[12 pts] 4- CAPM-1Answer[6 pts] 5-Derivation of the formula for Growing AnnuitySuppose an 8% coupon, 30-year bond is selling at $1,276.76.a. Show how to solve the average rate of return on this bond (the rate of return that would be earned by an investor purchasing the bond at this price). What is it called?b. Suppose the solution to the problem above is 3%, per half-year. For this problemi. What is Bond Equivalent Yield?ii. What is Effective Annual Yield?[8 pts] 7- Effective versus Stated Annual Rates[12 pts] 8- Stock Valuation and Growth Opportunities[10 pts] 10- Option to AbandonFinanciad Economics ECN134Final ExamSSI 2008 Prof. Farshid Mojaver************************************************************************Multiple Choice Questions: There are 12 MC questions worth 12 points. Please write the correct answer in your blue book. 1. The expected return/beta relationship is used ___________. A) by regulatory commissions in determining the costs of capital for regulated firms B) in court rulings to determine discount rates to evaluate claims of lost future incomes C) to advise clients as to the composition of their portfolios D) all of the above E) none of the above Answer: D 2. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict. A) higher than B) equal to C) less than D) twice as much as E) more information is required to answer this question Answer: C3. If a market proxy portfolio consistently beats all professionally managed portfolios on a risk-adjusted basis, it may be concluded that A) the CAPM is valid. B) the market proxy is mean/variance efficient. C) the CAPM is invalid. D) A and B. E) B and C. Answer: D 4. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios. A) greater than B) equal to C) less than D) unrelated to E) more information is necessary to answer this question Answer: C5. Malkiel (1995) calculated that the average alphas, or abnormal returns, on a large sample of mutual funds between 1972 and 1991 were A) significantly positive. B) significantly negative. C) statistically indistinguishable from zero. D) positive before 1981 and negative thereafter. E) negative before 1981 and positive thereafter. Answer: C6. Proponents of the EMH think technical analysts A) should focus on relative strength. B) should focus on resistance levels. C) should focus on support levels. D) should focus on financial statements. E) are wasting their time. Answer: E 7. In an efficient market, __________. A) security prices react quickly to new information B) security prices are seldom far above or below their justified levels C) security analysts will not enable investors to realize superior returns consistently D) one cannot make money E) A, B, and C Answer: E 8. The weak form of the efficient market hypothesis contradicts A) technical analysis, but supports fundamental analysis as valid. B) fundamental analysis, but supports technical analysis as valid. C) both fundamental analysis and technical analysis. D) technical analysis, but is silent on the possibility of successful fundamental analysis. E) none of the above. Answer: D 9. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%. You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that A) bad news about Matthews was announced yesterday. B) good news about Matthews was announced yesterday. C) no news about Matthews was announced yesterday. D) interest rates rose yesterday. E) interest rates fell yesterday. Answer: B10. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that A) bad news about Music Doctors was announced yesterday. B) good news about Music Doctors was announced yesterday. C) no news about Music Doctors was announced yesterday. D) interest rates rose yesterday. E) interest rates fell yesterday. Answer: A 11. The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from King. You observe that King hadan abnormal return of 0% yesterday. This suggests that A) the market is not efficient. B) King stock will probably rise in value tomorrow. C) King stock will probably fall in value tomorrow. D) the approval was already anticipated by the market E) none of the above. Answer: D 12. If you believe in the reversal effect, you should A) sell bonds in this period if you held stocks in the last period. B) sell stocks in this period if you held bonds in the last period. C) sell stocks this period that performed well last period. D) go long. E) C and D Answer: C [6 pts] 1- Portfolio Optimization: Consider three risky securities A, B and C. A has the highest risk and expected return, C has the lowest ones and B has ones in between. a. Draw a combination line between A and B assuming that there is zero correlation between the two securities. What does it represent?b. Draw a combination line between securities B and C assuming these securities arenot correlated. c. Draw a combination line for the three securities and mark the efficient frontier.[6 pts] 2- Optimal Risky Portfolio-1Suppose you have a project that has 70% chance of doubling your investment in a year and 30%chance of halving your investment in a year. What is the standard deviation of the rate of returnon this investment?AnswerThe probability distribution is:Probability Rate of Return0.7 100%0.3 −50%Mean = [0.7  100] + [0.3 (50)] = 55%Variance = [0.7 (100  55)2] + [0.3 (50  55)2] = 4725Standard deviation = 47251/2 = 68.74%[6 pts] 3-Optimal Risky Portfolio-2Suppose that you have $1 million and the following two opportunities from which to construct aportfolio: (a) Risk-free asset earning 12% per year, (b) Risky asset with expected return 30% peryear and standard deviation of 40%. If you construct a portfolio with a standard deviation of 30%,what is the expected rate of return?Answer P = 30 = yy  y =