Oregon State UniversityCollege of BusinessBA 443Midterm Examination Instructor: Prem MathewDate: November 3, 2008Time allowed: 1 hour and 50 minutesPoints: 50 (equivalent to 27% of the total course evaluation)Student name: ___________________________________Instructions:1) Attempt all questions. 2) You may separate the formula sheets and additional pages at the end of the exam. If you have work you would like to turn in on the additional pages, please slip it inside the exam when finished.Multiple Choice. Circle the correct answer. Each question is worth 1 point.1. Which of the following is not an investor life cycle phase?a) Discovery phaseb) Accumulation phasec) Consolidation phased) Spending phasee) Gifting phase 2. It is important to develop an Investment Policy Statement for a client because:i. It allows clients to understand their needs and objectives.ii. It ensures that the return generated by the portfolio will always exceedthe benchmark.iii. It reduces the possibility of inappropriate behavior by the portfoliomanager. a) ib) i, iic) i, ii, iiid) ii, iiie) i, iii3. What effect does a stock split have on a price-weighted series?a) Index remains the same, divisor will increase/decrease.b) Divisor remains the same, index will increase/decrease.c) Index and divisor will both remain the same.d) Index and divisor will both reflect the changes (immediately).e) Not enough information is provided.4. Which of the following are factors that make it difficult to create and maintain a bondindex?a) The universe of bonds is broader than stocks.b) The universe of bonds is constantly changing due to new issues, bond maturities, calls, and bond sinking funds.c) It is difficult to derive value, up-to-date prices.d) Choices a and ce) All of the above5. Which of the following statements concerning active equity portfolio managementstrategies is true?a) The goal of active equity portfolio management is to earn a portfolio return thatexceeds the return of a passive benchmark portfolio (net of transaction costs) on arisk-adjusted basis.b) An actively managed equity portfolio has lower total transaction costs.c) An actively managed equity portfolio has lower risk than the passive benchmark.d) A key to success for an actively managed equity portfolio is to maximize tradingactivity.e) All of the above6. Under the risk premium approach to determine the yield on an Investment Grade Corporate Bond asset class you add the current Treasury Bond yield of the same maturity to the following risk premium(s):i. Inflation premiumii. Tax premiumiii. Default premiumiv. Illiquidity premiuma) i, ii, iiib) i, iii, ivc) ii, iii, ivd) i, ii, ive) i, ii, iii, iv7. Although venture capital investments tend to be riskier than investments in public firms, reported standard deviations for a VC index between 1980 and 2000 was considerably lower than that for an index of publicly traded firms. This anomaly is most likely because a) VC index data is lagged b) there is survivorship bias in the measurement of the indexes c) VC investment data tends to be smoothed data d) VC investments are actually less risky e) none of the above8. In passive equity management, compared to full replication, sampling has which of the following advantage or disadvantage:a) it has greater transaction costsb) it has greater tracking errorc) it will generate greater returnsd) it will require investing in more stockse) none of the aboveUse the following information to answer questions 9 and 10.You are attempting to learn more about a particular ETF that you are interested in investing in. You obtain the following output from a 4-factor model regression where youregress 5 years of monthly returns for your ETF against the market, size, value and momentum factors.Coefficient t-statIntercept 1.21 0.56Mkt 1.31 34.01SMB 0.56 0.55HML 1.11 13.26MOM 0.23 12.239. Based on the output, you conclude that the ETF is aa) Small-cap Growth ETFb) Mid-cap Value ETFc) Large-cap Growth ETFd) Large-cap Value ETFe) Small-cap Value ETF10. Calculate the expected risk premium for the ETF with the following historical risk premiums for each of the risk factors: Mkt: 6.7%; SMB: 0.9%; HML: 3.8%; MOM: 11.7%. The ETF risk premium isa) 16.19%b) 17.4%c) 14.71%d) Cannot be determined without the risk free rate.Short Answer.1. (10 points) A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob Bowman and Tom Luck. The characteristics of the three model portfolios under consideration are provided in the table below.PortfolioAsset Mix (weights)PortfolioExpectedReturn(%)PortfolioStandardDeviation(%)Stock BondA 0.75 0.25 15 20B 0.4 0.6 8 10C 0.3 0.7 5 5a. If Mr. Bowman has a risk aversion parameter of 7 and Mr. Luck has a risk aversion parameter of 1, which portfolio would you recommend for each of the clients?b. Mr. Bowman’s initial portfolio has a value of $1 million. He would like to withdraw $50,000 annually to contribute to charity. He would like an allocation that allows him to have the greatest chance of withdrawing that amount without reducing his portfolio valuebelow $1 million. Which portfolio would you recommend?c. Mr. Luck’s initial portfolio has a value of $100,000. He would like to purchase a boat in 10 years that he believes will cost $210,000 at that time. Which of the portfolio(s) would provide him the return to achieve his goal? Assume that the portfolio expected return above represents an expected arithmetic return.2. (6 points) One of the challenges in forecasting is that analysts and clients tend to havebiases in their forecasts and opinions. State and describe three psychological traps that analysts or clients may fall into that would lead to biased forecasts.3. (12 points) You have been asked to develop expected returns and a covariance matrixfor two asset classes, U.S. equities asset class (USE) and emerging market equities asset class (EME). Your firm uses the ICAPM to develop these expectations. Your firm’s proprietary models have estimated a Sharpe ratio for the global investable market (GIM) of 0.28. Based on your analysis of historical data for these asset classes, you determine that the USE is 80% integrated with the GIM and that the EME is 60% integrated with the GIM. You also determine that the correlation between USE and the GIM is 0.65 and the correlation between EME and the GIM is 0.55. The risk-free rate is 4% and the GIM standard deviation is 18%. Other historical