Wrong answers for test 1

Question 1

An analyst observes the following four annual returns: R1 = +10%, R2 = –15%, R3 = 0%, and R4 = +5%. The average compound annual rate over the four years is closest to:

Answer 1

G = [(1.10)(0.85)(1.00)(1.05)]0.25 – 1

G = (0.98175)0.25 – 1 = 0.9954 – 1 = –0.00459 ≈ –0.5%

Question 2

Assume that one- and two-year risk-free rates are 1.80% and 2.50%, respectively. Using the cash flow additivity principle, the one-year reinvestment rate, one year from now is closest to:

Answer 2

Forumla is 1+ first percentage fo return squared divided by the 1+ second percentage squared. We then subtract back out the percentages

Question 3

Compute the standard deviation of a two-stock portfolio if stock A (40% weight) has a variance of 0.0015, stock B (60% weight) has a variance of 0.0021, and the correlation coefficient for the two stocks is –0.35?

Answer 3

The standard deviation of the portfolio is found by:

[W12σ12 + W22σ2 2+ 2W1W2σ1σ2ρ1,2]0.5

= [(0.40)2(0.0015) + (0.60)2 (0.0021) + (2)(0.40)(0.60)(0.0387)(0.0458)(–0.35)]0.5

= 0.0264, or 2.64%.

formula is [W12σ12 + W22σ2 2+ 2W1W2σ1σ2ρ1,2]0.5

basically
step 1 = weight squared x SD squared (or just variance) for first stock

step 2 = weight squared x SD squared (or just variance) for second stock

step 3 = 2 x weight of first x weight of second x SD of 1 x SD of 2 x COV

step 4 = square root this

Question 4

Recall that the correlation coefficient for two variables is:

Answer 4

CORR CO = COV / SDa x SDb

Question 5

An investor looks at her monthly brokerage statement and notices that the yield to maturity on her 5-year corporate bond with a 4% annual coupon rate has gone from 4.2% last month to 3.8% this month. The statement will reflect a bond price that, over the last month, has:

Answer 5

DECREASED

bond prices and yields move in the opposite direction

Question 6

Roy’s safety first calculation if you get a acceptable return of 9%

Answer 6

SUBTRACT 9 from the expected return and then divide by SD –> bigger the better

Question 7

A perpetual bond with a face value of $100,000 pays annual interest of 5%. The bond is quoted at a yield of 7%. The bond’s price is closest to:

Answer 7

100000(.05) / .07

Question 8

An analyst is using the constant growth dividend discount model (DDM) to evaluate XYZ stock. The stock is currently trading at $20 per share and recently paid an annual dividend of $1.50. Assuming a constant growth rate of 4.5%, the implied required rate of return on the stock is closest to:

Answer 8

Question 9

A pure discount instrument with a face value of €1 million matures eight years from today. If its yield to maturity is –1.5%, its price today is closest to:

Answer 9

Given these three answer choices, you can choose the correct answer without performing the calculation. With a negative yield, the price of a single future cash flow must be greater than the amount of the cash flow. In this case, €1,000,000 / (1 – 0.015)8 = €1,128,522.

Question 10

A bond was purchased exactly one year ago for $910 and was sold today for $1,020. During the year, the bond made two semi-annual coupon payments of $30. What is the holding period return?

Answer 10

HPY = (1,020 + 30 + 30 – 910) / 910 = 0.1868 or 18.7%.