SEM1

Question 1

Efficient Portfolio

Answer 1

Means there is no way to reduce the volatility of the portfolio without lowering expected return
efficient portfolio has the highest sharpe ratio

Question 2

inefficient Portfolio

Answer 2

Means it is possible to find another portfolio that is better in terms of both expected return and volatility

Question 3

How does change in YTM effect current bond prices

Answer 3

as YTM’s go down, Current Bond market prices increase

Question 4

As Maturity date increaes what happens to YTM

Answer 4

Usually investors demand more yield in return for investing their money for longer term, so YTM is higher.
Leading to an upwards sloping yield curve

Question 5

• What does a sharply increasing yield curve suggest
• What does a decreasing yield curve suggest

Answer 5

sharply increasing indicates that short term interest rates are expected to rise in the future
an inverted yield curve signals expected decline in future interest rates.

Question 6

How does coupon rate effect a bonds sensitivity to YTM/interest rate changes

Answer 6

higher coupon rate bonds are less sensitive to YTM/Interest rate changes

Question 7

Enterprise Value defintion

Answer 7

The present value of the Free Cash Flows of a whole company.
this is the value of the firm to all who have financed it minus any cash in the company bank accounts

Question 8

What is required return

Answer 8

is the expected return that is necessary to compensate for the risk investment i will contribute to the portfolio

Question 9

State the 3 CAPM assumptions

Answer 9

• investors can buy and sell at competitive market price with no transaction costs, and can borrow/lend at the risk free rate
• investors are regional agents, they only hold efficient portfolios of traded securities
• investors have homogeneous expectations regarding the volatilities , correlations, and expected returns of securities

Question 10

What is a securities beta

Answer 10

securities exposure to systematic risk ( the market risk present in the securities return) Beta of market portfolio = 1
Beta of risk free asset = 0

Question 11

Why would an investor hold stocks with a negative beta

Answer 11

negative beta shows an inverse correlation with the market
they are purchased as recession insurance, held for diversification purposes

Question 12

What is Capital Budgeting

Answer 12

process used to analyse alternate investments and decide which to accept

Question 13

What is a constant annuity

Answer 13

stream of N equal cash flows paid at regular intervals

Question 14

what is cannibalisation in finance

Answer 14

when a new investment project decreases some of the sales of an existing business

Question 15

What are the problems with using IRR

Answer 15

• investment project may have multiple IRR’s
• investment project may have no IRR’s
• delayed investment fallacy

Question 16

how are bond yields/interest rates linked to bond prices

Answer 16

Bond prices are inversely related to bond yields

Question 17

How does a bond duration affect sensitvity to YTM/ interest rate changes

Answer 17

Duration is a measure of sensitivity not time
high duration = high sensitivity

Question 18

What does ESG stand for with examples

Answer 18

Environmental - climate / sustainability
Social - Human rights/ Diversity
Governance - Corporate structure

Question 19

What is the size effect

Answer 19

when the market portfolio is not efficient we expect that stocks with low market caps will have positive alphas
As positive alpha implies a stock has a relatively higher expected return > lower price >lower market value

Question 20

What is the momentum strategy ( past returns)

Answer 20

it is found that the best performing stocks had positive alphas for the next 3-12 months.
strategy is to buy stocks with high past returns and short poorly performing stocks

Question 21

SMB portfolio

Answer 21

small minus big
short the big stocks , financing,
longing the small stocks

Question 22

HML

Answer 22

High minus low
buying big stocks ( above 70th percentile)
financing this by shorting small stocks
this portfolio is equally weighted

Question 23

PR1YR

Answer 23

prior one year momentum portfolio
each year ranking stocks by their return over the last 1 year, buying the stop 30% shorting the bottom 30%

Question 24

CML vs SML

Answer 24

cml looks at total volatility whereas sml only considers systematic risk (beta)
cml applies to portfolios combining risk free investments and market efficient portfolio, where the sml applies to any individual stocks or portfolios
cml cannot deduct a clear relation between individual stock risk and expected returns as opposed to sml which shows the required return for each security as a function of its beta with the market

Question 25

In general, the difference between the cost of capital and the IRR is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.

True or false

Answer 25

True

Question 26

The IRR can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.

True or False

Answer 26

True

Question 27

If the cost of capital estimate is more than the IRR, the NPV will be positive.

True or False

Answer 27

False

Question 28

When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input

True or False

Answer 28

False

Question 29

Shorter maturity zero coupon bonds are less sensitive to changes in interest rates than are longer-term zero coupon bonds.

True or False

Answer 29

True

Question 30

when looking at historical returns how do you calculate variance

Answer 30

using variance on the formula sheet

Question 31

Beta corresponds to the slope of the best fitting line in the plot of the securities excess returns versus the market excess return.

True or False

Answer 31

True