return of 14% and a standard
deviation of 20%. Brianna's portfolio has an expected rate of
return of 11% and a standard deviation of 12%. The risk-free
rate is 3%. According to the Sharpe measure,
•
a. Allison has the better portfolio.
b. Brianna has the better portfolio.
c. the portfolios are equally desirable.
d. the answer depends on Allison and Brianna's risk tolerance.
e. Insufficient information to answer the question
•
2012 Sem 1 Exam

• Allison's portfolio has an expected return of 14% and a beta of 1.3.
Brianna's portfolio has an expected rate of return of 11% and a beta
of 1. The risk-free rate is 3%. According to the Treynor measure,
•
• Allison has the better portfolio.
• Brianna has the better portfolio.
• the portfolios are equally desirable.
• the answer depends on Allison and Brianna's risk tolerance.
• Insufficient information to answer the question
2012 Sem 1 Exam

• A portfolio has a total return of 10.5%, a
beta of 0.72 and a standard deviation of
6.3%. The risk free rate is 3.8%, the
market return is 12.4%. What is Jensen's
measure of this portfolio's performance?
2010 Sem 2 Exam

• The first step of portfolio management according to
Maginn and Tuttle is:
•
• a. to assess market conditions.
• b. to determine objectives, constraints and preferences.
• c. to develop strategies and implement them.
• d. to adjust the portfolio as necessary.
• e. to form return expectations.
•
2010 Sem 2 Exam

• Which one of the following measures generally
produces the most similar rankings to those by
Treynor performance measure?
•
• a. Sharpe performance measure
• b. Dollar-weighted return
• c. Time-weighted return
• d. Jensen’s differential return measure
• e. Total return
2010 Sem 2 Exam

• Which one of the following statements regarding the coefficient of
determination, or R2, is INCORRECT?
•
• a. It indicates the degree of diversification.
• b. It shows the proportion of non-systematic risk.
• c. It is obtained as part of the process of fitting a characteristic line,
whereby the portfolio’s returns are regressed against the market’s
returns.
• d. It ranges between 0 and 1.
• e. It measures the percentage of the variance in the independent
variable that is explained by the dependent variable.
•
2010 Sem 2 Exam

• Which one of the following is NOT a problem with portfolio
measurement?
•
a. Investors may not be able to borrow and lend at Treasury
note rate (RF).
b. Multiple benchmarks are available when we evaluate
portfolio performance.
c. There is a movement to global investing.
d. Some funds are newly established.
e. Widely used indexes, such as S&P/ASX 200 Index, are poor
proxies for the true market portfolios.
2010 Sem 2 Exam

• Which one of the following statements is INCORRECT?
•
a. When we evaluate the performance of a portfolio, the question to be answered
is whether the return, less all expenses, is adequate to compensate for the risk
taken.
b. When portfolio performance is evaluated, the investor should be concerned
with the total change in wealth.
c. The dollar-weighted rate of return is equivalent to the internal rate of return.
d. The dollar-weighted rate of return captures the rate of return earned by
portfolio manager.
e. The total return (VE – VB)/VB may not be accurate measure of a portfolio’s
performance when there are cash inflows and outflows during the
measurement period.
•
Return Measures
Dollar-weighted returns:
– Equivalent to internal rate of return.
– Equates initial value of portfolio (investment)
with cash inflows or outflows and ending
value of portfolio.
– Measure return to the portfolio owner
– Cash flow effects make comparisons to
benchmarks inappropriate.
122
Return Measures
Time-weighted returns:
– Unaffected by cash flows and permits
comparisons with benchmarks.
– Calculate a return relative for each time period
defined by a cash inflow or outflow.
– Use each return relative to calculate a
compound rate of return for the entire period.
𝐶𝐹 𝑡 + 𝑃𝐸
𝑅𝑒𝑡𝑢𝑟𝑛 𝑟𝑒𝑙𝑎𝑡𝑖𝑣𝑒=
𝑃𝐵 123
Which Return Measure Should Be Used?

Dollar- and time-weighted returns can
give different results.
◦ Dollar-weighted returns are appropriate for
portfolio owners.
◦ Time-weighted returns are appropriate for
portfolio managers.
 No control over inflows or outflows.
 Independent of actions of client.
Measuring performance of portfolio
managers best met by using time-weighted
returns. 124
2010 Sem 2 Exam

• Suppose you estimated the excess return (in percentage) for the following three portfolios.
•
• Portfolio A RA,t – RFt = -1.3 + 1.1(RM,t – RFt) R2 = 0.65
• Portfolio B RB,t – RFt = 1.2 + 1.5(RM,t – RFt) R2 = 0.45
• Portfolio C RC,t – RFt = 0.8 + 0.9(RM,t – RFt) R2 = 0.80
•
• The risk-free rate and the average return on the market portfolio were 5 per cent and 15 per
cent, respectively, over the investment horizon.
•
• Rank these portfolios based on Treynor’s measure of performance. (1 mark)
• Rank these portfolios based on Jensen’s measure of performance. (1 mark)
• Which portfolio is the least diversified? (1 mark)
• Which portfolio has the highest market risk? (1 mark)
•
•

125.241 Review of Problem Questions: Modules 1 To 3

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125.241 Review of Problem Questions: Modules 1 To 3

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Introduction to

School of Economics and Finance Introduction to

Module 1 – Problem One

(b) five years

(c) ten years?

Problem 2 – Margin Trading

Problem 3 – Margin Loans

Without margin With 50% margin

Calculate the Cumulative Wealth Index (CWI).

• Wealth has changed on an annual basis by –8.09%,

• Imply the dividend in one-year:

• Growth industries operate autonomously to the business

• Beta reflects the relative systematic risk for a share. Other

EBIT Sales NPBT NPAT

Recalling the following relationsh ip : TA  D  E, then :

2013 Sem 1 Test

2012 Sem 1 Exam

The Effects of Maturity

The Effects of Coupon

Implications of Bond Theorems

2012 Sem 1 Exam

2012 Sem 1 Exam

2012 Sem 1 Exam

2012 Sem 1 Exam

Estimating Price Changes

• Modified duration =D*=D/(1+ ytm)

2012 Sem 1 Exam

Chapter 17, p.452

2012 Sem 1 Exam

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

Term Structure Theories

Pure Expectations Theory

Liquidity Preference Theory

Market Segmentation Theory

2012 Sem 1 Test

2012 Sem 1 Test

a. higher; higher; higher

2009 Sem 2 Exam

2009 Sem 2 Exam

2009 Sem 2 Exam

Bond 2009 Sem

2009 Sem 2 Exam

2009 Sem 2 Exam

2015 Sem 1 Exam

Effects of various variables on

2013 Sem 1 Test

2012 Sem 1 Exam

2012 Sem 1 Exam

2012 Sem 1 Exam

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

2012 Sem 1 Test

• I. the writer of the call

2012 Sem 1 Test

2009 Sem 2 Exam

2009 Sem 2 Exam

2009 Sem 2 Exam