Oregon State UniversityCollege of BusinessDepartment of Accounting, Finance and Information ManagementBA 443Midterm Examination Instructor: Prem MathewDate: April 30, 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.NOTE: In FALL 2008, we have not covered MC 7 and SA 5 yet.1. In a value weighted index a) Exchange rate fluctuations have a large impact.b) Exchange rate fluctuations have a small impact.c) Large companies have a disproportionate influence on the index.d) Small companies have an exaggerated effect on the index.e) None of the above.2. Research has shown that the asset allocation decision explains % of the variation infund returns across all funds, and % of the variation in returns for a particular fundover time. a) 90 and 100.b) 100 and 40.c) 90 and 40.d) 40 and 100.e) 40 and 90.3. ____________ is an appropriate objective for investors who want their portfolio to grow in real terms, i.e., exceed the rate of inflation.a) Capital preservationb) Capital appreciationc) Portfolio growthd) Value additivitye) Nominal preservation4. The policy statement may include a __________ against which a portfolio's orportfolio manager's performance can be measured.a) Milestoneb) Benchmarkc) Landmarkd) Reference pointe) Market pair5. Value stocks would have the following characteristicsa) Low book value/market value, low price/earnings.b) High book value/market value, low price/earnings.c) Low book value/market value, high price/earningsd) High book value/market value, high price/earnings6. Which of the following is not a technique for constructing a passive index portfolio?a) Full replication b) Samplingc) Quadratic programmingd) Linear programminge) None of the above (that is, all are techniques for constructing a passive index portfolio)7. An examination of the relationship between stock prices and the economy has shown that the relationship isa) Weak, and that stock prices turn after the economy does.b) Nonexistent.c) Strong , and that stock prices turn after the economy does.d) Strong, and that stock prices turn before the economy does.e) Weak, and that stock prices turn before the economy does.8. Under the risk premium approach to determining expected returns for fixed income asset classes and securities, the difference between the real risk-free rate and an intermediate Treasury Bond asset class is captured in the following premiums:a) Inflation premiumb) Maturity premiumc) Inflation and maturity premiumsd) Inflation, maturity and tax premiumse) Inflation, maturity and illiquidity premiums9. The table below provides returns on a portfolio along with returns for thecorresponding benchmark index for the past eight quarters. The table also providesthe difference between portfolio returns and the benchmark index, the average ofthese differences over the past eight quarters and the standard deviation of thesedifferences.Period Portfolio Index Difference1 0.05 0.027 0.0232 -0.036 -0.046 0.0103 0.022 0.019 0.0034 0.012 0.022 -0.0105 -0.003 -0.001 -0.0026 -0.023 -0.03 0.0077 0.089 0.081 0.0088 -0.008 0.006 -0.014Average 0.003SD 0.011789The annualized tracking error for this period isa) 2.36%b) 4.08%c) 2.89%d) 3.33%e) 1.18%10. Based on an unweighted (or equal weighted) indexusing arithmetic means, what is the percentage change in the indexfrom Day T to Day T+1. Assume a base index value of 100 on Day T.Number of shares Closing Prices (per share)Companies outstanding Day T Day T + 11 2,000 $30.00 $25.002 7,000 55.00 60.003 5,000 20.00 25.004 4,000 40.00 45.00a) 5.35%b) 7.48%c) 9.93%d) 6.33%e) None of the aboveShort Answer.1. (6 points) Mr. Semih is an analyst at PortMgmt, Inc. In a recent presentation to the managing directors of the firm, he made the following comments. “Noting that year-end holiday sales have been weak over the past several years, I believe that current expectations should be likewise muted. In fact, just last week, I had an occasion to visit Macy’s and noticed that the number of shoppers seemed quite low. The last time I saw a store with so little pedestrian traffic was in December 2000, and that coincided with one of the worst holiday sales periods in the past two decades. Thus, there will be no overall year-over-year retail sales growth this holiday season.”Identify and describe three psychological traps that may be interfering with the creation of Mr. Semih’s forecasts.2. (9 points) Use the following information to answer the questions below. Asset allocation Expected return Standard deviationX 12% 19%Y 8.5% 15%Z 5.5% 9%a. Client A has a risk aversion parameter of 5. Recommend an asset allocation for him.b. Client B has a spending policy of 3.5% and therefore would like to choose an allocation that minimizes the probability that the portfolio return will be less than that. Recommend an asset allocation for her.c. Client C needs to spend 5% from her portfolio annually. She anticipates that inflation will be 2.4% annually and she incurs expenses of 0.6% a year in investing her portfolio. Which asset allocations satisfy her return requirement?3. (10 points) As a junior analyst at your firm, you have been assigned the task of developing expected returns and a covariance matrix for two asset classes, a U.S. equity asset class and a U.S. corporate fixed income asset class, that your firm invests their clients’ money in. This analysis will compliment analyses performed by other analysts to develop portfolios for your firm’s clients. Your firm uses a multifactor model approach to develop these expectations. Multifactor model specifics:You identify two factors that you believe drive all asset class returns. The returns and standard deviations of these two factors are given below. The covariance between the factors is 0.011.E(R) Std Dev.Factor 1 8% 10%Factor 2 12% 20%You run a regression for each asset class using these two factors and determine that the factor sensitivities are as follows:BetasFactor 1 Factor 2Equity AC 0 1.3Fixed Income AC 1.1 0a. Calculate the