BU283 FINAL - All Homework Solutions

Chapter 3
Compute the simple interest earned on a1-year $200 deposit that earns6% per year.
● $120
● $6
● $12
● $200
● $60
You invest $100 at the end of year 1. At the end of year 2, you receive $200. Which of the following
timelines represents the cash flows just described?
● C
● B
● A
An investment is an outflow so it is negative. The receipt is an inflow and so positive. The
investment happens at the end of Year 1, which is t=1 on the timeline.
When a financial manager uses present value techniques, at what point in time does the financial
manager usually start?
● January 1
● December 31
● the point when the last cash is received
● the current or present point in time
The manager typically starts at time zero. Time zero represents the present. It also represents the
beginning of the first period.
For the following mixed stream of cash flows, determine the future value at the end of the third year if
deposits are made at the beginning of each year into an account paying annual interest of 10%,
assuming no withdrawals are made during the period.
Year Cash Flow
1 10,000
2 9,100
3 6,900
● $21,306.54
● $31,911.00
● $23,437.19
● $29,010.00
You deposit $100 in a bank in a 7-year time deposit. With a time deposit, you cannot withdraw funds
from the account until the end of the term. Interest in the account is compounded semi-annually
(m=2) at the annual nominal rate of 10%. In the final compounding interval, what is the dollar amount
of interest that is earned from earlier interest (rather than off of the original principal)?
● $5.00
● $0.57
● $4.43
● $9.43
Your daughter just gave birth to a baby girl. You are going to invest $10,000 to help pay for college,
which you expect her to start in 18 years. Your broker offers you two investment choices: 1) a portfolio
of technology stocks that is expected to earn an interest rate of 9%; or 2) a portfolio of industrial
stocks that is expected to earn a rate of 8%. How much larger is the gift (when she starts college) with
the higher interest rate (compared to the lower rate)?
● $6,160.87
● $7,211.01
● $8,427.97
● $5,255.93
Today you invested $1,000 in your bank account. Next year you plan to invest $3,000 in the account.
How much will you have in the account in two years if the bank pays interest at the rate of 9%?
● $3,593.97
● $3,917.43
● $4,458.10
● $4,859.33
● $4,090.00
Today you deposited $992 in a bank that pays interest at the rate of 10% (compounded annually). How
much will you have in the bank in 20 years?
● $6,673.68
● $6,066.98
● $7,341.05
● $5,559.58
Paying interest more frequently impacts the future value in what way?
● depends on the interest rate

● reduces it
● doesn’t change it
● increases it
As the number of compounding periods per year increases, the future value will increase.
How much will be in an account earning 10% at the end of 5 years if $100 is deposited today?
FV = $100 x (1.10)^5 = $161.05
How much will be in an account earning 8% at the end of 5 years if $100 is deposited today,
assuming quarterly compounding?
If $100 is placed in an account that earns a nominal 4 percent, compounded quarterly, what
will it be worth in 5 years?
Using the basic formula for future value alone with the given interest rate, k, and number of
periods, n, calculate the future value interest factor (FVIF) in each of the following cases.
Round to four decimal places.
Case Interest Rate, k (%) Number of FVIF

Periods, n
A 10 2
B 8 4
C 6 3
D 4 2
You have $540 in an account which pays 4.8% compounded annually. If you invest your money for
8 years, then how many dollars of interest will you earn by the end of the term?
● $260.78
● $1,031.50
● $785.75
● $245.75
You have $520 in an account which pays 4.4% compounded annually. How many additional dollars
of interest would you earn over 7 years if you moved the money to an account earning 6.8%?
● $702.92
● $122.22
● $1,527.06
● $824.14
You are investing $100 in a bank account for 10 years. The bank compounds interest 4 times per year.
If you are going to calculate the future value of thedeposit, how many compounding intervals will you
use in the problem?
● 48
● 1
● 10
● 40
The number of compounding intervals is 40 periods. It is computed as the periods per year times
the number of years, so 10 x 4 = 40.
You are investing $100 in a bank account for 2 years. The bank compounds interest 52 times per year.
If you are going to calculate the future value of thedeposit, how many compounding intervals will you
use in theproblem?
The number of compounding periods is found by multiplying the number of periods per year times
the number of years. So 52 x 2 = 104.
Compute the FV for each of the following cash flows. Round to two decimal places.
Compounding Initial Int rate Number Future
periods per year Deposit of years value
1 600 15% 6
2 200 13% 21
12 100 8% 5
What is the future value of a $1,300 deposit after 5 years with an annual interest rate of 7%
compounded 26 times peryear? ( Round to the nearestcent.)
For each of the following cases, calculate the future value of the single cash flow deposited
today that will be available at the end of the deposit period if the interest is compounded
annually at the rate specified over the given period. Round to the nearest cent.
Cas Single Cash Flows Interest Rate Deposit Period Future

e ($) (%) (Years) Value
A $100 6 30 $
B $5,000 10 25 $
C $12,500 12 7 $
D $23,200 14 10 $
Calculate the balance you would have in an account after four years assuming $6,000 was
deposited today at 16% compounded annually, semiannually, and quarterly. Round to 2 decimal
points.
For the following mixed streams of cash flows, determine the future value at the end of the final
year if deposits are made at the beginning of each year into an account paying annual interest of
10%. Assume that no withdrawals are made during the period.
Year Cash Flow Stream
1 $1,000
2 $500
3 $2,000
For the following mixed stream of cash flows, determine the future value at the end of the third year if
deposits are made at the beginning of each year into an account paying annual interest of 10%,
assuming no withdrawals are made during the period.
Year Cash Flow
1 10,000
2 9,100
3 6,900
● $21,306.54
● $23,437.19
● $29,010.00
● $31,911.00
The _________ rate is the amount you would need to earn with annual compounding to be as
well off as you are with multiple compounding periods per year.
● real
● nominal
● required
● effective
The nominal rate is not the same as the effective rate. As the nominal rate is compounded
multiple times per year, the effective rate increases.
Paying interest more frequently results in a _____ future value.
● indeterminant
● constant
● smaller
● greater
As the number of compounding periods increases, the FV also increases.
What is the effective interest rate for a nominal rate of 8%, which is compounded monthly?
A bank advertises a nominal annual interest rate of 7.6% on a loan. However, interest is compounded
monthly. In decimalform, what is the effective interest rate on theloan?
● 0.037
● 0.825
● 0.0787
● 0.00633
The Piccadilly Savings and Loan offers a savings account with a quoted rate of 4% which is
compounded 4 times per year. Not to beoutdone, the Thames Embankment Bank wants to offer a
competing account with daily compounding. What quoted rate does Thames have to offer in order
to produce the same effective interest rate as offered byPiccadilly? Assume a 365-day year.
● 4.12%
● 3.98%
● 3.87%
● 3.25%
Your bank offers an annual nominal interest rate of 5% compounded 12 times per year. What is the
effective interest rate on theaccount?
● 0.0557
● 0.0512
● 0.621
● 0.05
Andy promises to pay Opie $3,000 when Opie graduates from Mayberry University in 11 years. How
much must Andy deposit today to make good on his promise if he can earn 7% on his investments?
● $1,425.28
● $6,228.48
● $6,314.56
● $1,444.98
Suppose that the NASDAQ Composite index hit a level of 4,698 in February of 2000. In February of
1994 it was at a level of 2,100. What was the annual average compound growth rate over the
period?
Suppose that the NASDAQ Composite index hit a level of 2,052 in February of 2000. In
February of 1990 it was at a level of 4,690. What was the annual average compound growth
rate over theperiod?
● 8.23
● -7.93
● -7.52
● -8.32
In February of 2000 the NASDAQ Composite index peaked at a level of 4,698 (just before the Tech
Bubble popped). In February of 2006 it was at a level of 2,012. The NASDAQ index has historically
grown at an average rate of 9.5%. If the index continues to grow at its historic rate, then how many
years will it take for the index to grow from its February 2006 level back to the February 2000
level? Answer to the nearest full year.
● 10
● 8
● 7
● 9
Calculator solution: I = 9.5, PV= 2012, PMT = 0, FV=-4698: CPT N = 9.34
What interest rate makes $100 grow to $255.80 over 9 years?
● 8%
● 9%
● 11%
● 10%
Calculate the average annual growth rate if an investment of $100 grows to $134.01 in 6 periods.
● 7%
● 5%
● 6%
● 4%
Solution: N=6, PV = 100, PMT = 0, FV = -134, Cpt I = 5.00
What is the value today of $1,250 to be received 3 years from now, assuming a 12% discount rate?
(Answer to nearest whole number.)
● $880
● $900
● $910
● $890
Using the basic formula for present value along with the given discount rate, i, and number of
periods, n, calculate the present value interest factor (PVIF) in each of the following cases.
Express you answer to three decimal points

Case Discount Rate, i (%) Number of Periods, Present Value Interest
n Factor
A 5 5
B 10 3
C 12 2
Ted Roberts has been offered a future payment of $1,000 three years from today. If his
opportunity cost is 7% compounded annually, what value would he place on this opportunity?
(Answer to nearest whole number.)
● $816
● $860
● $820
● $840
What would be the present value today of $1,250 to be received 3 years from now, assuming a 12%
discount rate and quarterly compounding? Express your answer to the nearest cent.
Andy promises to pay Opie $3,000 when Opie graduates from Mayberry University in 11 years. How
much must Andy deposit today to make good on his promise, if he can earn 7% on his investments?
● $1,425.28
● $1,444.98
● $6,228.48
● $6,314.56
Ted Roberts has been offered the following future payments nyears from today. If his
opportunity cost is i, compoundedannually, what value would he place on eachopportunity?
Round your answer to the nearest cent
Future Value ($) Interest Rate (%) Years Present Value ($)
8,100 6 11
5,500 7 27
6,700 15 30
2,600 11 19
Maria expects to receive a payment of $36,000 in 3 years. At a discount rate of 8%, what is the present
value of thispayment?
● $23,478.23
● $36,000
● $28,577.96
● $27,586.23
For each of the followingcases, find the present value at time zero at the given nominal interest
rate. Round your answer to the nearest cent.
Round your answer to the nearest cent.
Number of FV Deposit Nominal Deposit Present
Compounding (%) Interest

Periods Value
Periods in the Year Rate (%) (Yrs) ($)
(m)
1 900 17 10
2 800 10 21
12 400 4 3
Find the present value of the following mixed stream of cash flows using a 10% discount rate.
(Assume deposits are made at the end of each year.) Select the closest answer.
Year Cash Flow Stream
1 $20,000
2 $15,000
3 $10,000
● $38,020
● $37,900
● $38,090
● $38,050
You will receive a $100,000 inheritance in 6 years. You could invest that money today at
12% compounded semi-annually. What is the present value of yourinheritance?
● $49,723
● $49,680
● $49,697
● $49,735
Supposeyou'll inherit $8,700 in 22 years but need some money now. How much can you borrow from
a bank today if you promise your inheritance as repayment(interest andprincipal) of the loan?
Assume that the bank wants to earn interest of 3.4% per annum(compounded annually) on its loan.
● $4,169.34
● $4,182.17
● $4,121.25
● $4.150.23
Select the best choice below. If the interest rate iszero, then the present value interest factor(PVIF) is:
● one
● infinity
● indeterminant
● zero
The PV interest factor is 1/(1+i). If I = 1, then the factor is (1/1) = 1.
You want to withdraw $7,000 from your bank account in 2 years and $8,000 the following year. How
much do you have to have in your bank account today in order to make those withdrawals if the bank
pays interest at the rate of 11?
● $11,657.25
● $11,621.25
● $11,530.89
● $11,547.25
You want to have a balance in your bank account of $100 in 3 years. Your bank offers an interest rate
of 9% (per annum) with compounding 12 times per year. How much do you have to deposit in the
account today in order to have the balance you want in 3 years?
● $76.41
● $77.48
● $75.23
● $77.26
You are offered a tree(a giant Sitkaspruce) that will grow to its optimum size in 11 years, at which
time its lumber will be worth $13,000. What will you pay today for the tree if your alternative
investments can generate a return of 5.1%?
● $7,489.23
● $7,423.56
● $7,510.26
● $7,521.66
Your VISA bill for September has oneitem: a 72-inch Plasma television costing $3,866 which was
purchased on September 15. It is now October 15 at midnight. You have missed the payment deadline
and now owe interest. VISA calculates interest on the daily balance(with dailycompounding) from the
date of purchase. Assume that the purchase occurred atmidnight, so the September 15 purchase
accrues its first day of interest at the end of September 16. The annual rate charged by VISA is 19%. If
you pay off the debt(including interest) right now(at midnight on October 15), then how much do you
have topay? (Assume a365-day year and that the number of days is 30.)
● $3,950.23
● $4,025.17
● $4,026.20
● $3,926.83
Lyon's Furniture is advertising a"Ho! Ho! Hold the Payments for 2 FullYears!" sale.Lyon's advance
factors all of its receivables to Citibank. Citibank has credit checking terminals in all of thecompany's
stores. Once a customer isapproved, Citibank assumes the liability of collecting the receivable from
the customer(in 2 years) and immediately advancesLyon's a percentage of the sale price. If Citibank
wants to earn 14% on invested funds to cover the cost of capital and defaultrisk, then what
percentage of the purchase price will it advance toLyon's?
● 0.79
● 0.86
● 0.77
● 0.83
Chapter 4
An ordinary annuity may be defined as:
● A series of equal payments made any time over the course of a year, extending for a period of
several years.
● A series of equal payments made at regular intervals that are paid at the beginning of each
period.
● A series of payments, which may or may not be equal in value, that are received at regular
intervals at the end of each period.
● A series of equal payments made at regular intervals that are received at the end of each
period.
● Any series of payments that occur in the future.
Annuity payments are equal and occur at regular time intervals. Ordinary annuity payments occur
at the end of each period.
Sabrina deposits $400 in an account at the end of each year for 4 years. If the account pays 4%
interestannually, how much money will be inSabrina's account at the end of 4 years?
Calculate the future value of a 15-year ordinary annuity. The first payment of $22,000 occurs in one
year. Use an interest rate of 7%.
● $496,111
● $530,838
● $591,537
● $552,838
Calculate the future value of a 15-year annuity due. The first annual payment of $22,000 occurs
immediately. Use an interest rate of 7%.
● $530,838
● $552,838
● $496,111
● $591,537
Homer deposited $250 in the bank today and plans to make the same deposit next year and again the
year after that. How much will Homer have in the bank in twoyears? Homer's bank pays an interest
rate of 5.6%.
● $1,087
● $543
● $837
● $793
Homer plans to deposit $200 in the bank in one year. He plans to make the same deposit two years
from today and three years from today. How much will Homer have in the bank in fouryears? Homer's
bank pays an interest rate of 5%.
● $905
● $662
● $631
● $862
Complete the sentence by choosing the correct response from the drop-down list.
Think of the annuity in the figure as if it were athree-period ordinary annuity. If you solve for the
future value of the annuity using the formula for athree-period ordinaryannuity, then you will get the
future value as of date2.
The ordinary annuity future value formula generates the future value on the date of the last
payment in the annuity. Note that the figure doesn’t show the period prior to t=0, but with an
ordinary annuity there is no payment on that date.
In two years you will receive the first of four annual payments of $436.33. If the annual interest rate is
10%, what will be the balance in your account after the fourth payment is deposited?
● $1,260
● $1,200
● $1,344
● $2,025
● $1,272
Tony Hawk plans to retire in 30 years. Upon retirement, Tony wants to buy a home in the prestigious
Westbrook Manor Estates. He has already selected the home of his dreams and it sells, today, for
$60,000. House price inflation is expected to cause this price to increase at a rate of 4% peryear until
his retirement. How much does Tony have to save at the end of each year (starting in one year) to have
enough money to buy his dream home? Assume Tony can earn 9% on his savings.
● $1,428
● $903
● $440.18
● $1,070
Nicole is diligent and, starting on her 20th birthday, she saves $1,000. She continues her annual
deposits until her 25th birthday when she makes her final deposit and decides to stop saving. But she
leaves her accumulated savings in the bank until age 65. Paris doesn't start saving until she is 26, at
which time she starts saving $1,000 a year every year until (and including) age 65. The interest rate is
11.1589%.
What is the difference between Paris and Nicole’s savings at age 65?
You are 62 and planning your retirement. If you retireimmediately, then your Social Security benefit is
$1,963 per month. If you retire at age 67 then the benefit is $2,584 per month. If you expect to live to
age 90, then when should you retire and start claiming retirementbenefits? The interest rate is 2.8%
per annum. Assume that benefits are collected at the end of each month. Express your answer as the
difference in the future value of the benefits. (Early – Late.)
Uriah Heep celebrated his 18th birthday by opening a savings account at the Thames River Bank and
depositing $2,100. He continued to deposit the same amount on every subsequent birthday until he
was 30 years old. After making his final deposit on his 30th birthday Uriah decided to abandon his
savings plan. He never saved again, but he left the accumulated savings in the bank account. The bank
paid an interest rate of 8%. When Uriah turned 65, he withdrew the money from the bank. What was
the amount of his withdrawal?
Happy birthday! You are 30 years old today. You want to retire at age 60. You want to have
$3,000,000M at retirement. Realistically, you know that the most that you can save from your 31st
birthday until your 50th is $20,000 per year (you only save on your birthdays). How much do you have
to save each year from your 51st to your 60th birthday in order to achieve your retirement goal if you
can earn 7% on your savings?
You've graduated from college and landed a good job. You want to replace yourcar, butdon't want
to take out a car loan. Instead, you decide to invest $6
00 per month in the stock market and hope
to earn 12%. If the market performs asyou're hoping, how many years will it take to accumulate
$5
0,000? Ignore taxes.
You have been making $12,000 per-year contributions to your company retirement plan for 25
years. It now has a balance of $758,988.45. What average compounded return have youearned?
Express your answer in percentage form rounded to two decimals.
Calculate the present value of a 10-year ordinary annuity. The first payment of $10,000 occurs in one
year. Use an interest rate of 5%.
How much must be invested today to make four annual withdrawals of $20,000 each for tuition
payments if you can earn 8% compounded annually on your investment and the first withdrawal will
take place in one year? Round to the nearest whole dollar.
● $57,342
● $51,242
● $47,393
● $66,243
● $79,854
Starting one month fromnow, you need to withdraw $300 per month from your bank account to
help cover the costs of your university education. You will continue the monthly withdrawals for
the next four years. If the account pays 0.3% interest permonth, how much money must you have
in your bank account today to support your futureneeds?
If a 6-year regular annuity has a present value of $1,334.23, and if the interest rate is 11%, what is the
amount of each annuity payment?
● $300.20
● $240.42
● $346.87
● $315.38
● $263.80
Homer expects to receive $250 next year. He also expects to receive $250 in two years and again
in three years. What is the present value of those payments one year fromtoday? Assume an
interest rate of 5.6%.
You are trying to calculate how much money you should have at retirement. On your 65th birthday
you will retire and immediately make your first withdrawal of $9,983.35. You plan to make 12 such
withdrawals each year. You plan to continue withdrawing at that level and frequency until you are
90 years old. (Assume beginning of period withdrawals with the first withdrawal on your retirement
date and no withdrawal on your final birthday.) During retirement your savings will earn only 3.5%
per annum. How much do you have to have saved at retirement to fund these planned
withdrawals? Calculate to two decimal places.
Calculate the present value of a perpetuity with annual payments of $15,000. Use an interest rate
of 6% and assume that the first payment occurs one year from today.
Calculate the present value of a 60-year ordinary annuity. The first payment of $22,000 occurs in one
year. Then calculate the present value of a perpetuity with the same payment. (Assume that the first
payment occurs in one year.) Use an interest rate of 8%. What is the difference between the PV of the
perpetuity and the PV of the annuity? Express the difference as a percentage of the PV of the
perpetuity.
The preferred stock of Marble Comics pays annual dividends of $1 in perpetuity(starting in oneyear).
If you buy a preferred share for $14.29 and hold it inperpetuity, then what is your annual rate of
return? Express your answer as a percentage rounded to 2 places. (i.e. 1 2.3456%= 12.35%.)
What is the future value of a perpetuity with annual payments of $1,000 compounding at 10%?
● $100,000
● It depends on the length of the perpetuity.
● Infinity
● $10,000
A perpetuity is infinite in length, therefore the future value is infinity.
An endowed faculty chair is created when a benefactor makes a donation of sufficient size that
earnings from the donation pay the salary and benefits of a professor forever. How much would have
to be donated to endow a chair in your name if the salary and benefits were $90,000 and the interest
rate was 5%? Assume that the first salary(with benefits) is paid in oneyear’s time.
Calculate the present value of a perpetuity with annual payments of $22,000. Use an interest rate
of 8% and assume that the first payment occurs immediately.
Homer expects to receive $317.25 two years from today. He also expects to receive $317.25 in three
years and again in four years. What is the present value of those payments today? Assume an interest
rate of 6%.
Wally, president of Wally's Burgers, is considering franchising. He has a potential franchise
agreement that would see him receive 13 end-of-year payments starting one year from now. The
first two payments would be $27,000 and $23,000 in one and two years respectively, and then
$19,000 per year after that for 11 years. If Wally requires a return of 10.7%, what is the present
value of this stream of cash flows?
Gina is interested in buying a house beside the university which she will rent to students. She
expects to receive $900 a month in rental income. G ina's real estate agent estimates that she will
be able to sell the property for $225,000 at the end of 2.25 years. Gina wants a return of 0
.5% per
month. What is the most that she should pay for theproperty? Assume that she will purchase the
house today and receive the first(beginning ofmonth) rental payment today.
Suppose your credit card balance is $14,000. The minimum monthly payment is $364, and the
annual interest rate is 17.8%. If you pay the minimum payment every month, how long will it take
you to pay off the credit cardbalance? Express your answer in months rounded to the nearest
month.
You have been making $2,200 per-year contributions to your company retirement plan for 20
years. It now has a balance of $254,000. If you want to withdraw $20,800 per year for 30 years,
what annual compounded return must youearn? Express your answer in percentage form rounded
to two decimals.
You are 30 years old today. You want to retire at the age of 60. You expect to live until age 90. You
would like to have annual income of $170,000 in retirement. How much do you have to save (per year)
during your working years in order to achieve your retirementgoal? Assume end of period payments,
so you start saving at age 31, end savings on your 60th birthday, begin retirement withdrawals at age
61, and make your last retirement withdrawal at age 90. Assume an interest rate of 6%.
PVIFA
You tried to sneak a cappuccino into the movie theatre. It spilled on your leg and scalded you. Your
lawyer says that you can expect a payout from the coffee shop’s insurance company of $10,000 per
year for 11 years. The only catch is that the first payment won’t happen until the court case is over in 2
years. What is the present value of your settlement as of today? Assume an interest rate of 4%
While exploring your grandparents’ attic you found an old Consol bond. The bond was issued in 1751
by the British government and promised the holder an annual payment of $5 every year on January 1
in perpetuity. Today is January 1, but the British Government didn’t make its promised payment. Due
to financial difficulties, it has suspended Consol bond payments. It has promised to resume those
payments in 2 years. What is the present value of the bond’s payments if the interest rate is 2%?
You are trying to decide how much money you will need at retirement. You expect to retire at age 65.
You hope to travel extensively while you are healthy enough. To finance your travels (and cover your
basic living expenses) you think you will need income of $175,000 per year (at the end of each year).
You will make your first withdrawal on your 66th birthday. You expect to stay healthy enough for travel
for the first 13 years after retirement and thus make a withdrawal of $175,000 at the end of each of
those 13 years. Once your active travel years are over you will settle down into a retirement home.
During your retirement home years you will only need $120,000 in income per year. You expect to live
in the retirement home for 6 years. You will make the first retirement home withdrawal 14 years after
retirement and all subsequent withdrawals will continue to be at year-end. If retirement savings will
earn a return of 7%, then how much will you need at retirement to fund these planned withdrawals?
In the followingcase, the mixedend-of-period cash flow stream has an annuity embedded within
it. Calculate the present value of the cash flowstream, assuming a 6% discount rate.
Year Cash Flow

1 $6,500
2 $3,500
3 $1,500
4 $1,500
5 $1,500
6 $1,500
7 $8,500
Two years ago, you bought 100 shares of MegaCorp for $10 per share. Last year you bought
another 100 shares for $9 per share. Yesterday you sold the 200 shares for $12. What is your
compound annual return on the investment?
You are trying to choose between investing in an Index mutual fund (that mimics the S&P500) or
buying units of an exchange-traded-fund (ETF) that invests directly in the S&P500. Both investments
give you exposure to the S&P500, but the difference is in the way fees are assessed. The mutual fund
subtracts an annual fee of 1% from the gross returns on the fund. The S&P500 is expected to grow at a
rate of 8% (0.667% per month) in the future, so the return on the Index mutual fund will be 7%
(0.5833% per month). You are 30 years old today. You plan to save $400 per month at the end of each
month until your 65th birthday. So, you expect to accumulate $720,421.84 by investing in the mutual
fund. Alternatively, you could invest in the ETF. With the ETF there are no management expenses
which reduce the return--you will earn the same return as the S&P500. However, you pay a brokerage
commission ($fee) each time that you trade (so your actual ETF purchase each month is $400 – $fee).
How big does the trading commission ($fee) have to be on the ETF in order for the future value of the
two strategies to be equal? (Assume monthly periodicity and monthly purchases of the ETF. Ignore any
commission on selling at age 65.)
You are 30 years old today. You want to retire at the age of 55. You expect to live until age 85. You
would like to have a monthly income of $10,000 per month in retirement. How much do you have to
save per month during your working years in order to achieve your retirementgoal? Assume end of
period payments. Assume an annual interest rate of 5% in retirement and 7% during your working life.
You are 40 years old and want to retire at age 60. Eachyear, starting one year fromnow, you will
deposit an equal amount into a savings account that pays 7% interest. The last deposit will be on your
60th birthday. On your 60th birthday you will switch the accumulated savings into a safer bank
account that pays only 4% interest. You will withdraw your annual income of $140,000 at the end of
that year(on your birthday) and each subsequent year until your 85th birthday. On that birthday you
want to give $1,000,000 to your children. How much do you have to save each year to make this
retirement planhappen?
Yesterday, you invested $40 in an investment. Assume that investment repays you a lump-sum of $50
in one year. Use this information to answer the following question.
If you receive an additional cash payment from the investment of $5 at the end of the year, then what
interest rate have you earned over the year?

in one year. Use this information to answer the following questions.
If you receive an additional cash payment from the investment of $8 at the end of the year, then what
interest rate have you earned over the year?
in one year. Use this information to answer the following question.
If you receive an additional cash payment from the investment of $5 at the beginning of the year (right
after you make the investment), then what interest rate have you earned over the year? Round your
answer to the nearest hundredth.
You are going to borrow $97,000 to fund the start of your new restaurant. The bank wants to be
repaid with a balloon payment in 4 years. They charge 9% interest. How much will your payment
be?
Sally wants to buy a Ford Mustang. The MSRP is $30,000. Ford offers a purchase financing plan with no
money down and 48 end-of-month payments of $650. Should she buy the car for cash or take Ford's
purchase financing? Assume that she has the cash and could invest it to earn 3%. Calculate the present
value of each alternative and enter your answer as the PV of the cash purchase minus the PV of the
financing.
You want to borrow $60,000. Your bank offers an amortized loan with annual, end-of year
payments over a 25-year term. The bank charges an interest rate of 11%. What are the annual loan
payments?
You have just borrowed $318,800.01 to buy a new home. The term of the amortized loan is 30 years.
You have decided to make monthly payments. If the stated (nominal) annual interest rate is 4%, what
is the amount of each of the monthly payment? Round to the nearest whole dollar.
● $1,515
● $1,440
● $1,493
● $1,522
● $1,472
The BMW M5 retails for $90,000 (all taxes included). BMW Financial Services offers a 3-year car
loan at an interest rate of 5.5% with end-of-month payments. The payments are $2,717.63. How
much interest will you pay over the life of the loan (in the blended payments)?
A Hummer H3 sells for $64,329.12 tax included. GMAC lends money at the rate of 3% APR. If you buy
the car and borrow through GMAC, then what are the monthly (end-of-month) payments for a seven
year term?
You borrow $11,000 over a 5-year term. The loan is structured as an amortized loan with annual
(end-of-year) payments and an interest rate of 5%. The annual payments are $2,540.72. How much of
the second payment is a repayment of principal? Round your answer to two decimal places.
You borrow $300,000 over a 30-year term. The loan is structured as an amortized loan with annual
payments and an interest rate of 8%. How much principal is owing at the end of two years? Round
your answer to two decimal places.
The Shelby Cobra retails for $43,956.65 (all taxes included). What are the monthly loan payments for
the car if you make a down payment of $5,000? The term is 5 years and the APR is 3%. (Car loan
payments are made at the end of each month.)
You borrowed $343,191.15 14 years ago. The loan is structured as an amortized loan. The interest rate
is 4% and you make monthly payments of 1811.49. The loan is amortized over 25 years. How much
principal have you paid over the first 14 years?
The BMW M5 retails for $90,000 (all taxes included). BMW Financial Services offers a 5-year car loan
at an interest rate of 5% with end-of-month payments. The payments are $1,698.41. How much
reinvestment interest does BMW earn over the life of the loan?
You borrow $ 220,000. The loan is structured as an amortized loan to be repaid over 3 years with
52 (end-of-period) payments per year. The lender is charging you a rate of 15.5% APR. ( Assume
that the lender can continue to earn 15.5% by reinvesting thepayments.) How much interest does
the lender earn over the life of theloan?
Angela owes $ 9,951.56. She has made arrangements to repay the debt in installments of $248.73
permonth and will be charged monthly interest of 1.62% on the overdue balance. How many
months will it take her to repay the debt andinterest? Assumeend-of-month payments. Round
your answer to months.
PV = PMT x PVIFA
In the early2000s, GM sold the Chevrolet Cavalier for a cash price of $15,000. GM also offered0%
financing over a 70-month term, thatis, a loan where you buy the car with end-of-month payments.
With0% financing, the payments do not include any interest--they are just equal to the price
divided by the number of payments. The catch with0% financing was that the price used to
calculate the payments was higher than the cash price of the car. For the sake of thisexample,
let's say that it was $
16,500. Given this higherprice, what is the actual APR (‘i') of theloan?
Express your answer in percentage form and round to two decimal places(e.g., 12.34%).
Some banks allow you to skip a loan payment and roll it into your principal. This is especially attractive
in January when the Christmas VISA bill arrives. Consider the following simplified example. You
renovated your house last year and borrowed $90,000. The term of the loan is threeyears, the rate is
7% (APR), and the annual(end-of-year) payments are $34,294.65. The end of the first year arrives and
you can’t afford to make the first payment. You want to roll it into your principal. Your bank has
offered to increase the size of the second and third payments to allow you to do this. Answer the
following two questions.
What will your new(second andthird) loan paymentsbe? (Hold everything else in your loanconstant,
e.g., remaining amortization period and interestrate.)

Compare the amount of interest in the two sets of loan payments. How much more interest do you
pay over the life of the loan(if you skip the firstpayment) compared to what you would have paid if
youhadn't skipped the firstpayment?
South Penn Tracking is financing a new truck with a loan of $10,235.12 to be repaid in 5 annual
end-of-year installments of $2,700. What annual interest rate is the company paying?
● 7%
● 9%
● 10%
● 11%
● 8%
Jed wants to borrow $
1,000 from you. He is proposing to repay you with three annual payments of
$379.69 starting immediately. Inaddition, he will make a finallump-sum payment of $
150 three
years from today. What rate of return are you earning on theloan? Express your answer in
percentage form rounded to two decimal places.
You have just taken out an amortized loan for $500,000. Assume that the loan will be paid in 72
equal monthly installments of $8,286.44and that the first payment will be due 1 month from
today. How much of your third monthly payment will go toward the repayment ofprincipal? Fill in
the value for the ‘Principal Repayment’ month 3 in the worksheet below. Round your answer to two
decimal places.
Step 1: solve for i:
https://www.calculator.net/interest-rate-calculator.html?cloanamount=500000&cloanterm=6&cmo
nthlypay=8286.44&x=109&y=25
(i/m) = i / 12
Jed wants to borrow $1,000 from you. He is proposing to repay you with three end-of-year
payments of $330.69. In addition, he will make a final lump-sum of $150. What rate of return are
you earning on the loan? Express your answer in percentage form rounded to two decimal places.
You are going to lease a new Hudson Hornet. The sticker price for the car is $31,035.95. The term of
the lease is 36 months, the rate on the lease is 3% and the buyout is 45%. If you decide not to make a
down payment, then what are the monthly lease payments (before tax)?
the lease is 36 months, the rate on the lease is 2.5% and the buyout is 45%. If you decide not to make
a down payment, then what are the monthly lease payments (before tax)?
● $550
● $510
● $530
● $570
the lease is 36 months, the rate on the lease is 2% and the buyout is 45%. If you decide not to make a
down payment, then what are the monthly lease payments (before tax)?
You are going to lease a brand new Edsel Corsair. The price of the Corsair is $56,104.10. You intend to
make a $3,000 down payment. The term of the lease is 48 months and the lease rate is 3% APR. The
buyout for the lease is 43% of its purchase price. What are the monthly lease payments (before tax)?
You are going to lease a brand new Edsel Corsair. The price of the Corsair is $61,998.55. You intend to
make a $3,000 down payment. The term of the lease is 48 months and the lease rate is 2% APR. The
buyout for the lease is 45% of its purchase price. What are the monthly lease payments (before tax)?
One year ago you signed a 4-year lease on a DeSoto Fireflite Sportsman. The sticker price on the car
was $46,657.97, the lease rate was 2%, and the monthly payments (starting at the time of signing)
were $544.10. The buyout was $23,328.98 due at the end of the lease term. Now (one year after
signing the lease but just before the 13th lease payment) DeSoto has just released the new Fireflite
Sportsman with better styling and 20% more horsepower. You want to get out of your lease on the old
car and lease one of the new ones. How much remains owing on your lease?
One year ago you signed a 4-year lease on a DeSoto Fireflite Sportsman. The sticker price on the car
was $55,762.32, the lease rate was 2%, and the monthly payments (starting at the time of signing)
were $650.27. The buyout was $27,881.16 due at the end of the lease term. Now (one year after
signing the lease but just before the 13th lease payment) DeSoto has just released the new Fireflite
Sportsman with better styling and 20% more horsepower. You want to get out of your lease on the old
car and lease one of the new ones. How much remains owing on your lease?
Two years ago you signed a 4-year lease on a DeLorean DMC-12. The sticker price on the car was
$39,952.61, the lease rate was 3%, and the monthly payments (starting at the time of signing) were
$530. The buyout was $17,978.68 due at the end of the lease term. Now (two years after signing the
lease but just before the 25th lease payment) DeLorean has just released the new DMC-13 with better
styling and 20% more horsepower. You want to get out of your lease on the old car and lease one of
the new ones. DeLorean is happy to take your car from you and cancel the lease if you have positive
equity in the car. That is, if the resale value of the car exceeds the principal sill owing (the difference is
positive equity). However, if the resale value is less than the principal outstanding, DeLorean will
require you to pay the difference in order to exit the lease. The resale value of the old DeLorean is
$29,794.75. What is the value of your equity in the car?
You would like to lease a car. The car costs $59,337.53. You have $5,000 for a down payment. The
dealer has offered you a48-month lease with monthly payments of $700. At the end of theterm, the
buyout for the lease is 49% of the purchase price. What is the APR on thislease?
You would like to lease a car. The car costs $65,816.28. You have $5,000 for a down payment. The
dealer has offered you a48-month lease with monthly payments of $750. At the end of theterm, the
buyout for the lease is 49% of the purchase price. What is the APR on thislease?
You want to drive a Studebaker Hawk (Price = $68,743.24) but you really can’t afford it. So, your plan is
to lease it for four years and then borrow the money for the buyout. The lease rate is 6.9% and the
buyout is 52% of the purchase price. The loan for the buyout will have monthly (end-of-period)
payments over a four-year term with a rate of 6%. How much interest will you pay over the eight year
period? (Ignore taxes.)
You want to drive a Studebaker Hawk (Price = $83,126.79) but you really can’t afford it. So, your plan is
to lease it for four years and then borrow the money for the buyout. The lease rate is 4.9% and the
buyout is 52% of the purchase price. The loan for the buyout will have monthly (end-of-period)
payments over a 4-year term with a rate of 4%. How much interest will you pay over the 8-year
period? (Ignore taxes.)
The AMC Gremlin has a sticker price of $105,500. You are trying to choose between a lease or a loan
and you wonder if there is a tax advantage to the lease. The lease rate is 6.9%. The term of the lease is
four years. The buyout is $58,025 at the end of the lease. The lease payments are monthly. With
leases, the lessee pays sales tax on all payments including the buyout. The loan charges the same rate
as the lease and payments are monthly over a 4-year term. With loans, the sales tax is paid on the
price of the car and forms part of the loan principal. What is the difference between the tax on the
lease and the loan? (Discount all taxes to time zero, the date of the lease/loan, and assume a sales tax
rate of 13%.)
Kelvinator Appliances sells its 4.0 cubic foot, stainless steel front-load washer and steam dryer set for
$1,900. It offers a 48-month purchase financing arrangement with end-of-month payments of $40.
Customers have to make a final lump-sum payment called the “buy-out.” After the buy-out customers
own their washer-dryer. Whirlpool advertises its financing rate of 6% APR. What buyout makes this a
fair deal?
● $250.02
● $279.40
● $194.60
● $182.83
You have just purchased a $250,000 home, and the bank has quoted you an interest rate of 3% on a
25-year mortgage. You chose to make 24 payments per year. What periodic rate should you use to
calculate the mortgage payments? Express your answer in percentage form rounded to four decimal
places.
You bought a house and need a mortgage for $1,011,057.55. The interest rate on the mortgage is
2.75% and the amortization period is 30 years. You chose to make 26 payments per year. How much is
each payment?
You bought a ski chalet at Mount Tremblant for $357,367.07. You borrow the full amount over a
25-year term. The bank quotes you a rate of 3%. You choose to make monthly payments. Over the life
of themortgage, what is the total amount of interest that youpay?
● 150,000
● $125,000
● $200,000
● $175,000
You bought a house 3 years ago. To finance thepurchase, you took out a mortgage for $962,305.82.
The interest rate on the mortgage is 3% and the amortization period is 30 years. You chose to make 26
payments per year and each payment is $1,866.82. Your last payment was yesterday. How much
principal remains owingtoday?
You have just negotiated a home mortgage with a principal of $700,000. The bank’s quoted rate is 3%.
You chose a 25-year amortization and you decide to make 24 payments per year. Each mortgage
payment is $1,655.33. How much interest do you pay in the first year? Express your answer as a
percentage of the total value of your mortgage payments in the first year.
Mister Greenjeans wants to borrow $4,500,000 to purchase farm land to grow soy beans. He has
approached the Agriculture Services division at his bank to arrange a farm mortgage. The bank has
quoted him a rate of 6%. Mister Greenjeans wants to make quarterly payments of $101,044. He also
anticipates that he will have to borrow an additional $500,000 after 15 years for land improvement
costs. This extra principal will be added to the balance owing on the mortgage. How long will it take
Mister Greenjeans to pay off the mortgage? (Express the answer in quarters.)
Kastle Homes Inc. builds luxury homes. Kastle Financial offers mortgage financing for Kastle home
buyers. You are the new analyst at Kastle Financial. Your boss wants to offer a promotion whereby
buyers of their new model home, the Motte & Bailey (M&B), receive another identical M&B home at
the end of the amortization period. An M&B home retails for $787,921.23. Kastle offers mortgages
with a 25-year amortization period, monthly payments and it charges a rate of 3%. Your boss wants
you to calculate the monthly mortgage payments for the promotion.
Chapter 5
The relationship between risk and return can best be described as______.
● logarithmic
● inverse
● convoluted
● direct
As risk increases, the return must also increase.
A _________ return usually incurs__________ risk.
(Select the best choicebelow.)
● higher; lower
● decent; very high
● lower; higher
● higher; higher
As returns increase, it is usually accompanied with increased risk.
Which of the following is a true statement?
● Although economists understand the relationship between risk and return, they have been
unable to develop a way to quantify it.
● There is a direct relationship between risk and expected return.
● Riskless investments do not usually earn a positive return.
● Risk and the likelihood of realizing future cash flows from an investment are unrelated.
Options A, C, and D are not correct because economists have quantified risk, securities such as
treasury bills–which are riskless–do earn positive returns, risk and return are clearly related, and
the length of any recession is difficult to predict. Therefore, B is the correct answer.
If there is absolutely no risk to an investment,
● there will be some return.

● the return will be zero.
● the return will depend upon market conditions.
● the return will be negative.
Even when risk is zero, investors demand a return for delaying consumption. The treasury bill is
considered zero risk, but it usually provides a small return.
You have invested in Even Temper Dog Collars Inc. Your initial investment is $101.12. After a year your
investment is valued at $111.76. The firm paid a $2.56 dividend at the end of the year. What is the
capital gainyield?
● 10.52%
● 2.29 %
● 17.05 %
● 2.53%
Capital gain yield is (111.76 - 101.12)/101.12 = 10.52%.
Assume you buy a share of stock at $29, it pays $1.97 individends, and you sell it 237 days later for
$22. What is your annualizedreturn? Enter a negative percentage for a loss and assume a365-day
year.
● -13.30%
● 17.34%
● -26.71%
● -17.34%
Which average rate of return best reflects what an investor earns overtime? (Select the best choice
below.)
● average return
● weighted average return
● arithmetic return
● compound return
The compound return reflects the actual increase in wealth an investor will realize from an
investment.
You bought stock in your favorite online retail company at a price of $76 per share. You recently sold
the stock for a price of $83 per share. While holding thestock, you received dividends of $1.07.
What was your holding periodreturn?
● 9.72%
● 13.16%
● 10.75%
● 10.62%
Compute the holding period return for a security you bought for $29.78 last year and sold yesterday
for $35.71. You received $1.07 in dividends while you owned the stock.
● 22.58%
● 23.51%
● 17.25%
● 16.58%
You invested in a stock when it was selling for $10 per share. You just sold it for $17 per share.
What was your holding period return?
Can this return be compared to annual returns without making adjustments? (NO)
Assume that you buy a share of stock at $20.50, it pays $1.00 in dividends, and you sell it 90 days later
for $21.00. What is your annualized return?
● 28.5%
● 30.4%
● 29.7%
● 7.32%
You bought a stock for $76.81 and sold it after 4 years for $100.37. What is the average compound
annualreturn?
● 7.58%
● 10.25%
● 6.92%
● 9.37%
Which of the following statements best describes the expected return concept? (Select the best
choice below.)
● The expected return is the weighted average of all stocks in your portfolio.
● The expected return is the arithmetic average of the expected states of nature.
● The expected return is the weighted average return where the weights represent what you
expected the security to return in various states of nature.
● The expected return is the return you need to be satisfied with your investment.
The process of computing the expected return is to compute the probability of each state of
nature and the expected return in each of these states. You then find the weighted average.
Which of the following statements is true?
● Investment analysts do not need to be skilled at predicting the future to properly assign
expected returns.
● Investment analysts spend most of their time building tables that reflect all the possible
states of nature and assigning probabilities to each.
● There are usually only 5 or 6 meaningful states of nature.
● The concept of assigning weights to the possible states of nature is only a way of describing
the mental process analysts go through to determine the expected return.
Analysts don’t really try to assign weights to the different states of nature. This discussion is only
a way of describing a mental process.
What is the expected return for a security ifthere's a 45% probability of returning 11% and a 55%
probability of returning 18%?
● 14.85%
● 13.58%
● 16.25%
● 13.12%
Suppose you purchased 1,000 shares of Pan Am Airlines at the beginning of the year for $15.08. By the
end of theyear, the stock price had appreciated to $18.79. At the end of theyear, Pan Am paid a
dividend of $1.02 per share. Calculate your capital gain on this investment over the year.
● 24.46%
● 24.60%
● 23.45%
● 23.78%
You bought stock in ZULU Corp 4 years ago at $28.57/share. You just sold it for $40.88/share. What
was your compound averagereturn?
● 4.32%
● 9.37%
● 8.65%
● 10.77%
Compute the expected return for a security with the following projected returns.
State of the Probability Projected
Economy (%) Return (%)
Recession 8 -14.02
Moderate 19 5.05
Average 51 11.13
Good 15 18.67
Outstanding 7 21.05
● 9.79%
● 11.56%
● 10.25%
● 12.47%
The table below shows the closing value(end ofyear) and returns on the NASDAQ Composite
Index from 1998 to 2003. You will note that there was a fair amount of variation in the yearly
returns over thisperiod! Compute the arithmetic average and the compound average of the returns
over the period from Dec31, 1998 to Dec31, 2003. Calculate the difference between the
arithmetic average and the compound average.
Year Index Return
1998 2,192.68
1999 4,069.31 85.59%
2000 2,470.52 -39.29%
2001 1,950.40 -21.05%

2002 1,335.51 -31.53%
2003 2,003.37 50.01%
A. The arithmetic average return is
%. (Round to two decimalplaces.)
B. The compound average returns is negative
C. The difference is
It costs $100 to enter the following game of chance based on the outcome of a coin toss(fair coin). If
the coin comes up'heads,' you walk away with $125. However, if the coin comes up'tails,' you walk
away with $55. What is the expected return on thisgamble?
● -12%
● 10%
● 90%
● -10%
You hold a portfolio composed of 20% security A and 80% security B. If A has an expected return of
10% and B has an expected return of 15%, what is the expected return from yourportfolio?
● 14%
● 15%
● 16%
● 18%
Which of the following is a falsestatement? (Select the best choicebelow.)
● Expected returns are not always predicted accurately.

● Accurate predictions of expected returns depend on theanalyst's ability to estimate
probabilities.
● Expected returns may differ from actual returns because of an unforeseen recession.
● Although expected returns may differ from actualreturns, they seldom do.
Actual returns often depart from what was expected.
The expected return on an asset is 13% and the required return is 12%. You should probably
● hold the asset.

● sell the asset now.
● wait and see what happens to actual returns before making a decision.
● buy the asset now.
The answer is D because if you expect 13, but only require 12 to be happy, then the security is a
good deal.
Why do you square the deviations from the mean in one step of computing the standard deviation and
then reverse it later by taking the squareroot?
● This process allows you to practice using your calculator.

● This process is meant to confuse those whohaven't taken finance.
● This process standardizes the result to allow for comparisons across companies.
● This process eliminates negative signs to avoid matching negative surprises with positive
surprises to mask volatility.
Variability in returns adds to risk regardless of whether it is positive or negative. We need to
capture both positive and negative deviations by our measure of risk. If we didn’t square the
deviations, the positive and negative deviations could cancel.
The following data are available for Agness Corporation. (Assume an equal probability for each
possible economy.)
Project Project
1 2
Investmen $1,000 $1,000

t
Expected Return
Recessio 3% 0%
n
Normal 5% 5%
Boom 7% 10%
a. What is the expected return for each project?
Project 1:
Project 2:
b. What is the range of return of each project?
Project 1:
Project 2:
c. Which project is most risky?
Project
You believe that next year there is a 30% probability of a recession and 70% probability that the
economy will be normal. If your stock will yield −10% in a recession and 20% in a normalyear, what is
the standard deviation of thestock?
● 12.25%
● 13.50%
● 13.75%
● 14.25%
You believe that next yearthere's a 29% probability of a recession and a 71% probability the
economy will be normal. If your stock will yield -9% in a recession and 18% in a normalyear, what
is your expected annual return and standarddeviation? Round your answers to four decimal
places.
Your portfolio has an expected return of 11.60%. The portfolio includes two stocks. The first stock has
a weight of 0.70 and the second has a weight of 0.30. If the expected return on the first stock is 11%,
then what is the expected return on the second stock in percentageterms?
● 13%
● 14%
● 11%
● 12%
As a beerconnoisseur, you've decided to invest in some beer companies. Your father suggests that you
buy 950 shares ofAnheuser-Busch InBev, which are currently priced at $26.42 per share. Your brother
suggests that you buy 1,360 shares of MolsonCoors, which are currently priced at $34.26 a share.
What is the portfolio weight for theAnheuser-Busch InBevholding?
● 0.40
● 0.35
● 0.50
● 0.45
Consider a portfolio that includes the following twocompanies:
Company 1 Company 2
Price Number of Shares Price Number of Shares
$6.00 700 $9.00 1,400
The portfolio has weights which are equal to the value of eachcompany's shares relative to the total
value of both companies. What is the portfolio weight for Company1?
● 0.25
● 0.45
● 0.35
● 0.75
Sabina Resources has a claim in the Hackett River of the Northwest Territories that is estimated to
contain some 47 million tons of ore rich insilver, zinc,copper, lead, and gold. Hackett River
Explorations has staked a claim besideSabina's and will issue stock to raise funds for test drilling. The
table below outlines the various possible outcomes of the test drilling and the associated returns on
the stock if you buy some. What is the expected return on the stock if you buy some of the newissue?
States of Nature Probabilities Returns
Nothing of value in claim 0.40 −100%
A small area of ore 0.30 −20%
A large amount of zinc 0.15 75%
A large amount of silver 0.15 250%
● 2.50%
● 2.75%
● 2.25%
● 3.00%
Compute the expected return for the following portfolio.
Security No. of Shares Price per Expected Return
in Portfolio Share($) on Security(%)
A 36 49.06 29.4
B 97 20.73 21.9
C 98 12.62 13.8
● 3.16%
● 22.54%
● 22.25%
● 22.75%
Which of the following is a false statement?
● Expected returns are not always predicted accurately.

● Historical returns can be calculated with more confidence than expected returns.
● Expected returns may differ from actual returns because of an unforeseen recession.
● Although expected returns may differ from actual returns, they seldom do.
The correct answer is D. Historical returns can be predicted with perfect accuracy. Expected
returns may differ from actual because expected returns are just an educated guess. The accuracy
of the expected return is entirely dependent on the skill of the analysts. In fact, actual and
predicted are frequently very different.
Select the best choice below. An expected return from a portfolio
● will exceed the highest expected return from any of the securities in the portfolio.
●will be lower than the expected return from the security in the portfolio with the lowest yield
because portfolios have less risk than individual securities.
● will lie somewhere between the highest and lowest expected returns from securities in
the portfolio.
● can be calculated more accurately than the expected return from any of the securities in the
portfolio.
The expected return is really just a weighted average and averages lie between the highest and
lowest values.
What is the expected return for a portfolio composed of 42% of assetA, with an expected return of
12%, and 58% of assetB, with an expected return of 16%?
● 14.32%
● 13.41%
● 13.65%
● 14.06%
What is the expected return for the following portfolio?
Security # of shares Price per share Expected return
Winner 100 $25 12%
Loser 200 $20 6%
● 8.31%
● 3.69%
● 9.25%
● 4.62%
The expected return of the portfolio is 8.31%.
Select the best choicebelow. Correlation
● may only be positive.

● measures the degree to which a change in the riskiness of one security causes the risk of
another to change.
● ranges between -1 and 1.
● is usually negative for a portfolio with two securities.
Correlation coefficients range from perfectly negatively correlated (-1) to perfectly positively
correlated (+1).
If the required return from an asset is 9.9% and the asset has a 55% probability of yielding a 21.5%
return and a 45% probability of earning a 5.9% return. Which investment activity should youmake?
● You should not purchase the assets since the required return exceeds the expected return.
● You should not purchase the assets since the expected return exceeds the required return.
● You should purchase the assets since the required return exceeds the expected return.
● You should purchase the assets since the expected return exceeds the required return.
If Microsoft stockholders expect either a 25.6% return or a 1.8% return, each with a 50% probability,
and Apple Computer shareholders expect a 10.3% return withcertainty, what is the expected return
from a portfolio comprised of equal amounts of stock from bothfirms?
● 11%
● 12%
● 9%
● 10%
Assume you currently hold one type of security and decide to construct a portfolio. Which of the
following would provide the greatest degree of riskreduction?
● Adding a security that has perfect negative correlation with the one you are holding.
● Adding a security that has perfect positive correlation with the one you are holding.
● Adding a security that is uncorrelated with your current one.
● Adding apositively, but notperfectly, correlated security.
Adding negatively correlated securities will reduce the risk of the portfolio.
Select the best choicebelow. By incrementally adding securities to aportfolio,
● you may reduce portfoliorisk, even if new securities are not negatively correlated with
others in the portfolio.,
● you can reduce portfolio risk only if the new security is uncorrelated with the others in the
portfolio.
● you raise portfolio risk since having more securities in a portfolio increases the likelihood
that one of them will become worthless.
● you reduce risk at an increasing rate.
Adding securities to a portfolio typically lowers risk unless they are perfectly positively correlated
with the portfolio.
If you have a portfolio and want to add a security to reduce your total portfoliorisk, you would prefer
to add one that is __________ with the other securities you hold.
● negatively correlated
● uncorrelated
● positively correlated
● alternatively correlated
Adding negatively correlated securities will reduce the risk of the portfolio.
Is it possible to hold a portfolio where the risk of the whole portfolio is lower than the risk of any asset
within it?
● No – risk will be the average of assets in the portfolio and will fall between the high and low.
● Yes – diversification among stocks lets the positive and negative swings due to individual
security attributes cancel.
● No – risk is cumulative and will be multiplicative of the individual risk.
● No – risk is summative and will be the sum of the risk of the individual securities.
When stocks are less than perfectly positively correlated, the swings in one stock can cancel the
swing in another the resulting portfolio can have lower risk that either stock individually.
Chapter 6
Consider the data provided in the table for a portfolio of assets A and B. The correlation of returns of
the two assets is 0.43. What is the standard deviation of the portfolio?
Asset A Asset B
Portfolio Weight 0.55 0.45

Standard
Deviation 0.38 0.39
Variance 0.1444 0.1521
Consider a two-asset portfolio containing two risky assets with positive portfolio weights. As the
correlation between the two stocks goes down, the variance of returns of the portfolio
● goes up.
● goes down.
● stays the same.
The first derivative of the variance of a two-asset portfolio with respect to the correlation
coefficient is positive, which means that an increase in correlation raises portfolio variance and a
decrease reduces variance.
Consider the data provided in the table for a portfolio of assets A and B. The standard deviation of the
portfolio is 46.7%. What is the correlation of returns of the two assets?
Asset A Asset B
Portfolio Weight 0.33 0.67
Standard
Deviation 0.4 0.5
Variance 0.16 0.25
When you form a portfolio with two risky assets that have a correlation of ___________, the standard
deviation of the portfolio is simply a weighted average of the standard deviations of the two stocks.
● minus one (-1)
● plus one (+1)
● zero (0)
What is the correlation of returns for the two assets whose portfolio return and standard deviations
are shown in the graph? (Both assets are risky and all portfolio weights are positive.)
● correlation = -1
● correlation = 0
● correlation = +1
The feasible set of portfolios of two assets is slightly bowed (like a sideways ‘u’) when the
correlation between the two returns is zero. There are a few combinations of the two assets that
yield a standard deviation that is less than the least risky of the two assets. This can be confirmed
by calculating and graphing the return and standard deviation of a portfolio of two assets for
several sets of portfolio weights when the correlation is zero.
● correlation = 0
The feasible set of portfolios of two assets is a sideways ‘v’ when the correlation between the two
returns is minus one. There is one portfolio that has a standard deviation of zero. This can be
confirmed by calculating and graphing the return and standard deviation of a portfolio of two
assets for several sets of portfolio weights when the correlation is minus one.
● correlation = 0
The feasible set of portfolios of two assets is a straight line when the correlation between the two
returns is plus one. The standard deviation of the portfolio is a simple weighted average of the two
assets’ standard deviations. This can be confirmed by calculating and graphing the return and
standard deviation of a portfolio of two assets for several sets of portfolio weights when the
correlation is minus one.
You are a portfolio manager building a low-risk portfolio. Two of your analysts are arguing over
whether the portfolio should include shares in Intelsat, the satellite manufacturer. Which of the
following of the analysts’ arguments is correct?
● The stock should be included, because it is low risk. The event of a launch failure is
uncorrelated with the risks affecting the other stocks in the portfolio.
● The stock should not be included because it is too risky. It has a very high standard deviation
of returns, because if a rocket launch fails, then the company loses a satellite worth more than
$250 million.
The risk of a launch failure is uncorrelated with any other event in the economy. In the context of a
portfolio of weakly correlated stocks, adding a stock with a correlation of zero with all other stocks
will reduce the average covariance of the portfolio and so reduce the risk of the portfolio.
The graph below shows the returns and standard deviations of the portfolios of assets A and B. Asset
A has an expected return of 5% and standard deviation of 20%. Asset B has an expected return of 12%
and standard deviation of 50%. The returns on the two assets are perfectly positively correlated.
Portfolio X has an expected return of 6.75% and standard deviation of 27.5%. What is the portfolio
weight on asset B in the portfolio marked X on thegraph?
WB = 0.25
If you calculate the standard deviation of returns for a singlestock, what type of risk are you
measuring?
● unsystematic (diversifiable) risk

● total risk
● systematic (non-diversifiable) risk
Total risk of an asset (or portfolio) can be divided into two parts: diversifiable and non-diversifiable
risk. Non-diversifiable risk is proportional to beta. The standard deviation of returns of the asset
(or portfolio) captures the sum of both parts, which is total risk.
The Wilshire 5000 index includes the shares of5,000 U.S.-listed equities. If you measure the standard
deviation of returns on theindex, whattype of risk are you(mostly) measuring?
● total risk
As the number of assets in a naively diversified portfolio is increased, the amount of firm-specific
(diversifiable) risk is reduced towards zero. The Wilshire 5000 index isn’t naively diversified, but it
is so large and well diversified that it contains virtually no diversifiable risk.
What is another name for unsystematic risk?
● specific risk
● firm-specific risk
● total risk
● non-diversifiable risk
● market risk
Firm-specific risk is the risk of holding one (or a few) firms in a portfolio. This is risk that can be
eliminated through diversification. Also called diversifiable risk or unsystematic risk.
Match each of the following with its type of risk: systematic or unsystematic.
- Worries about deflation: systematic
- Latest unemployment figures increased, as expected: systematic
- Tim Cook to step down as Apple CEO due to improprieties: unsystematic
- Toll Bros (luxury home builder) raises EPS guidance due to large increase in housing
starts: systematic
- Federal government’s deficit larger than expected: systematic
- GM loses large Chinese government truck contract: unsystematic
- Higher quarterly loss than expected for Proctor and Gamble: unsystematic
Unsystematic (firm-specific) risk is the risk of holding one (or a few) firms in a portfolio. This is
risk that can be eliminated through diversification. Corporate vicissitudes are an unsystematic
risk. The events at Proctor and Gamble, Apple, and GM are unwelcome changes of circumstances
but are isolated to those companies. In the case of Toll Bros, an increase in housing starts
presages widespread economic growth as many industries are stimulated by increasing home
construction. Unemployment, deflation, and government deficits all have widespread deleterious
economic impacts and so cannot be avoided through diversification. They are examples of
systematic risk.
What type of risk can be eliminated through greater diversification and is due tofirm-specific or
industry-wide factors such as strikes or resource pricechanges?

● total risk
Firm-specific risk is the risk of holding one (or a few) firms in a portfolio. This is risk that can be
eliminated through diversification. Also called diversifiable risk or unsystematic risk.
Which index is popularly thought to best represent changes in technology companystocks?
● S&P 500
● Wilshire 5000
● NASDAQ 100
● Dow Jones
The Nasdaq-100 includes 100 of the largest domestic and international non-financial companies
listed on the Nasdaq Stock Market based on market capitalization. The Nasdaq-100 Index is home
to some of the world’s most innovative companies—including Apple, Google, Intel, and Tesla.
Which of the following is not a value-weighted index?
● NASDAQ 100
● Wilshire 5000
● Dow Jones
● S&P 500
Which of the following is a risk-free asset?
● a 3%, 5-year bond issued by Apple (rated AAA)

● a 52-week T-Bill
● a 2%, 10-year T-Note
● an Iranian 52-week T-Bill
Federal T-Bills (or strip bonds) are risk free. Since they are issued by the Federal government there
is no default risk and, since they have coupons, there is no re-investment rate risk. Iranian T-bills
are not risk free since there is a significant risk of default.
The Tiny stock market has two companies listed on the exchange. Data for the two shares is given in
the table below. The Tiny Market Index (TMI) is value-weighted and its base day is Day 1. What is the
percentage change in the TMI from Day 1 to Day 2?
Company A Company B
Day Price # of Shares Price # of Shares
1 $8 500 $11 1,900
2 $8.56 500 $12.10 1,900
the table below. The Tiny Market Index (TMI) is value-weighted and its base day is Day 1. What is the
portfolio weight for Company A on Day 1?
Company A Company B

1 $10 500 $11 2,000
2 $10.80 500 $11.55 2,000
The value of the shares in theS&P 500 index is $12,270B. Apple Inc. is the largest company in the
index—it is worth $552.15B. If you want to build a portfolio that earns the same return as theS&P
500, what is the portfolio weight onApple?
● 5.5%
● 6.5%
● 4.5%
● 3.5%
The Dynamic Duo is avalue-weighted index with twostocks: A and B. A constituted 75% of the value
of the index at the beginning of the year. During theyear, A went up 15% and B rose 6%. What was the
percentage change in Dynamic Duo index over theyear?
the table below. The Tiny Market Index (TMI) is value-weighted and its base day is Day 1. You hold a
portfolio with one share of company A and three shares of company B.
Company A Company B
1 $8.00 900 $12.00 2,683
2 $8.64 900 $13.56 2,683
Express your answers to the following questions in percentage form rounded to one decimal.
1. What is the return on your portfolio from Day 1 to Day 2?
2. What is the difference between the return on your portfolio and the return on the TMI from Day 1
to Day 2? (Your return minus the index return.)
3. What is the difference between the weight of company A in the TMI and the weight of Company A
in your portfolio? (Your weight minus the index weight.)
The Tiny stock market has two stocks: Company A and Company B. End-of day data for three days are
shown in the table. The Tiny Market Index is a value-weighted index on the Tine market. Answer the
questions that follow.
Company A Company B
Price # of Shares # of Shares

Price
Outstanding Outstanding
$8 500 1,900
$11
$8.56 500 1,900
$12.1
$8.817 500 1,900

$12.705
Part 1:
You created a portfolio on Day 1 to mimic the index. What is the portfolio weight on Company
A? Express your answer in percentage form rounded to two decimal places.
Part 2:
Calculate the return on the Tiny Market Index and the return on your mimic portfolio from Day 1
to Day 2. What is the difference? (Portfolio return minus Tiny Market Index return.) Express your
answer in percentage form rounded to two decimals.

Part 3:
What portfolio weight for Company A do you need to have on Day 2 in order to earn a return on
your mimic portfolio from Day 2 to Day 3 which is equal to the percentage change in the Tiny
Market Index? Express your answer in percentage form rounded to two decimals.
Part 4:
What trades did you have to make on Day 2 to adjust your portfolio so that it tracked the
index from Day 2 to Day 3?
● buy A and sell B

● sell A and buy B
● no trades
Which of the following is/are true for a stock with beta equal to 1.5?
I) The stock has a 50% higher expected return that the market portfolio.
II) Given a market risk premium of 10%, the expected return on the stock would be 15%.
III) The stock has 50% more systematic risk than the average stock.
● I, II, and III

● II only
● III only
● I only
● I and III only
The market has a beta of 1. Beta describes how much systematic risk a security has relative to the
market. Therefore, this stock has just 50% more risk than the market (we assume the market is
represented by the average stock in this case). I and II are only true if kF = 0, which is not possible.
The Templeton mutual fund has a beta of 1.2 and the Fidelity fund has a beta of 1.8. If you had
invested 60% of your wealth in Templeton and the remainder in Fidelity, then what was your
portfolio's beta?
What is the beta of a portfolio where you invest 75% of your money in the risk-free asset and the rest
in the market portfolio?
● 0.25
● 0.50
● 0.15
● 0.75
What is the beta of the portfolio shown in the table below?
Stock Value of Beta

Investment
Exxon $20,000 0.9
Walmart $50,000 0.8
Intel $60,000 2.1
What is the beta of a portfolio where you invest 40% of your money inthe risk-free asset and the rest
in the market portfolio?
● 0.80
● 0.40
● 0.60
● 0.20
Which one of the following risks is relevant in determining the size of the beta of the shares of EA
Games, the popular computer gaming manufacturer? EA Games makes titles such as Madden NFL
Football, James Bond 007, FIFA Soccer, and Need for Speed.
● Sega is trying to lure away software programmers from EA Games with attractive salaries and
bonus deals.
● Sega, a competitor, might release a new version of its football game, NFL 2K, before EA
can release the new version of Madden NFL.
● Computer games are a luxury good with high income elasticity of demand. If the economy
weakens, sales will likely fall.
● EA might not be able to renew its exclusive license with the NFL.
Computer games are a luxury good with high income elasticity of demand. If the economy
weakens, sales will likely fall. If a risk factor affects all (most) firms in the market, then it is a
systematic risk factor and is captured by beta. The other risks are all firm specific which can be
diversified away and do not affect beta.
Refer to the table below on prices and returns for Hershey and the S&P 500 to answer the following
question.
Column A Column B Column C Column D Column E
Hershey Price Hershey Return S&P 500 Index S&P 500 Return
Sep $55.80 -4.7% 1219.1 0.8%
Oct $56.31 0.9% 1190.2 -2.4%
Nov $53.97 -4.2% 1242.5 4.4%

If you were going to estimate Hershey’s beta, then you would run a regression with:
● Hershey’s price (column B) as the independent (X) variable and the S&P 500 index (column
D) as the dependent (Y) variable
● The S&P 500’s returns (column E) as the independent (X) variable and Hershey’s returns
(column C) as the dependent (Y) variable
● Hershey's price (column B) as the independent (X) variable and the S&P 500 index (column
D) as the dependent (Y) variable
● Hershey’s returns (column C) as the independent (X) variable and the S&P 500 returns (column
E) as the dependent (Y) variable
Use returns not prices (levels). The S&P 500’s returns (column E) as the independent (X) variable
and Hershey’s returns (column C) as the dependent (Y) variable.
Refer to the table on prices and returns for Hershey and the S&P 500 to answer the following
question.
Month Hershey S&P 500

Return Return
Sep -4.7% 0.8%
Oct 0.9% -2.4%
Nov -4.2% 4.4%
Dec 1.9% -0.2%
Jan -7.3% 2.4%
Feb 0.4% 0.6%
What is Hershey’s beta?
● B>1
● B<0
● 0<B<1
● B=1
● B=0
From looking at the chart, we can see that the returns on Hershey and the market are negatively
correlated. When the market returns are positive, the returns on Hershey are negative and vice
versa. Thus, cov(kH,kM) < 0 and so BH < 0. The characteristic line has a negative slope.
A sales representative for a popular mutual fund is telling you why you should invest in their fund
instead of the market portfolio. The sales rep claims that their fund is as good as the market when the
market rises, but that it provides down-side protection. In other words, it doesn’t fall as much as the
market when the market falls. What is the sales rep saying about the fund’s beta?
● The beta is equal to 0 when the market rises and less than 0 when the market falls.
● The beta is negative.
● The beta is equal to 1 when the market rises and less than 1 when the market falls.
● The beta is equal to 1 when the market rises and negative when the market falls.
● The beta is less than 1.
When the market rises, the fund is as good as the market—meaning it rises by the same amount,
making its beta 1. When the market falls, the fund does not fall as much, meaning it is less
reactive, and its beta is less than one (but greater than zero since it’s in the same direction).
You sell some of your Exxon common stock (which tends to earn the same return every year) and
replace it with the common stock of GoldCorp, Inc. (whose shares tend to rise sharply when the
economy grows and fall dramatically when the economy is in recession). Your portfolio's beta should
● either increase or decrease.

● remain unchanged.
● increase.
● decrease.
● definitely exceed the beta of the market when all is said and done.
From the description, Exxon has a beta near zero and GoldCorp has a beta greater than one. Recall
that the portfolio beta is the weighted average of the betas of the individual securities in the
portfolio. The GoldCorp beta is higher than the Exxon beta so the portfolio beta will increase.
Use the returns in the table below to estimate Bozo’s beta.
Bozo Market Portfolio

Inc.
Februa 6.0% 4.0%

ry
March 8.0% 7.0%

The two figures below show characteristic lines for Hershey and for Pulte. Which company has a beta
of zero?
● Hershey
● Pulte
● neither
The characteristic line for Hershey is flat, so its slope is zero and so is its beta. Pulte’s line is
upward-sloping so its beta is greater than zero. (Its beta = 1.25.)
The two figures below show characteristic lines for Pulte and for an exchange traded fund that buys
the S&P 500 index on margin. Which investment has more firm-specific (unsystematic) risk?
● Margin Index Fund
● Pulte
The Margin Index Fund (MIF) has almost no firm-specific risk. For MIF, the points on the scatter
diagram are all on or near the line of best fit. In statistical terms, the R-Square is very high (near
100%). This means that most of the variation in the returns of MIF is explained by variation in the
return on the market. This is not surprising, as the fund is designed to move proportionally with the
market. Thus, MIF has systematic risk and almost no unsystematic risk. In contrast, Pulte’s returns
are spread out around its line of best fit. Its R-Square is 26%, which means only 26% of the
variation in Pulte’s returns can be explained by changes in the return on the market. Pulte has quite
a bit of firm-specific risk.
The table below presents prices (levels) and returns for Ford Inc. and the S&P 500 Index (market
portfolio). What is Ford’s beta?
Ford S&P 500 Index
Price Return Price Return
January $41.90 $1,750.00
February $43.58 4.00% $1,837.50 5.00%

March $44.01 1.00% $1,855.88 1.00%
Using the data in the table, what is Walmart’s (NYSE: WMT) beta?
S&P 500 WMT
2000 -9% -23%
2001 -12% 9%
2002 -22% -12%
2003 28% 6%
2004 11% 0%
2005 5% -10%
2006 16% 0%
2007 5% 5%
2008 -37% 20%
2009 26% -3%
2010 15% 3%
2011 2% 14%
2012 16% 17%
2013 32% 18%
2014 14% 12%
2015 1% -27%
2016 12% 16%
2017 22% 47%
2018 -4% -3%
● 1.44
● 0.26
● 0.84
● 0.08
A line that shows all of the return and beta combinations that are possible by combining a given risky
asset with therisk-free asset isthe:
● characteristic line
● reward-to-risk line
● portfolio possibility line
● security market line
You want to build a two-asset portfolio which includes the risk-free asset and the market portfolio. You
want the portfolio to have an expected return of 8.5%. The expected return on the risk-free asset is 4%
and the expected return on the market is 10%. What is the portfolio weight on the market portfolio?
● 0.90
● 0.50
● 0.75
● 0.25
You have $32,000 to invest and you want to buy 100 shares of Vandalay Industries at $485 per share.
Since you don’t have enough money to make the purchase, you will have to borrow some money. (You
will buy the shares on margin.) What is the portfolio weight of Vandalay Industries in this simple
margin portfolio?
Consider the information on themarket, therisk-free asset,and a mutualfund. You want to build a
two-asset portfolio comprising the market portfolio andthe risk-free asset such that your portfolio
beta is the same as the mutual fund. What is the portfolio weight on the market in yourportfolio?
Mutual Fund Market Risk Free
E(k) 11.1% 8.5% 2.0%
Beta 1.4 1 0
A friend says that she expects to earn 6% on her portfolio with a beta of 0.4165. You have atwo-asset
portfolio including stock X and arisk-free security. The expected return of stock X is 14.2% and its beta
is 1.7. The expected return on therisk-free security is 4%. If you construct your portfolio so that its
beta is equal to the beta on yourfriend's portfolio, then what is the expected return of yourportfolio?
● 6.5%
● 6.0%
● 5.5%
● 7.0%
You want to build a two-asset portfolio which includes the risk-free asset and the market portfolio. You
want the portfolio to have an expected return of 16%. The expected return on the risk-free asset is 4%
and the expected return on the market is 10%. What is the portfolio weight on the risk-free asset?
● -0.50
● -0.25
● -1.0
● -1.5
The Socially Responsible Fund (SRF) has a portfolio beta of 0.9. You have atwo-asset portfolio
including the market portfolio and the risk-free asset. The expected return on the market is 10% and
the expected return on therisk-free asset is 4%. If you construct your portfolio so that its beta is equal
to the beta on SRF, then what is the expected return of yourportfolio?
Based on the following information, what is the Treynor index for the Human Fund?
Human Fund Market Risk Free
E(k) 11.0% 8.5% 2.0%

Beta 1.25 1 0
● 7.2%
● 6.5%
● 2.0%
● 8.8%
You are building two-asset portfolio out of therisk-free asset and a risky asset, Stock X. Therisk-free
rate is 2%, the expected return on Stock X is 7.25%, and its beta is 0.75. You want the portfolio to have
an expected return of 19.5% and a beta of 2.5. You only have $150 to invest. How much do you have
to borrow?
You have a portfolio of two stocks: one long position and one short position. You bought 1,089 shares
of Moose Inc. at $75 per share. Part of the funds needed to take the long position were derived from
selling 700 shares of Squirrel Ltd. for $50 a share. You invested the difference from your own funds.
What is the portfolio weight on the Squirrel position?
● -0.75
● -0.85
● -0.25
● -0.50
The risk-free rate is 2% and the expected return on the market is 9%. Wayne Enterprises has a beta of
1.429. What is the expected return for Wayne Enterprises according to the CAPM?
● 10.5%
● 10.0%
● 11.0%
● 12.0%
A mutual fund manager expects her portfolio to earn a rate of return of 8.8% this year. The fund has a
beta of 0.8. The risk-free rate is 3% and the expected return on the market is 9%. Should you invest in
her mutual fund?
● no
● yes
● not enough information
The slope of the security market line is equal to:
● beta
● [E(k M ) – k F ] / β
● [E(kM) – kF]
● [E(kM) – kF ] / σm
Analysts have the following prediction about the price of shares in Gamestop in one year’s time: If the
economy grows strongly, then the share will reach a price of $440; if the economy stays at its present
intermediate growth rate, then the price will be $420; finally, if the economy goes into recession, then
the price will be only $370. Analysts do not expect Gamestop to pay a dividend. Analysts’ predictions
and the associated probabilities are summarized in the table below.
State of Economy Probabilities Price Return
Strong 0.2 $440 16.10%
Intermediate 0.5 $420 10.82%
Recession 0.3 $370 -2.38%
Assume that you can buy Gamestop for $379 today. Gamestop’s beta is 1.25, the risk-free rate is 4%,
and the expected market return is 9.5%. Is Gamestop's stock currently undervalued or overvalued?
● undervalued
● Overvalued
Shares in Seafun Safari are currently trading today, January 1, for $14 per share. Seafun's next dividend
(on December 31st) is expected to be $0.30. You plan to sell your shares after the next dividend and
expect to receive $14.75. Seafun's beta is 0.9, the expected return on the market is 9%, and T-Bills are
expected to earn 2%.
After comparing the anticipated holding period return to the equilibrium rate of return, you conclude
that Seafun is a BAD investment right now.
Therisk-free rate is3% and the expected market rate of return is9%. If you purchase stock X with a
beta of 0.4 and you think it will earn a return of 6% then you will outperform the SML.
Asset A has an expected return of 14%. The expected market return is 10% and therisk-free rate is 2%.
What is AssetA's beta?
● 1.25
● 1.50
● 0.75
● 0.5
You own two riskyassets, both of which plot on the security marketline. Asset A has an expected
return of 7.6% and a beta of 0.9333. Asset B has an expected return of 9.2% and a beta of 1.2. If your
portfolio beta is the same as the marketportfolio, what proportion of your funds are invested in Asset
A?
● 1.25
● 1.50
● 0.75
● 0.50
If a stock lies below the SML, it is
● overvalued.
● undervalued.
● fairly valued.
If a stock lies below the SML, then its return is less than the equilibrium (or fair) return for that
level of beta risk. A stock’s return is low if its price is too high, so the stock must be overvalued.
Based on the following information, which is better: Stock A or Stock B?
A B Market Risk Free
E(k) 0.1097 0.128125 0.0955 0.025
Beta 1.4 1.65 1 0
● they are equal

● Stock B
● Stock A
The SML impliesthat if you could find an investment with a negativebeta, its expected return, E(k),
would be:
● 0 < E(k) < kf

● kF < E(k) < E(kM)
● E(k) < 0
● E(k) < kf
If a common stock has a beta of2, then its expected return, E(k), is:
● = 2 x E(km)
● > 2 x E(k m )
● = E(km)
● < 2 x E(km)
Assume the market has a Treynor Index of 4%. What is the Treynor Index of your portfolio consisting of
therisk-free asset and the market portfolio if the portfolio weight on the market is 25% (and the
balance is in therisk-free security)?
● 1%
● 4%
● 3%
A portfolio comprised of the risk-free asset and the market portfolio is on the SML and has the
same Treynor index as the SML.
A friend says that she expects to earn 13.5% on her portfolio with a beta of 2. You have a two-asset
portfolio including stock X and the risk-free security. Stock X is on the SML (you’re not sure about your
friend’s portfolio) with an expected return of 11.5% and a beta of 1.25. The expected return on the
risk-free security is 3.5%. You construct a portfolio (with X and the risk-free asset) to match your
friend's return. What is the beta of your portfolio and is your friend getting a good or bad deal?
● beta = 1.79; friend is getting a good deal

● beta = 1.70; friend is getting a bad deal
● beta = 1.79; friend is getting a bad deal
● beta = 1.70; friend is getting a good deal
Explosive BetaSML is a fund management company that has created a family of exchange
traded (mutual) funds that are designed to put investors at various points along the Security
Market Line. One of Explosive's products, called the Market Bull Plus fund, is designed to
provide a return that is twice the market portfolio’s expected return. The Bull Plus fund is
constructed by borrowing money at the risk-free rate and then buying the market portfolio. If
the risk-free rate is 4% and the expected return on the market is 12%, then what is the
portfolio weight of the market index for the Market Bull Plus fund?
● 2.5
● 2.3
● 3.5
● 3.0
You are considering buying shares in Chattanooga Railways. The stock is currently trading for $17.24.
Analysts expect the next annual dividend to be $1.25. (The next dividend will be paid in one year.)
Dividends are expected to grow in perpetuity at the annual rate of 2%. Chattanooga’s beta is 1.077.
The risk-free rate is 2% and the expected return on the market is 8.5%. Use this information to answer
the questions that follow.
Part 1:
What annual return will you earn on Chattanooga if you buy it today, hold it, and receive the perpetual
stream of growing dividends?
● 8.75%
● 9.25%
● 8.55%
● 9.05%
Part 2:
Under the CAPM, what is the equilibrium rate of return on Chattanooga’s shares given its systematic
risk?
● 9.6%
● 9.0%
● 8.6%
● 9.4%
Part 3:
Draw the Security Market Line and plot Chattanooga’s risk and return point.
Chattanooga plots above the SML.
Part 4:
Chattanooga’s stock price is currently cheap.
The Beta Bear Plus Fund is constructed so that its average return is equal to two times (200%) the
inverse (opposite) of the average return on the market index. In other words, E(kp) = -2 x E(kM). Where
E(kp) is the expected return on the fund. This fund is designed for investors who want to make money
when the market falls. If the risk-free return is 2.3% and the expected return on the market is 9.2%,
then what is the beta of this fund?
Use the following information to compare Fund A and Fund B and answer the following questions.
A B Market Risk Free
E(k) 11.33% 6.59% 10.48% 3.30%
Beta 1.3 0.5 1 0
Part 1.
Calculate the Treynor index for each Fund. Fund B has a higher Treynor index.
Part 2.
Calculate the difference between each fund’s return (from the table) and the return predicted by the
SML given its beta. (Subtract the return predicted by the SML from the return given in the table.)
Fund B is doing better relative to the SML.
You have been scouring The Wall Street Journal looking for stocks that are "good values" and have
calculated the betas and ‘anticipated returns’ for four stocks. The ‘anticipated returns’ are based on
your research and best estimates. The expected return on the market is 13% and the risk-free rate is
7%. Which security is the best investment? (Assume you must choose just one.)
Stock Anticipated Return Beta

A 5.04% -0.67
B 11.50% 2.5
C 9.01% 1.7
D 8.74% 0.87
● B
● C
● D
● A
Nassim Taleb argues in his book of the same name that we can be “fooled by randomness”.
This cognitive bias is particularly evident in how we interpret historical financial performance.
The following questions show how we can draw faulty conclusions from small samples. In the
first few questions, we will treat investment performance as a discrete random variable with a
uniform distribution across two states of nature: win or lose. In other words, like a coin toss
with a fair coin.
Part 1:
If 100 portfolio managers flip a fair the coin five times in a row, then how many do you expect
will flip five heads?
● 32
● 1
● 5
● 3.125
Part 2:
Consider the experiment described in last question. Assume that each of the one hundred
portfolio managers continues to toss their coin for a total of 1 million coin tosses. What do
you expect is the proportion of heads achieved by any one of the managers who flipped five
heads on the first five tosses?
● 0
● 0.5
● 1
● 0.25
Part 3:
Consider the last two questions. Were the portfolio managers who flipped five heads skillful
or lucky?
● skillful
● lucky
Part 4:
Assume that the stock market is efficient and the Capital Asset Pricing Model is true. In a
given year, is it possible for a portfolio manager to generate a return above that predicted by
the Security Market Line?
● yes
● no
PART 5:
Assume that the stock market is efficient and the Capital Asset Pricing Model is true. If a
portfolio manager earns a return that is above that predicted by the Security Market Line in
one (or a few years), does that imply (with certainty) that the manager’s long run average
return will be higher than that predicted by the SML?
● yes
● no
Chapter 7
What is the face value of a zero couponbond?
● The amount of money that the bond holder(owner) pays the issuer at the time of issue.
● The amount of money that the issuer pays the bond holder(owner) at maturity.
● The amount of money that the bond holder(owner) pays the issuer at maturity.
● The amount of money that the issuer pays the bond holder(owner) at the time of issue.
The face value is the amount an issuer pays the holder at maturity.
The main difference between a coupon bond and a zero coupon bond is that
● the zero coupon bond has no coupons and pays its face value at maturity.
● the zero coupon bond pays all of its coupons and its face value at maturity.
● a coupon bond only pays coupons and a zero only pays a face value.
● the zero coupon bond has no coupons or face value.
A coupon bond pays semi-annual (or annual) coupons and a face value at maturity. A zero coupon
bond has no coupons and only pays its face value at maturity.
Most zero coupon bonds trade in the _________ market.
● bond
● secondary
● capital
● money
The money market is the market for bonds with a maturity of less than 1 year. These bonds are all
zero coupon bonds and include bankers' acceptances and government T-Bills. Strip bonds are also
zero coupon bonds. They do not trade in the money market but the value of secondary trading in
strip securities is much smaller than the value of trading/issuance in the money market.
The issuer of a zero coupon bond_________ money. The owner has a________ position in the bond
and the issuer has a_________ position.
● lends; long; short

● borrows; short; long
● lends; short; long
● borrows; long; short
A zero coupon bond is a promise to pay by the issuer. Thus, the issuer borrows money from the
owner. A long position is defined as a position of ownership. If the owner is in a long position, then
the issuer must be in a short position.
The _______ of a bond varies daily as the bonds are bought and sold.
● maturity
● price
● coupon rate
● face value
The face value, coupon rate, and maturity of a bond are printed on the bond and remain fixed. The
price of the bond changes daily as supply and demand conditions change.
Cyberdyne Systems is issuing a series of zero coupon bonds to raise $500M to fund research and
development at its Skynet division. Each bond will have a face value of $1,000 and will mature in 10
years. The yield on the bond is 10.159%. What is the fair price for one of Cyberdyne’s zero coupon
bonds?
You just bought a strip bond with a face value of $1,000 and 8 years to maturity. You paid $627.41.
What is the yield on the bond?
What is the percentage change in price for a zero coupon bond if the yield falls by 1% from 4% to 3%?
The bond has a face value of $1,000 and it matures in 9 years. (Pafter – Pbefore.)
The table below shows market prices for three zero coupon bonds with three different terms: one,
two, and three years. The bonds all have a face value of $1,000. Calculate the yields on the zero
coupon bonds and graph the yield curve. What is the shape of the yield curve?
Zero Coupon Bond Prices
Term (years) Price ($)
1 943.40
2 890.00
3 839.62
● downward sloping
● upward sloping
● flat
Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 8 years, for
$858.31. What is the implicit interest in the first year of the bond's life?
Three-month commercial paper has ________ yield than three-month T-bills.
● the same
● a higher
● a lower
T-Bills are issued by the U.S. Government. Commercial paper is issued by corporations. The U.S.
Government has less default risk than a corporation, so commercial paper yields have a default
risk premium whereas T-Bills have no default risk premium.
Consider the treasury spot rate yield curve. That is, the yield curve constructed from zero coupon
bonds issued by the Government with no default risk. If expected inflation rises in all future periods
(by an equal amount), then the yield curve will:
● shift up (and get steeper)

● shift down (parallel)
● extend
● shift up (parallel)
If the nominal rate of interest is 5.06% and the real rate of interest is 2%, what is the expected rate of
inflation?
The real rate of interest is 3%and the expected rate ofinflation is 1.94%. What is the nominal rate of
interest?
The1-year spot rate is 5% and the expected spot rate next year is 5%. What is the2-year spot rate
predicted by the expectationstheory?
Combs-R-Us Corp. bonds have been downgraded by Standard and Poor's because of the growing
number of men who shave their heads. Which of the following should result from this development?
● the coupon yield will fall
● the maturity date will change
● the bond price will fall
● the yield to maturity will fall
The downgrade will raise the default risk premium and so raise the yield to maturity of the bond.
Bond prices and yields move inversely, so the bond price will fall.
Consider the information on various bonds in the table and answer the question that follows.
The yield on the Texas State Highway Bond exceeds the yield on a 10-year U.S. Government T-Note
because of:
● credit or default risk

● liquidity risk
● inflation risk
● maturity risk
The1-year spot rate is 3%. The1-year spot rate expected for next year is 5.0097% and the 1-year spot
rate expected in two years is 7.0289%. What are the2-year and3-year spot rates predicted by the
pure expectationstheory?
Express your answers in percentage form rounded to the nearest percent.

2 year spot rate: 4%
3 year spot rate: 5%
What is the default risk premium of a corporate bond if the real rate is 4%, the expected inflation is
5%, the liquidity premium is 3%, the maturity risk premium is 1%, and the nominal yield of the bond is
15.7%?
What is the nominal yield on a 10-year government T-note if the real rate is 4%, the expected inflation
is 5%, the liquidity premium is 1%, and the maturity risk premium is 1%?
● 2.0%
● 1.5%
● 1.0%
You are comparing a 10-year, 3% U.S. government zero coupon bond (which is priced to yield 4%) to a
10-year, 3% coupon bond issued by the Aerocar Motor Co. (which is priced to yield 5%). The difference
between the two yields is due to:
I. maturity premium
II. default premium
III. liquidity premium
● I only
● II only
● III only
● II and III
Which of the following is not a fixed feature of a bond?
● the coupon dates

● the coupon
● the price of the bond
● the maturity date
The 10-year T-note has a Bloomberg price quote of 98-26. What is the price as a percentage of
facevalue?
● 98.8125
● 98.71875
● 98.0625
● 98.46875
A U.S. Government 2-year T-Note has a face value of $100 and pays annual coupons of $7. The first
coupon is due in one year. What is the correct price for the coupon bond today? Use the term
structure of interest rates shown in the table.
Term Spot Rate
1-year 6.5%
2-years 7.595%
● $98.00
● $99.00
● $96.00
● $97.00
A U.S. Government 3-year T-Note has a face value of $100 and pays annual coupons of $8. The first
coupon is due in one year. What is the correct price for the coupon bond today? Use the term
structure of interest rates shown in the table.
Term Spot Rate
1-year 5.0%
2-years 6.5%
3-years 8.5961%
● $99.00
● $98.00
● $96.00
● $97.00
The yield to maturity on a bond
●is approximately equal to the return the bond investor will earn if they pay the price and
hold the bond to maturity.
● is the effective yield earned only from coupon payments.
● remains fixed over its life.
● is the discount rate that equates the face value of a bond with the present value of all its
future cash flows.
Springfield Nuclear Energy Inc. bonds are currently trading for $97.33. The bonds have a face value of
$100, a coupon rate of 5% with coupons paidannually, and they mature in 3 years. What is the yield to
maturity of thebonds?
Holding the yield to maturity and the coupon rate of a bondconstant, as the maturity date moves
further into the future (time to maturity increases):
● the sum of the present value of the coupon payments represents a larger share of the
total bond value than the present value of the principal
● the discount factor used to calculate the present value of the principal increases
● the discounted face value of the bond represents a larger percentage of thebond's total
value than the total present value of the interest payments
● the value of the bond will fluctuate less for any change in market yields
What is the price of a bond with 3 years to maturity, a 5% couponrate (annual coupons), and $100
face value if the yield to maturity is 6.125%?
A Ford Motor Co. coupon bond has a face value of $100, a coupon rate of 2%, and pays annual
coupons. The next coupon is due tomorrow and the bond matures 15 years from tomorrow. The yield
on the bond issue is 3.282%. What is the fair price for the bond today?
Tegridy Farms Inc.’s semi-annual coupon bonds are currently trading for $103.78. The bonds have a
face value of $100, a coupon rate of 4%, and they mature in 6 years. What is the yield to maturity of
thebonds? (Note: these solutions are semi-annual. Don’t forget to annualize.)
City Wok Inc. bonds trade for a price of $89.490. The bonds have 8 years to maturity and a yield to
maturity of 4.6%. The bonds pay annualcoupons (the next coupon is due in oneyear) and the face
value is $100. What is the coupon rate of thebond?
● 4.0%
● 5.0%
● 2.0%
● 3.0%
Hooli Inc. bonds trade for a price of $109.197. The bonds have a coupon rate of 6% (annual) and a
yield to maturity of 4.6%. The face value is $100. How many years until the maturity of the bond?
● 8 years
● 12 years
● 6 years
● 10 years
Consider an annual coupon bond with a face value of $100, 13 years tomaturity, and a price of $90.
The coupon rate on the bond is 3%. If you can reinvest coupons at a rate of 4.038% perannum, then
how much money do you have if you hold the bond tomaturity?
A U.S. Government T-bond matures in 24 years and has a face value of $100. The bond has a coupon
rate of 4% paid semi-annually (the next coupon is due in 6 months). The yield on the bond is 5%. If
coupons are re-invested at 2.8332% per annum, then how much interest is earned on re-invested
coupons over the life of the bond? Calculate the interest as a percentage of the total cash flows
received at maturity by the bondholder.
● 16%
● 18%
● 17%
● 19%
Rudy purchased a 7.5% coupon rate bond one year ago for its face value of $100. He bought the bond
just after the coupon date. Yesterday the bond paid its annual coupon. The bond currently has 17
years until maturity and has a yield to maturity of 7.395%. If Rudy sells the bond today, then what is
his return for the last year?
A U.S. Government T-bond matures in 13 years and has a face value of $100. The bond has a coupon
rate of 3% and the next (annual) coupon is due in one year. You bought the bond today for $90. If you
can re-invest the coupons at 9.1858%, then what is your total return (per annum) on the bond? (The
total return is the interest rate that grows the investment to the future value of the bond’s proceeds at
maturity.)
The "price value of a basis point" (PVBP) measures the change in the price of a bond if the yield
changes by one basis point (one one-hundredth of a percent—0.01%). PVBP is expressed as the
absolute value of the change in price. For example, if the yield on a bond rises from 8% to 8.01% and
the bond price falls by $0.3992 (on a $1,000 face), then the PVBP is 0.3992. Drawing on your
knowledge of the price-yield properties of coupon bonds, which of the following bonds has the
highest PVBP?
● 20 years, 8% coupon
The possibility of a bondholder suffering losses when yields-to-maturity on similar bonds change is
called
● term structure risk.

● market yield risk.
● systematic risk.
● interest rate risk.
A bond that sold for $900 three months ago is selling for $1,000 today. Which of the following must be
true?
● The coupon rate must have decreased over the last three months.
● Interest rates must have decreased over the last three months.
● Interest rates must have increased over the last three months.
● The coupon rate must have increased over the last three months.
The "price value of a basis point" (PVBP) measures the change in the price of a bond if the yield
changes by one basis point (one one-hundredth of a percent—0.01%). PVBP is expressed as the
absolute value of the change in price. Consider a coupon bond with a face value of $100, an annual
coupon rate of 8%, and 15 years to maturity. What is PVBS if the yield rises from 8% to 8.01%?
Consider the two bond quotes in the table: a two-year U.S. Government bond and a two-year U.K.
Government bond. Which bond has greater interest rate risk?
Issuer Coupon Maturity Price (% of FV) Yield
U.S. Government 0.375% 2 years 99.91 0.42%

U.K. Government 4.5% 2 years 107.58 0.67%
● U.K. Government
● U.S. Government
Which bond's price is least sensitive to changes in interest rates?
● A
● D
● B
● C
Consider two zero coupon bonds. Both have face values of $100. Bond A pays its face value in 8 years,
and Bond B pays its face in 2 years. If interest rates change from 9% to 8%, what is the percentage
change in the long maturitybond's price minus the percentage change in the short maturitybond's
price?
Investors who purchase bonds at a discount will
● be able to sell the bond at a premium if interest rates rise above their current level.
● fare worse than those investors who bought the same bond at a premium if the borrower
defaults.
● receive lower coupon payments than from those bonds sold at face with the same coupon
rate.
● earn a capital gain if they hold the bond to maturity.
A9% coupon bond has a yield of9.75%. The bond is selling at a price that is______ par.
● higher than
● equal to
● lower than
Without doing any calculations, which of the bond price quotes is incorrect?
Issuer Maturity Coupon Price Yield
Amtrack 21-Sep-30 6.00% 110.38 5.0%

Boeing Corp. 21-Sep-35 5.75% 102.99 5.5%
U.S. Government 21-Sep-45 4.00% 101.52 4.5%
● Amtrak
● U.S. Government
● Boeing
A BBB corporate bond has 8 years remaining to maturity, pays annual coupons (yesterday) of $8.5, and
has a face value of $100. The current price of the bond is $87.09 to yield 11.011%. What is the capital
gain rate for the coming year if the yield to maturity remains constant?
A bond has 8 years remaining to maturity, pays annual coupons (yesterday) of $5, and has a face value
of $100. The current price of the bond is $88.057 and the price next year is expected to be $89.221.
(Interest rates are not expected to change over the coming year.) What is the yield to maturity on the
bond?
As the maturity date of a bondapproaches,
● the price of the bond approaches its face value.

● the bond will always sell at a discount.
● default risk decreases.
● the bond will always sell at a premium.
A newly issued U.S. Federal T-Bond matures in 24 years. The coupon rate is 4% and coupons are paid
semi-annually. The bond is priced at $86.11 (FV = $100) and yields 5%. The economy is slowing and
many forecasters predict a recession. You expect that the monetary authorities to lower interest rates.
You expect the yield to fall to 4.26%. You want to earn $1M by investing in bonds to profit from the
interest rate change, how many bonds do you buy?
Quantity = 100,000
The ‘yield spread’ is defined as the difference in yields between a U.S. Treasury and an otherwise
equivalent Baa rated corporate bond. The yield spread is the compensation to investors for bearing
default risk and it varies over time, peaking in recessions. Following the financial crisis, the spread
peaked in the Fall of 2008 at 611 basis points (bps) or 6.11%. If you had anticipated that the spread
had peaked, then what positions would you have taken in the two bonds to profit from the decline in
the spread after the Fall of 2008?
● short treasuries, long Baa

● long treasuries, short Baa
● long treasuries, long Baa
● short treasuries, short Baa
Use the information in the table to calculate the expected spot rate in year 2.
Zero Coupon Bond Prices & Yields

(FV = $100)
Maturity Price Yield
1 95.238 5.000%
2 90.273 5.250%
Use the information in the table to calculate theone-year forward rate starting two years fromtoday.

(FV = $100)
1 96.154 4.000%
2 92.013 4.250%
3 87.632 4.499%
Assume that the 4-year spot rate is k4=2.437% and the 3-year spot rate is k3= 2.25%. What is the
forward rate in the fourth year?
Assume that the one-year spot rate is 1% (k1=1%) and the expected future spot rate is 3.01% (E(k1) =
3.01%). What two-year spot rate is consistent with these values under the expectations theory and
what is the shape of the yield curve?
● k2 = 2%, downward sloping

● k2= 2%, upward sloping
● k 2 = 2%, flat
● k2 = 3.01%, upward sloping
Assume that the one-year spot rate is 2% (k1=2%) and the expected future spot rate is 3.01% (E(k1) =
3.01%). Investors don’t like long-term investments, so the two-year bond yield includes a maturity risk
premium of 1%. Answer the questions that follow.
Part 1
What two-year spot rate is consistent with these values under the maturity preference hypothesis?
● 3.00%
● 2.50%
● 3.01%
● 3.50%
Using the two-year spot rate from Part 1, calculate the forward rate. The resulting forward rate is _______
the expected future spot rate.
● smaller than
● the same as
● larger than
Consider a2-year coupon bond with a face value of $100 and a coupon rate of 8% (the next annual
coupon is due in one year). The one-year spot rate is 8.5%, the two-year spot rate is 9.9109%, and the
bond is trading today for $96.774. What is the expected price for the coupo
bnhbgvfrvcvffffvn bond after the firstcoupon?
● $100
● $97
● $99
● $98
Consider atwo-year coupon bond with a face value of $100 and a coupon rate of 8% (the next annual
coupon is due in one year). The one-year spot rate is 8%, and the two-year spot rate is 8.9954%. What
is the expected holding period return if you buy the bond after the first coupon? (Assume no change in
the economy.)
Consider atwo-year coupon bond with a face value of $100 and a coupon rate of 8% (the next annual
coupon is due in one year). The one-year spot rate is 7%, the two-year spot rate is 8.9816%, and the
bond is trading today for $98.409. What is the expected holding period return if you can sell the bond
after the first coupon?
● 7%
● 4%
● 5%
● 6%
In this question you will compare three investment strategies in a situation where interest rates are
expected to rise. Many investors consider the lock-in to be inferior when rates rise because of interest
rate risk. What you will see in this example is that anticipated rate increases are priced into the yield
curve and so all strategies are equivalent. However, with unanticipated rate increases, there is a
dominant investment strategy. Use the data in the table for zero coupon bonds below to complete
parts (1) through (6).
(FV = $100)
1 90.498 10.5%
2 58.719 30.5%
Part 1
The lock-in: If you buy the two-year bond at its quoted price and hold to maturity, then what return do
you earn (per annum) over the two years?
Part 2
What is the expected spot rate in year 2? (Enter your answer in percentage form rounded to one decimal
place.)
Part 3
If you had bought the two-year bond at t=0 and the spot rate had risen to 54.12% at t=1 as expected, then
what could you have sold the bond for? (Round your answer to two decimal places.)
Part 4
If you had bought the two-year bond at t=0 and the spot rate had risen to 54.12% at t=1 as expected, and
then you had sold your two-year bond in order to buy a new one-year bond, what compound average
return would you have earned over the two years? (Enter your answer in percentage form rounded to one
decimal place.)
Part 5
The roll-over: Assume that you buy 0.6488 of a one-year bond at t=0. Assume that bond matures at t=1 and
you use the proceeds to buy the new bond at t=1. Assume that the interest rate rises at t=1 to 54.12% as
expected. How much money do you have at t=2 and what is your compound average return? (Enter your
answer in percentage form rounded to one decimal place.)
Which strategy generates the highest average compound return over the two years when interest
rates are expected to rise?
● They are all the same.

● start with lock-in, sell it at t=1, and buy the new 1-year bond
● roll-over
● lock-in
Chapter 8
Stock is all of the followingexcept (select the best choicebelow):
● a seasoned issue
● representative of an equity interest in a company,
● a security that may be purchased on margin
● a security traded on both the primary and secondary markets
A seasoned issue is one that is issued by a firm that already has issues outstanding. A stock can
be a seasoned issue, but it doesn’t have to be.
A long position in a stock is all of the followingexcept (select the best choicebelow):
● the most common way to buy stock

● used to take advantage of expected declines in astock's price
● provides a loss when the stock falls
● provides a profit when the stock rises
A short position is used to take advantage of an expected decline in a stock’s price.
Which of the following is not true aboutstock? Select the best choicebelow.
● Stock can be sold in an initial public offering.

● The shares are issued by incorporated companies.
● You will find stock shares selling in both the primary and secondary markets.
● Only public companies can issue stock.
Both public and private companies can issue stock.
Which of the following statements isfalse?Select the best choicebelow.
● In both long and short positions, the investor hopes that stock prices will rise.
● In a long position the investor owns the stock.
● In a short position, the investor has sold stock that is borrowed.
● Investors want stock prices to rise when they take a long position and drop when they take a
short position.
Only in a long position will investors hope the price will rise.
You take a short position when you sell a security you do not own by borrowing it from your broker.
You make money by:
● covering your short position by selling additional share of another security

● covering your short position by purchasing the stock later, hopefully at a higher price
● covering your short position by buying additional shares of another security
● covering your short position by purchasing the stock later, hopefully at a lower price
You make money on a short sell if you sell it first at a high price and cover your position by
purchasing the same stock later at a lower price.
When you take a long position, your goal isto do which of the following? Select the best choicebelow.
● buy first and sell later

● repay first and borrow later
● borrow first and repay later
● sell first and buy later
A long transaction is the typical way to invest. You buy a security today and hope to sell it later at a
higher price.
Which of the following is NOT a characteristic of preferredstock?
● Common stock dividends must be paid before preferred dividends.

● Preferred dividends are typically given less legal priority than bond interest payments.
● Preferred stock does not mature like a bond.
● Preferred stock dividends may be delayed.
Preferred stock has a higher priority than common stock so dividends must be paid to preferred
shareholders before they can be paid to common shareholders.
A share of preferred stock pays a dividend of $0.20 annually. The required rate of return is 4%. What is
the preferredstock's price pershare?
● $6
● $4
● $7
● $5
If investors require an 8% return, and the preferred stock pays an annualend-of-year dividend of
$6.75, what is the market price pershare?
● $84.20
● $83.75
● $83.98
● $84.38
What is the price of a share of preferred stock that has a dividend of $2.56 if the return required on
preferred stock is 14.9%?
● $17.18
● $17.10
● $17.35
● $16.58
If preferred stock sold for $90 a share and $2.70 dividends were paidannually, what would be the
required rate ofreturn?
● 2.95%
● 2.90%
● 3.00%
● 3.10%
A share of preferred stock has a par value of $10. It pays a 2% dividend. If the required return is 4%,
what is the price of thestock?
● $4
● $5
● $7
● $6
Because of declining sales, Wayne Enterprises Inc. announced today that it is suspending dividend
payments on its preferred shares. The shares have a 5.8% annualdividend, have a par value of $55,
and are not cumulative. The next dividend would have been paid tomorrow(if it were notsuspended).
Analysts expectWayne's profits to rebound strongly in the coming year and also expect Wayne to
resume regular annual dividend payments of $3.19 in two years. What is the fair price for the shares
today if investors require a return of 7.2%?
● $41.33
● $33.06
● $62.00
● $57.86
Because of decliningworld-wide sales of its number oneconfection, the petitBearsbum Confection

announced today that it is suspending dividend payments on its preferred shares. The shares have a
6% annualdividend, a par value of $100, and are cumulative. The next dividend would have been paid
tomorrow(if it were notsuspended). Analysts expectBearsbum's profits to rebound strongly in the
next year and half due to the introduction of a new line of sour gummy bear paws. As aresult, analysts
expect that Bearsbum will resume dividends of $6.00 in two years’ time. What is the fair price for the
shares today if investors require a return of 7%?
● $74.87
● $80.11
● $90.59
● $85.71
Vandalay Industries paid $2.00 per share in dividends yesterday. Its dividends are expected to
grow steadily at 7% per year. What are dividends expected to be for each of the next 3years?
Round your answers to the nearest cent.
You are contemplating the purchase of a stock you will hold for 2 years. You will receive $0.82 per year
individends, and then you expect to sell it for $21. If the required return is 9%, what is the most you
would pay for thestock?
● $19.12
● $19.78
● $19.25
● $19.49
CarlsonEnterprises' common stock dividend is expected to grow at 1% per year. The dividend recently
paid was $0.46 pershare, and the required return is 4%. What is the estimated value of the common
stock?
● $15.25
● $14.45
● $15.78
● $15.49
Bryson Industries paid $2.95 per share in dividends yesterday. Its dividends are expected to grow
steadily at 6% per year. If the required return is 6.3%, what is the current price (P0)?
● $1,004.45
● $1,045.25
● $1,042.33
● $1,505.49
Kramerica Industries paid $2.05 per share in dividends yesterday. Its dividends are expected to grow
steadily at 6% per year. If the required return is 6.9%, what is the estimate of thestock's price 1 year
from now (P1)?
● $255.93
● $260.25
● $262.25
● $258.56
The Peterman Company does not currently pay dividends.However, investors expectthat, in 6years,
Peterman will pay its first dividend of $1.50 per share and will continue to grow at 10% per year
forever. If investors require a 12% annual return on thestock, what is the currentprice?
● $44.52
● $41.65
● $43.89
● $42.56
Teal Corp. has been having trouble. The last dividend was $2.86, andit's projected to fall 3% per year
indefinitely. If the required return is 6%, what is TealCorp.'s stockprice?
● $30.60
● $30.82
● $30.52
● $31.02
What would you pay for a share of common stock where the last dividend was $3 and that was
expected to grow at −5% per yearindefinitely, assuming a 25% cost ofequity?
● $9.50
● $9.75
● $9.20
● $8.75
CompanyY's common stock recently paid a dividend of $1. They have traditionally grown their
dividend at 2%.However, after a year of greatperformance, they have decided to begin growing their
dividend at 3%. The price of the common stock is $14.57. If the required return on the common stock
is 9%, what will the new stock price be after the change in the dividend growthrate?
● $17.17
● $16.69
● $17.00
● $16.58
Lincoln Corp does not currently pay dividends.However, investors expectthat in 4years, Lincoln will
pay its first dividend of $2.09 per share and will continue to grow at 11% per year forever. If investors
require a 13% annual return on thestock, what is the currentprice?
● $89.57
● $70.42
● $72.42
● $104.50
If a company were tofail, what is the order that stakeholders would get paid beginning with who gets
paidfirst? Select the best choicebelow.
● preferred, bond, common stock

● bond, commonstock, preferred
● commonstock, bond, preferred
● bond, preferred, common stock
Bond holders are paid before preferred stockholders who are paid before common stockholders.
Suppose you have some extra money to invest for 1 year. After ayear, you will need to sell your
investment to pay tuition. After listening to Bloomberg, you decide that you want to buy Intel Corp.
stock. You call your broker and find that Intel is currently selling for $50.96 per share and pays $0.15
per year in dividends. The analyst on Bloomberg predicts that the stock will be selling for $59.50 in 1
year. Assume that you would be satisfied to earn 11.9%. What is the current value of the stock based
on the dividend pricing model?
● $55.85
● $54.58
● $51.56
● $53.31
Select the best choicebelow. The reason that we can ignore the future sales price of the stock when
developing the dividend growth model isbecause
● since wewon't get that final sales price, we must ignore it when computing current value.
● any cash flows after we sell the security are irrelevant.
● the present value of a very distant cash flow is a small number thatwon't impacttoday's
price significantly.
● the present value of a growing annuity is always equal to zero.
When you discount a far distant sum to the present it becomes irrelevant.
growth rate is a constant 5%, and the required return is 14.1%?
● $35.85
● $33.08
● $34.58
● $33.31
Compute the price of the stock if the required return is 19.2%, the growth rate is 14%, and current
dividend is $3.43.
● $70.25
● $72.50
● $75.20
● $74.10
If dividends for ABC Corp. were $1.44 at the end of 2002 and $3.06 at the end of 2011, what is the
average compounded growthrate?
● 8.74%
● 9.10%
● 9.72%
● 9.90%
What is the return on equity if D1=$1.28, P0=$9.25, and g=3.9%?
● 17.50%
● 18.25%
● 17.74%
● 17.92%
CompanyA's common stock recently paid a dividend of $1.00. The next dividend is expected to be
$1.02. If the required return is 9%, what is the estimated value of the commonstock?
● $14.57
● $15.15
● $14.10
● $13.52
If you have dividends beginning in 2001 through2010, what n will you use in computing the growth
rate?
● 11
● 9
● 8
● 10
What is the price of a share of stock if the beta is1.5, its next dividend is projected to be $2.50, and its
growth rate is expected to be a constant 9%, assuming the market return is 13% and therisk-free rate
is 6%?
● $33.33
● $35.21
● $36.89
● $34.54
Which of the following is an effective way to compute the required return for a stock?
● Gordon growth model

● CAPM
● discounted cash flow
● PE method
Kramerica Industries paid $3.00 per share in dividends yesterday. Its dividends are expected to grow
steadily at 4% per year. If the required return is 8.4%, what is the current price (P0)?
● $68.52
● $70.91
● $70.10
● $69.24
You are contemplating the purchase of a stock you will hold for 2 years. You will receive $0.82 per year
individends, and then you expect to sell it for $22. If the required return is 8%, what is the most you
would pay for thestock?
● $19.90
● $21.89
● $19.58
● $20.32
Teal Corp. has been having trouble. The last dividend was $2.84, andit's projected to fall 4% per year
indefinitely. If the required return is 6%, what is TealCorp.'s stockprice?
● $27.26
● $29.90
● $31.89
● $30.32
Shares of Luna Sea Hotels Inc. currently sell for $44.42. Yesterday, Luna Sea paid a dividend of $0.81
per share. Assume that the growth rate of dividends will be 7.7% and that dividends will grow at a
constant rate forever. Giventhis, what is the implicit return of thestock?
● 9.70%
● 11.58%
● 8.56%
● 10.50%
The last dividend paid by Abbot Company was $3.29. Dividends are expected to grow at 15% for the
next 2years, then grow at a constant 4% indefinitely. If the required return is 6%, what should be the
current stockprice?
● $198.56
● $208.80
● $204.32
● $199.90
You are considering buying shares in Chattanooga Railways. The stock is currently trading for
$19.46. Analysts expect the next annual dividend to be $0.90. ( The next dividend will be paid in
oneyear.) Dividends are expected to grow in perpetuity at the annual rate of 4.00%. Chattanooga's
beta is 0.75. The risk free rate is 4.50% and the expected return on the market is 10.00%. Express
your answer in percentage form rounded to one decimal place.
Use this information to answer the questions that follow.
a. What annual return will you earn on Chattanooga if you buy ittoday, hold it, and receive the
perpetual stream of growingdividends?
b. Under theCAPM, what is the equilibrium rate of return onChattanooga's shares given its systematic
risk?
What is the price of a share of stock if the beta is1.5, its next dividend is projected to be $2.50, and its
growth rate is expected to be a constant 6%, assuming the market return is 13% and therisk-free rate
is 5%?
● $27.80
● $22.73
● $19.56
● $19.90
The next dividend for ABC Corp. is expected to be $1.26. It will rise to $2.17 the next year and grow at
a constant 5.9% from then on. The required return is 11.7%. What is the current price of thestock?
● $39.47
● $34.62
● $32.45
● $36.58
Shares ofS&M Family Outlet Inc. trade on the NYSE(NYSE: S&M). The shares traded today at a price of
$15.88. Yesterday, S&M paid a dividend of $1.09 per share. The next dividend is expected in oneyear's
time. If investors require a 9% return and if the dividends are expected to grow at a constant rate
forever, what growth rate is currently priced into theshares?
The implicit growth rate of the stockis:
● 1.4%
● 2.0%
● 3%
● 2.8%
Analysts expect Sturk Industries to make payouts of $4.825 billion at the end of this year. Assume that
all payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts
forecast thatSturk's payouts will grow at 4.5% in perpetuity. Sturk stockholders require a return of 9%.
Sturk has 0.95 billion shares outstanding. What is the fair price forSturk's sharestoday?
● $116.78
● $112.87
● $110.58
● $114.59
Yesterday, Cyberdyne Systems paid out $1.825 billion in dividends and repurchased $4.795 billion
worth of shares. Assume that all payouts occur at the end of the year. Next year's payouts (due in one
year) are expected to be 1% bigger than last year's and are expected to grow at that same rate in
perpetuity. Cyberdyne Systems has 1.48 billion shares outstanding and its shareholders require an 8%
rate of return. What is the fair price forCyberdynes's sharestoday?
● $64.54
● $69.25
● $67.45
● $60.48
Analysts expect Oscorp Industries to make payouts of $2.18B at the end of this year. Assume that all
payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts
forecast thatOscorp's payouts will grow at a constant rate of 1.5% in perpetuity. Oscorp has 2.74B
shares outstanding and its shares are currently trading for $16.54. What required return has the
market priced intoOscorp's shareprice?
● 6.3%
● 6.9%
● 8.8%
● 5.7%
Analysts expect Jocorp Industries to make payouts of $6.675 billion at the end of this year. Assume
that all payouts occur annually at the end of the year and that we are at the beginning of the year.
Analysts forecast thatJocorp's payouts will grow at a constant rate in perpetuity. Jocorp stockholders
require a return of 11%. Jocorp has 2.44 billion shares outstanding and its shares are currently trading
for $34.20. What growth rate has the market priced intoJocorp's shareprice?
● 6.1%
● 3.0%
● 2.2%
● 8.0%
Analysts expect Virtucon to make payouts of $3.365 billion at the end of this year. Assume that all
payouts occur annually at the end of the year and that we are at the beginning of the year. Analysts
forecast thatVirtucon's payouts will grow at 1.5% in perpetuity. Virtucon stockholders require a return
of 6%. Virtucon has 2.13 billion shares outstanding and has cash on hand of $6.42billion. What is the
fair price forVirtucon's sharestoday?
● $52.58
● $40.52
● $55.47
● $38.12
Because of the weakeconomy, Nakatomi Trading Corp. has suspended stock repurchases for the
current year. Nakatomi makes its payouts annually at the end of each year. Today is the first day of a
new year. Nakatomi has announced that it will pay dividends of $1.045 billion(in aggregate) at the end
of the current year. Next year Nakatomi will hold dividends constant and it will resume stock
repurchases. It plans to spend $4.045 billion repurchasing shares. In the yearsfollowing, analysts
expect payouts to grow in perpetuity at 3% per annum. Stockholders require a return of 10% and
there are 1.03 billion shares outstanding. What is the fair price forNakatomi's sharestoday?
● $60.52
● $65.10
● $63.25
● $64.10
Sirius Cybernetics faces tough competition from Cyberdyne systems. Sirius has decided to suspend
payouts and instead invest the cash inR&D. Sirius makes its payouts annually at the end of each year.
Today is the first day of a new year. Sirius has announced no payouts at the end of this year or next
year. Payouts will resume three years from yesterday and analysts expect it will pay dividends of
$1.445 billion(in aggregate) and repurchase $4.055 billion worth of shares. In the yearsfollowing,
analysts expect payouts to grow in perpetuity at 5% per annum. Stockholders require a return of 9%
and there are 1.23 billion shares outstanding. What is the fair price forSirius's sharestoday?
● $90.52
● $95.10
● $94.09
● $93.25
Thisyear, analysts expect Stark Industries to make payouts worth $5.2 billion. Assume that all payouts
occur annually at the end of the year and that we are at the beginning of the year. Analysts forecast
thatStark's payouts will grow at 3.1% in perpetuity. Stark stockholders require a return of 8.6%. Stark
has 2 billion shares outstanding. What is the fair price forStark's sharestoday?
● $98.75
● $94.54
● $47.27
● $45.85
Bearsbum Confection is experiencing decliningworld-wide sales of its number oneconfection, the

petit ourson. It announced today that it is suspending dividends and stock repurchases and will
resume them in two years. Analysts expect that total payouts will be $2.3 billion in two years and that
payouts will continue to be paid annually thereafter inperpetuity, growing at a rate of 1.8%. Bearsbum
has 443 million shares outstanding and its investors require a return of 7.2%. What is the fair price for
the sharestoday?
● $92.58
● $98.50
● $96.45
● $89.68
Company Z is currently priced at $41. They just reported earnings per share of $1.46. What is theP/E
ratio that investors are willing to pay for a share of CompanyZ's stock?
● 30
● 25
● 28
● 26
Howell Motors has a P/E constant of 15 and 137 million shares outstanding. Analysts forecast net
income to be $259.1 million in the next fiscal year. What is the fair price for a share of HowellMotors?
● $32.78
● $28.37
● $30.56
● $27.54
TheP/E ratio for a firm is 18.7. Expected earnings per share are $1.67. What is the current price of the
firm's stock?
● $30.56
● $31.23
● $28.37
● $27.60
When would you most likely use theP/E ratio approach to stockvaluation?
● when a firm does not pay dividends such as for privately held companies
● when stock prices are usually volatile
● when conducting ratio analysis of a company since theP/E ratio would be computed
anyway, [Choice D]
● when evaluating publicly held companies with stable dividend payouts
We cannot use valuation models based on the PV of dividends if no dividends are paid. This is
where the PE method becomes useful.
Constanza Energy is an oil company with average risk. The average industryP/E ratio for oil companies
is 20. If Constanza has earnings per share of $1.07, what would be a fair price for itsstock?
● $25.56
● $21.40
● $27.78
● $20.60
Select the best choicebelow. The reason why investors may think that the markets operate efficiently
isbecause
● most investors react slowing to the release of information allowing the markets to buffer and
correct for misinformation.
● veryintelligent, well-informed, and educated people in key positions work to keep prices
correct at all times.
● if a security is mispriced, investors will avoid it until the price corrects.
● many investors are looking for the samething, a good deal. When one is found they will
either buy or sell it until the good dealdisappears, thus driving it back to its correct price.
With many players in the market looking for good deals, they disappear quickly.
Select the best choicebelow. The implication for investors of efficient markets is that if they really are
efficient:
● truly skilled investors should be able to earn unusually high returns by picking winners more
often than other investors[Choice D]
● investors cannot earn positive returns on average
● investors should not expend resources picking stocks since all will represent fair values
● investors should watch and read every possible investing source prior to buying stock
If all securities are priced fairly, the effort should not be on stock selection, rather on risk
management and diversification.
According to the efficient markettheory, whenever investors find that the required return of a stock is
less than its expectedreturn, they'll buy the stock. This will
● drive down the price.

● not affect the price.
● cause the market to crash.
● drive up the price.
Buying and selling based on expected returns drives prices up or down respectively. This activity
keeps prices fair.
An efficient market exists when securities are priced fairly at all times and where
● new information is rapidly reflected in the price.

● new information is largely ignored.
● new information eventually is reflected in the price.
● new information is continually evaluated.
In efficient markets, prices are rapidly updated as new information is available.
The random walk hypothesis maintains which of the following?
● that prices follow a random pattern

● that the best estimate of tomorrow’s price is today’s price
● that prices are set randomly
● that the best estimate of tomorrow’s price is yesterday’s price
If the best estimate to tomorrow’s price wasn’t today’s price then the price would adjust today to
take advantage of the information.
What three conditions are necessary for markets to behaveefficiently? Select the best choice below.
● limited access toinformation, fewcompetitors, disparate goals

● similargoals, dissimilargoods, limited competitors
● manycompetitors, similargoals, speed
● manycompetitors, manymarkets, many goals
When many competitors with similar goals act quickly, we will see an efficient market.
Chapter 2
Incross-sectional analysis, afirm's financial ratiosare
● compared with a general standard.

● compared with ratios from all firms.
● judged against the performance of firms in the same industry or, if no clear industry is
apparent, to firms with similar characteristics.
● compared with thefirm's ratios from the most recent period.
Thefour-digit codes used by the government to classify firms into industries are knownas:
● ratio standards
● financial benchmarks
● SIC codes
● USIC codes
Find the return on assets if net income was $59,000, total assets are $115,000, EBIT was $97,000, and
equity is $73,000.
● 53.9%
● 48.2%
● 51.3%
● 59%
What is the return on equity if net income was $58,000, total assets are $118,000, EBIT was $98,000,
andstockholder's equity is $79,000?
● 61.7%
● 80%
● 73.4%
● 84.4%
Sales for a firm are $510,000, cost of goods sold are $395,000, and interest expenses are $15,000.
What is the gross profitmargin?
● 18.9%
● 20.5%
● 19.6%
● 22.5%
If net income was $

12,000, interest expense was $5,000, and taxes were $1,500, what is the
operating profit margin if sales were $60,000?
What is the current ratio if cash is $14,000, accounts receivable are $25,000, inventories are $35,000,
accounts payable are $40,000, and accrued payroll is $20,000?
● 0.26
● 1.70
● 1.14
● 1.23
A firm has sales of $1.2 million, net income of $287,000, total current assets of $315,000, and
accounts receivable of $220,000. What is thefirm's accounts receivable turnover?
● 5.45 times
● 5.14 times
● 5.75 times
● 5.85 times
What is afirm's debt ratio if its total assets are $137,000, equity is $34,000, current liabilities are
$21,000, and total liabilities are $103,000?
● 15.3%
● 81%
● 75%
● 40.1%
A firm has 104,000 shares of common stock outstanding and has just recorded $48,000 netincome.
What is itsprice/earnings ratio if its current share price is $31?
● 67.2
● 70.2
● .46
● 80.1
● .29
Suppose Lacey Corporation has total credit sales of $742,000. If the balance sheet reports accounts
receivable of $53,314, what isLacey's average collection period? (Assume a365-day year.)
● 21 days
● 25 days
● 26 days
● 28 days
● 29 days
Assume a national corporation has a net income of $1.10 million and 134,000 shares of common
stock. Currently, the stock is on the market for $24.00. Compute theprice/earnings ratio.
● 2.98
● 3.10
● 2.92
● 3.33
If net income was $12,000, interest expense was $3,900, and taxes were $1,100, what is the operating
profit margin if sales were $51,000?
● 33.3%
● 31.1%
● 24.2%
● 43.1%
When financial ratios are compared to financial ratios from previousyears, a time series analysis is
conducted.
All of the following are problems withcross-sectional financial analysis exceptthat:
● an industry may be dominated by a few firms.

● it provides no basis for comparison to other firms.
● many firms are conglomerates.
● annual reports sometimes do not disclose divisional financial data.
What is the quick ratio if cash is $10,000, accounts receivable are 30,000, inventories are $25,000,
accounts payable are $40,000, and accrued payroll is $16,000?
● 1.16
● 0.77
● 0.73
● 0.71
The quick ratio is 1.09. Current assets are $101,000 and current liabilities are $80,000. What is the
amount in the inventoryaccount?
● $12,006
● $16,146
● $11,592
● $15,732
● $13,800
If current assets are $10, current liabilities are $12, long-term assets are $19, and long-term debt is $8,
what is the debt equity ratio?
The debt equity ratio is
Use the following balance sheet and income statement to compute the following ratios:
Financial Ratio 20X1 20X0
Return on Equity (ROE) 3134/(4462-40)=0.7087 641/(411-17)=1.6269

Net income / (total equity -
preferred stock)
Return on assets (ROA) 3134/18861=0.1662 641/21998=0.0291
Gross Profit Margin 11877/69169=0.1717 7678/52857=0.1453
Operating Profit Margin (6099-272)/69169=0.0842 (2313-713)/52857=0.0303
Net Profit Margin 3134/69169=0.0453 641/52857=0.0121
Current Ratio 14365/7489=1.9181 17745/5987=2.9639
Net Working Capital 14365-7489=6876 17745-5987=11758
Inventory Turnover 57292/6700=8.5510 45179/10611=4.2578

Fixed Assets Turnover 69169/4496=15.3846 52857/4253=12.4282
Total Assets Turnover 69169/18861=3.6673 52857/21998=2.4028
Receivables Turnover 69169/6652=10.3982 52857/5109=10.3459
Average Collection Period 6652/69169*365=35.1021 5109/52857*365=35.2798
Average Payment Period 2331/57292*365=14.8505 1184/45179*365=9.5655
Debt Ratio 14399/18861=0.7634 21587/21998=0.9813
Debt-Equity Ratio 14399/(4462-40)=3.26 21587/(411-17)=54.79
Times Interest Earned (TIE) 6099/875=6.9703 2313/1245=1.8578

Ratio
Every line on the income statement is divided by what line to generate acommon-sized income
statement?
● total sales
● total income
● total equity
● total assets
Use the following the balance sheet and income statement to complete the common-sized income
statement and balance sheet.
Solution:
The DuPont analysis calculates ROE as the productof
● leverage, marketvalue, and turnover.

● margin, turnover, and leverage.
● profitability, liquidity, and leverage.
● activity, leverage, and debt.
Use the following financial statements to prepare a DuPont analysis.

Conduct a DuPont analysis to explain the change in Cadbury’s profitability from 2007 to 2008. Which
of the following is the best explanation for the change in ROE? (Ignore factors that make minor
contributions, i.e., less than 10%.)
● net profit margin (margins)
● total asset turnover (asset efficiency)
● net profit margin, total asset turnover, and leverage
● equity multiplier (leverage)
● net profit margin and total asset turnover
Conduct a DuPont analysis to explain the change in CP’s profitability from 2016 to 2017. Which of the
following is the best explanation for the change in ROE? (Ignore factors that make minor contributions,
i.e., less than 10%.)
Conduct a DuPont analysis to explain the change in AO Smith’s profitability from 2014 to 2015. Which
What one reason best explains the change in financial performance of Molson Coors between 2001
and 2002?
● increase in PP&E
● increase in sales
● an increase in leverage
● purchase of another company
● relaxation of the collection policy
Conduct a DuPont analysis to explain the change in Polaris’ profitability from 2004 to 2005. Which of
the following is the best explanation for the change in ROE? (Ignore factors that make minor
Initech’s net profit margin is 1.3% in 20X0 and 1.6% in 20X1, total asset turnover is 4.9 in 20X0 and 4.4
in 20X1, and the equity multiplier is 3.2 in 20X0 and in 20X1. What is Initech’s ROE for both years and
is this a good trend?
SOLUTION:
ROE for 20X0 = [Net profit margin*Total asset turnover*Equity multiplier]
ROE for 20X0 = [1.3%*4.9*3.2]
ROE for 20X0 = 0.20384 OR 20.38%
Initech’s net profit margin is 1.3% in 20X0 and 1.6% in 20X1, total asset turnover is 4.9 in 20X0 and 4.4
in 20X1, and the equity multiplier is 3.2 in 20X0 and in 20X1. What is Initech’s ROE for both years and
is this a good trend?
SOLUTION:
ROE for 20X1 = [Net profit margin*Total asset turnover*Equity multiplier]
ROE for 20X1 = [1.6*4.4*3.2]
ROE for 20X1 = 0.22528 OR 25.53%
This is a good trend.
Use the following the balance sheet and income statement to complete the common-sized income
statement and balance sheet.
Conduct a DuPont analysis to explain the difference between Walmart’s ROE and the ROE of the
Hudson’s Bay Company. Which of the following is the best explanation for the difference? (Ignore
factors that make minor contributions, i.e., less than 10%.)
Conduct a DuPont analysis to explain the change in Hershey’s profitability from 1998 to 1999. Which
Conduct a DuPont analysis to explain the change in Winn-Dixie’s profitability from Year 1 to Year 2.
Which of the following is the best explanation for the change in ROE? (Ignore factors that make minor
Conduct a DuPont analysis to explain the change in Blockbuster’s profitability from Year 1 to Year 2.
Conduct a DuPont analysis to explain the change in Tootsie Roll’s profitability from Year 1 to Year 2.
Use the financial statements and the information provided below to answer the following question.
In the early 2000s, Canada had four department store chains: The Hudson’s Bay Company, Sears,
Zellers, and Walmart. Zellers was a discount department retailer founded in 1931. It reached its peak
in the 1990s with 350 stores. Its inability to compete with Walmart led to its slow demise during the
2000s.
In 2011, Target Corp. purchased most of Zeller’s leases (135) for $1.636 billion. In 2013, in an
aggressive expansion into Canada, Target opened 124 stores in the locations previously occupied by
Zellers. The first year of operations was not good, with weak sales, empty shelves and complaints from
customers that product selection and prices did not match US stores. This was due to issues like
labelling laws (all Canadian labels must be bilingual), product packaging laws (packaging weight and
sizes are regulated), and Canadian import tariffs. For example, men’s clothing imported to Canada is
subject to a 13% tariff. These laws and regulations forced Target to source its products through
different (more expensive) Canadian suppliers and required it to set up three Canadian distribution
centers.
At the end of fiscal 2013, Target reported EBIT of -$941M on sales of $1,317M. In November of 2014,
speculation rose that Target might withdraw from Canada. Based on those rumours, Target’s stock
price rose from $60 in late October to $75 by mid-December. On January 15, 2015, Target announced
it would close all of its Canadian stores.
Using the Du Pont ratios, what is the biggest cause of the change in ROE from 2012 to 2013?
● change in leverage
● change in profit margin
● change in ROA
● change in stock price
● change in total asset turnover
Review the financial statements for Santa Fe Railways, read the notes to the financial statements, and
then answer the question that follows.
Financial statement notes:
1. Workforce reduction charges: In Year 2, the Company announced 1,146 job reductions, following its
commitment to improve productivity, and recorded a charge of $120 million. In Year 1, a charge of $98
million was recorded for the reduction of 690 positions. The charges included payments for severance
and early retirement incentives to be made to affected employees.
2. Accounting changes: U.S. personal injury and other claims. In the fourth quarter of Year 2, the
Company changed its methodology for estimating its liability for U.S. personal injury claims from a
case-by-case approach to an actuarial-based approach. Under the actuarial-based approach, the
Company accrues the cost for the expected personal claims, based on actuarial estimates of their
ultimate cost. Consequently, the Company recorded a charge of $281 million to increase its provision
for these claims.
3. Capital Stock:
A. Issued and outstanding common shares

During Year 2, the Company issued 7.8 million shares of which 1.8 million shares were
related to stock options exercised and 6.0 million shares were related to the conversion of
the company’s convertible preferred securities. The total number of common shares issued
and outstanding was 197.5 million as of December 31, Year 2 (and 192.7 million as of
December 31, Year 1).
B. Share repurchase programs
On October 22, Year 2, the board of directors of the company approved a share repurchase
program which allowed for the repurchase of up to 13.0 million common shares between
October 25, Year 2 and October 24, Year 3 pursuant to an open market stock repurchase at
prevailing market prices. As of December 31, Year 2, $203 million was used to repurchase 3.0
million common shares at an average price of $67.68 per share.
Which is the best explanation for the change in ROE?
● decline in total asset turnover

● decline in net profit margin
● decline in ROA
● decline in the equity multiplier
● increase in total asset turnover
Conduct a Du Pont analysis to explain the change in Cadbury’s profitability from 2007 to 2008. Which
2012 and 2013 were bitterly competitive years in the smartphone wars. In September
of 2011, Apple released the iPhone 4S. The “S” stood for Siri, the intelligent personal
assistant. The reaction to the 4S was positive. Apple sold four million phones over the
first weekend, which was more than double the sales of the iPhone 4 over its first
three days. A little over six months later (May 2012), Samsung released the Galaxy
SIII. While the 4S had a 3.5-inch (diagonal) display, the SIII boasted a 4.8 inch screen.
Tech commentators touted it as the "iPhone killer". T3 magazine awarded it "Phone of
the Year" in 2012. It played a major role in pushing Samsung's Q2 2012 operating
profit to a record level. Apple even sued Samsung over the SIII for patent
infringement.
In September 2012, Apple released the iPhone 5 with a 4-inch diagonal screen. While
larger than the screen of the 4S, it was still smaller than the screen of the galaxy SIII.
The extra features of the iPhone 5 boosted its cost to $207 which was $19 more than
the 4S model. Apple retailed the i5 for US$649, which was the same price as the 4S.
In March of 2013, Samsung responded by releasing the Galaxy S4 with an even
larger display (5 inches). In this mini case, you will analyze the impact that this battle
had on Apple’s 2013 performance.
Use the financial statements below and ratio analysis to answer the following
question.
What happened to Apple’s ROE in 2013 compared to 2012?
● stayed the same

● increased
● decreased
Use the financial statements and the information provided below to answer the following question.
United Technologies Corporation (UTC) is a diversified company that provides a broad range of
high-technology products and services to the global aerospace and building systems industries. The
commercial businesses include Otis elevators and escalators, and UTC Climate, Controls & Security,
which includes Carrier heating, air-conditioning, and refrigeration systems, as well as fire and security
solutions from brands such as Kidde and Chubb. The aerospace businesses include Sikorsky
helicopters, Pratt & Whitney aircraft engines, and UTC Aerospace Systems.
In 2012, sales ________________ and net income ____________.
● increased, decreased
● decreased, decreased
● decreased, increased
● increased, increased
In 2012, UTX's sales decreased and so did its net income.

Use the financial statements and the information provided below to answer the questions that follow.
What is the change in the payables period from Year 1 to Year 2? Calculate days payables in Year 2 and
subtract from it the value in Year 1. What is the difference? (Use sales instead of COGS.)
● -0.81
● 13.00
● 33.65
● 0.81
● -0.37
The change in the payables period is: 33.28 – 33.65 = -0.37.
Ouimet Distributors Inc. is a distributor of golf equipment to retail chains throughout North America. It
distributes products by Ping, Callaway, Adams, and other national brands. The company is based in
Brookline, Massachusetts. Answer the questions below using the financial statements provided.
What best explains the change in total asset turnover (TAT)? (ΔTAT = TAT2 – TAT1)
I. a decrease in inventory turnover

II. a decrease in accounts receivable turnover
III. an increase in leverage
● II only
● III only
● I and II only
● I only
● II and III only
Total asset turnover falls from 3.61 to 2.33. Total asset turnover falls because both accounts
receivable turnover and inventory turnover fall. Accounts receivable turnover falls from 5.8 to 4.3
and inventory turnover falls from 12.8 to 7.9. Leverage does not affect asset turnover.
Conduct a DuPont analysis to explain the change in Santa Fe’s profitability from Year 1 to Year 2. Which
● net profit margin and leverage
The DuPont analysis calculates ROE as the product of:
● profitability, liquidity, and leverage.

● activity, leverage, and debt.
● margin, turnover, and leverage.
● leverage, market value, and turnover
ROE is the most important ratio to investors, and it can be changed by either changes in margin,
turnover, or leverage. The DuPont ratio helps determine which of these is responsible.
The table below provides ratios for Los Pollos Hermanos Restaurants Inc. for last year. This coming
year, Los Pollos’ management expect total asset turnover to remain constant, but they expect the net
profit margin to improve to 8% due to a new chicken supply contract and head office cost reductions.
If Los Pollos wants the same ROE this coming year as last year, then what equity multiplier should it
have this coming year? Round your answer to three decimal places.
Equity multiplier = 1.305

What is likely the best outcome an analyst will get from ratioanalysis?
● clues that will lead to additional questions

● a paycheck
● absolutely clear answers
● frustration
Absolute answers are rare in ratio analysis. Usually the best we can hope for are clues that lead us
to ask clarifying questions.
Chapter 18
You have a long position in one wheat futures contract. At the close of trading yesterday, the futures
price was $5.50 per bushel. Today, the settlement price for wheat futures is $5.85. What is your daily
profit?
(Remember that there are 5,000 bushels in a contract.)
You have a short position in one wheat futures contract. At the close of trading yesterday, the futures
price was $5.50 per bushel. Today, the settlement price for wheat futures is $5.95. What is your daily
profit?
With a dry summer forecast, you expect that the soybean harvest will be smaller than normal and that
soybean prices will rise. To speculate on this expectation, you buy 10 soybean futures contracts with a
September maturity. The soybean futures price when you initiate the long position is $14.00 per
bushel. By August the soybean futures price has risen to $15.50 per bushel. You execute an offset
trade. What is your cumulative profit on the trades?
The dollar value of one Big Dow Index futures contract is the product of the futures price and the
futures contract multiple ($25). If the futures price is 10,000, then the contract value is $250,000
(10,000 x $25). The contract is cash settled, so at the settlement date, cash is exchanged between the
long and short positions. The current level of the index is 12,000. You are a mutual fund manager and
you think that the Dow Jones Industrial Index is going to rise. To speculate on this expectation, you buy
50 of the Big Dow futures contracts in the September maturity. Assume that one week passes and the
index rises to 12,090 and the futures prices rise accordingly. Assume that you execute an offset trade
at that time and sell 50 of the Big Dow futures contracts in the September maturity. What is your
cumulative profit on the trades?
Natural gas (NG) futures contracts trade on the CME. Each NG contract calls for the delivery of 10,000
million British thermal units (mmbtu) of natural gas to the Henry Hub, a pipeline junction in Louisiana.
Prices on the NG futures contracts are quoted as U.S. dollars and cents per mmbtu. If the price is
quoted as 8.30, that means 1 million British thermal units (1 mmbtu) costs $8.30. Typical daily volume
for the NG contract is 60,000 contracts. In the summer of 2007, Brian Hunter of Amaranth Advisors, a
hedge fund, lost $6.6 billion trading NG futures. Assume that Mr. Hunter took a long position in the
October futures contract in July of 2007 at a price of 8.30 and offset that position in September at a
price of 4.25. How many contracts did Mr. Hunter have in his long position in order to lose $6.6B when
he reversed in September?
You forecast a cold, rainy summer so you expect wheat harvests to be poor and prices to rise. To profit
from your expectation, you take a long position in 15 wheat futures contracts at a futures price of
$6.86 per bushel (each contract is for 5,000 bushels). You execute an offset trade near the maturity
date of the futures contract at a price per bushel of $3.20. What is your cumulative profit?
Last November you obtained an advance copy of the Florida Orange Juice Growers crop report. The
report forecasted a warm winter with abundant harvests and, consequently, low prices. To profit from
this information, you took a short position in 20 orange juice futures contracts (for May delivery) at a
futures price of 150.80. Each orange juice futures contract calls for delivery of 15,000lbs of orange
juice solids. Prices are quoted in cents and hundreds of a cent per pound. So a futures price of 150.80
is $1.5080 per pound. In April, the May orange juice futures contract is trading for 109.1 and you
execute an offset trade. What is your cumulative profit?
The basis of a futures contract is defined as the difference between the spot price and the futures
price.
Basist = Spot pricet – Futures pricet
The CME June soybean futures contract just traded at 1401’0. Today is April 1. The spot price today is
1395’4. If the spot price falls to 1390’0 by mid-June, then what will the basis be when the June
contract stops trading?
You are short one gold contract with a December maturity. You want to close out the position. What is
the offsettrade?
● long one gold futures contract
● long one January gold futures contract
● buy gold and deliver
● long one December gold futures contract
You have a long position in one soybean futures contract. The initial margin was $3,250 and the
maintenance margin is $1,750. At the close of trading yesterday, the futures price was $8.03 per
bushel and the balance in your margin account was $4,500. Today, the settlement price for soybean
futures is $7.43. Will you receive a margin call and what deposit will you be required to make?
You have a short position in one wheat futures contract. The initial margin was $3,000 and the
maintenance margin is $1,500. At the close of trading yesterday, the futures price was $6.48 per
bushel and the balance in your margin account was $1,750. Today, the settlement price for wheat
futures is $6.68. Will you receive a margin call and what deposit will you be required to make?
Tifany & Co. Jewelry Company sells 500 gold rings per day. Each ring uses about 0.2 of an ounce of
gold. Over a year, Tifany uses 750,000 ounces of gold. Tifany buys all of its gold on one day. Tifany uses
CME gold futures contracts to hedge the price risk of gold. The CME futures contract calls for the
delivery of 100 ounces of gold. The contract is priced in dollars and cents per ounce. To hedge the
price risk, should Tifany buy or sell gold futures and how many contracts should it trade?
Long = buy 7,500 contracts
You grow wheat on 1,125 acres near Normal, Illinois. It is late May. You just finished planting. Your
typical yield is 40 bushels per acre, so you expect to harvest 45,000 bushels in the fall. You worry that
the price of wheat might decline and you want to hedge your price risk. Wheat futures contracts trade
on the CME. The wheat contract calls for the delivery of 5,000 bushels. To hedge the price risk, should
you buy or sell December wheat futures? How many contracts should you trade?
Jack Straw grows soybeans on a 2,000-acre farm outside Wichita Kansas. It is late May and Jack has
just finished planting. His typical yield is 90 bushels per acre, so he expects to harvest 180,000 bushels
of soybeans in the fall. Soybean futures contracts trade on the CME. The soybeans contract calls for
the delivery of 5,000 bushels of soybeans. Assume that Jack enters the appropriate futures position (in
the December contract) to hedge his price risk at a futures price of $5.3325/bu. In the fall, Jacks sells
his harvest to his local grain elevator, who pays him the prevailing spot price of $5.55/bu.
Simultaneously, Jack executes an offset trade in the futures market. Assume that, due to convergence,
the futures price on that date is equal to the spot price. What is Jack’s cumulative profit from the
futures transaction and what are his proceeds from selling his wheat?
You are in charge of malt barley purchasing for Duff Brewery in Springfield. The brewery produces 1B
bottles (3.35 million hectoliters) of beer annually. Each hectoliter of beer requires 10.67 kilos of barley.
You purchase about 9,000 metric tonnes of barley each quarter. It is currently the beginning of the
second quarter and you are considering your next purchase of barley in three months’ time. Barley
futures contracts trade on the Winnipeg Commodities Exchange. The contract that you use is the
Western Barley contract, which calls for the delivery of 20 metric tons of barley. Assume that you
enter the appropriate futures position to hedge this price risk at a futures price of $185.00/tonne. As
the futures maturity date approaches, you buy your barley in the spot market, where it trades for
$200.00/tonne, and you execute an offset trade in the futures market. Assume that, due to
convergence, the futures price is equal to the spot price. What is your profit from the futures
transaction and what is your purchase cost for the 9,000 metric tonnes of barley?
Which of the following items gives the long position the right to sell an asset at a specified price if they
so choose?
In which type of option does the short side pay the premium to the long side?[This is the stem.]
Answer: neither
The owner of a put has the right to sell the underlying asset.
Which type of option restricts the buyer to exercising on the expiration day only?
● American
● European
● both
● neither
You have a long position in the December put option on the shares of Heartless Enterprises Inc. with a
strike price of $40. It is a European option. Today (in November), Heartless shares are trading for $30
and you want to close your position. What do you do?
I. Sell a December call option
II. Exercise your option
III. Sell a December put option
● I only
● II only
● III only
● II or III
You are long a call option with an exercise price of $100. The option expires today and the underlying
security is trading at $94. If you purchased the option for $4, should you exercise the option?
- NO
Simon Templar bought 1 put option on shares of Massive Dynamic for a premium of $2.00 (per share).
The strike price of the option is $30 and the stock price was $29.50. Subsequently, the price of Massive
Dynamic shares fell to $28.50 and Simon sold one put option at a premium of $3.00 (per share). What
was Simon’s profit (or loss) per share on the transactions?
Shares of VersaLife Corporation are currently trading for $30. Call options on VersaLife Corporation
shares, which expire in six months with a strike price of $20, are trading for $15. A trader buys one call
option contract. Assume that there is one share per contract. At maturity, what is the payoff to the call
option holder if the stock price is $30?
● $10
● -$10
● $20
● $0
Shares of ACME Corp. are currently trading for $15. Call options on ACME Corp. shares, which expire in
six months with a strike price of $25, are trading for $7.5. A trader writes one call option contract.
Assume that there is one share per contract. At maturity, what is the payoff to the call option writer if
the stock price is $35?
● $3
● -$20
● -$10
● $0
Shares of Vapid Motors are currently trading for $55. Put options on Vapid shares, which expire in six
months with a strike price of $50, are trading for $5. A trader buys one put option contract. Assume
that there is one share per contract. At maturity, what is the payoff to the put option holder if the
stock price is $51?
Shares of Maddoff Bank Inc. are currently trading for $25. Put options on Maddoff shares, which
expire in six months with a strike price of $20, are trading for $5. A trader writes one put option
contract. Assume that there is one share per contract. At maturity, what is the payoff to the put writer
if the stock price is $25?
The recession has caused car owners to defer a new car purchase and keep their existing car. Thus,
analysts do not expect automotive stocks to rise for the next few months. You plan to profit from this
by taking a short position in a call option on BorgWarner Inc., the car parts manufacturer. Shares of
BorgWarner are currently trading for $80. You write a call option that expires in three months and has
a strike price of $85. The option is trading for $5. At maturity, what is the profit of this call writing
strategy if BorgWarner's stock price is $90? Assume that there is one share per contract.
In the age of high-speed internet, you can buy video games online and download them to your game
console. As a result, you think that the brick & mortar video game store chain, GameStop, has no
future. To profit from your expectation, you buy one put contract on Gamestop’s shares. Gamestop
shares are selling for $35. Put options on Gamestop shares, which expire in six months with a strike
price of $30, are trading for $5. At maturity, what is the profit to your long put position if the stock
price is $10? Assume that there is one share per contract.
The Atlanta Braves have lost the first ten games of the season. Everyone is betting against them. You’re
more optimistic and decide to write put options on shares of the Liberty Braves Group (NASDAQ:
BATRK). BATRK shares are currently trading for $18. Put options on BATRK shares, which expire in three
months with a strike price of $15, are trading for $5. You write one put option contract. Assume that
there is one share per contract. At maturity, what is your profit if the stock price is $10?
Draw the profit diagram for a long position in a put option on shares of the Wireless Electricity Co. The
strike price of the option is $20 and the put premium is $3. What is the maximum loss that you could
earn on this position in this option? Assume that the option contract is for one share only.
● $3
● $17
● $20
● infinity
Draw the profit diagram for a short position in a put option on shares of the Wireless Electricity Co.
The strike price of the option is $20 and the put premium is $3. What is the break-even price for this
position in this option? Assume that the option contract is for one share only.
● $17
● $23
● $20
● $3
Draw the profit diagram for a long position in a call option on shares of the Wireless Electricity Co. The
strike price of the option is $20 and the call premium is $3. What is the maximum profit that you could
earn on this position in this option? Assume that the option contract is for one share only.
● $3
● $17
● $20
● infinity
C. Montgomery Burns just bought a controlling interest in Springfield Nuclear, a local utility. You have
observed Mr. Burns’ ownership style and you predict that Springfield’s share price will rise. You are
considering either buying shares of Springfield or purchasing call options on the shares. The stock
price is currently $20. The call option expires in three months, has a strike price of $20, and has a
premium of $2.00 (per share). Assume that the stock price rises to $30 by the maturity date of the
option. What is the rate of return on each investment? Express your answer in percentage form.
Option: 400%
Stock: 50%
premium of $6.00 (per share). Assume that the stock price falls to $36 by the maturity date of the
option. What is the rate of return on each investment? (Option return, stock return.)
premium of $6.00 (per share). Assume that the stock price falls to $36 by the maturity date of the
option. What is the rate of return on each investment? (Option return, stock return.)
● -100%, -10%
● 66.7%, 25%
● 400%, 50%
● 150%, 33.3%
Gamestop Inc. (NYSE: GME) operates a chain of brick & mortar stores selling video games. With the
advent of high-speed internet, you are convinced that online purchasing will drive GME out of
business. To profit from your prediction, you are trying to choose between short selling GME shares or
buying put options. The stock price is currently $40. If you short sell, then your broker requires you to
deposit 50% margin into your brokerage account. So if you sell 100 shares, you will need to deposit
$2,000. The put option expires in three months, has a strike price of $40, and has a premium of $6
(per share). Assume that the stock price falls to $20. What is the rate of return on each investment?
(Option return, stock return.)
● 250%, 25%
● 150%, 50%
● 150%, 67%
● 233%, 100%
Gamestop Inc. (NYSE: GME) operates a chain of brick & mortar stores selling video games. With the
advent of high-speed internet, you are convinced that online purchasing will drive GME out of
business. To profit from your prediction, you are trying to choose between short selling GME shares or
buying put options. The stock price is currently $30. If you short sell, then your broker requires you to
deposit 50% margin into your brokerage account. So if you sell 100 shares, you will need to deposit
$1,500. The put option expires in three months, has a strike price of $30, and has a premium of $4
(per share). Assume that the stock price rises to $33. What is the rate of return on each investment?
Express your answer in percentage form.
To profit from the growing popularity of ocean voyages, you take a long position in a call option on the
shares of White Star Line, a steamship company whose shares are currently trading for $30. The call
option expires in three months, has a strike price of $27, and has a premium of $3. What is the
intrinsic value of the option?
To profit from the declining usage of directories, you take a long position in a put option on the shares
of Yellow Pages Inc. whose shares are currently trading for $13. The option expires in three months,
has a strike price of $15, and has a premium of $5. What is the intrinsic value of the option?
With the proliferation of news and opinion web sites and YouTube channels, you think that the main
stream media is going to die. To profit from this expectation, you are considering put options on the
shares of The New York Times Company (NYT). The company’s stock is currently trading for $50. Put
options on NYT shares that expire in 3 months with a strike price of $60 are trading for $14. Which of
the following best characterises these puts?
● deep-in-the-money
● out-of-the-money
● in-the-money
● at-the-money
St < X, therefore put is in the money
With the growing popularity of electric cars, you think that the demand for lithium batteries will grow
for many years. To profit from this expectation, you are considering call options on the shares of
Lithium America (NYSE: LAC), a lithium mining company. The company’s stock is currently trading for
$14. Call options on LAC shares that expire in 3 months with a strike price of $10 are trading for $8.
Which of the following best characterises these puts?
● out-of-the-money
● in-the-money
● deep-in-the-money
● at-the-money
Today is April 1. June call options on shares of Gamestop Corporation (GME) with a strike price of $140
are trading for a premium of $50. The shares of GME are currently trading for $150. What is the time
value of the option?
Today is April 1. June put options on shares of Gamestop Corporation (GME) with a strike price of $150
are trading for a premium of $39. The shares of GME are currently trading for $150. What is the time
value of the option?
Last October you bought a call option on shares of Tesla with an April expiry and $120 strike price. You
paid a call premium of $12. Today (January 15), Tesla is trading for $160 per share and the April call
(with the $120 strike) is trading for $47. You think that Tesla has reached its peak price and will start
declining. You want to get out of your long option position today because as the price drops, the
intrinsic value will fall. Answer the following questions.
Part 1
What is your profit if you exercise? (Assume the option is American.)
Part 2
What is your profit if you execute an offset trade?

Part 3
The difference in the profits to the two methods of completion is equal to the
● time value.
● breakeven price.
● premium
● intrinsic value.

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BU283 FINAL - All Homework Solutions

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Chapter 3

Year Cash Flow

● depends on the interest rate

FV = $100 x (1.10)^5 = $161.05

Case Interest Rate, k (%) Number of FVIF

Compounding Initial Int rate Number Future

periods per year Deposit of years value

Cas Single Cash Flows Interest Rate Deposit Period Future

Year Cash Flow

Paying interest more frequently results in a _____ future value.

What interest rate makes $100 grow to $255.80 over 9 years?

Express you answer to three decimal points

Round your answer to the nearest cent

Round your answer to the nearest cent.

Number of FV Deposit Nominal Deposit Present

Compounding (%) Interest

Periods in the Year Rate (%) (Yrs) ($)

Year Cash Flow Stream

12​% compounded semi-annually. What is the present value of your​inheritance?

future value as of date​2.

ordinary annuity there is no payment on that date.

Year Cash Flow

interest rate have you earned over the year?

interest rate have you earned over the year?

e.g., remaining amortization period and interest​rate.)

A _________ return usually incurs​__________ risk.

(Select the best choice​below.)

Which of the following is a true statement?

If there is absolutely no risk to an investment,

● there will be some return.

What was your holding period​return?

Which of the following statements is true?

State of the Probability Projected

Economy (%) Return (%)

Year Index Return

1999 4,069.31 85.59%

2000 2,470.52 -39.29%

2001 1,950.40 -21.05%

2003 2,003.37 50.01%

A. The arithmetic average return is

​%. (Round to two decimal​places.)

B. The compound average returns is negative

%. ​(Round to two decimal​places.)

%. ​(Round to two decimal​places.)

Which of the following is a false​statement? ​(Select the best choice​below.)

● Expected returns are not always predicted accurately.

● hold the asset.

​(Select the best choice​below.)

● This process allows you to practice using your calculator.

Investmen $1,000 $1,000

a. What is the expected return for each project?

b. What is the range of return of each project?

c. Which project is most risky?

Consider a portfolio that includes the following two​companies:

Price Number of Shares Price Number of Shares

​$6.00 700 ​$9.00 1,400

States of Nature Probabilities Returns

Nothing of value in claim 0.40 −100​%

12% compounded semi-annually. What is the present value of yourinheritance?

future value as of date2.

e.g., remaining amortization period and interestrate.)

A _ return usually incurs__ risk.

(Select the best choicebelow.)

What was your holding periodreturn?

%. (Round to two decimalplaces.)

%. (Round to two decimalplaces.)

%. (Round to two decimalplaces.)

Which of the following is a falsestatement? (Select the best choicebelow.)

(Select the best choicebelow.)

Consider a portfolio that includes the following twocompanies:

$6.00 700 $9.00 1,400

Nothing of value in claim 0.40 −100%

A small area of ore 0.30 −20%

A large amount of zinc 0.15 75%

A large amount of silver 0.15 250%

in Portfolio Share($) on Security(%)

Select the best choicebelow. Correlation

(Select the best choicebelow.)

(Select the best choicebelow.)

Select the best choicebelow. By incrementally adding securities to aportfolio,

Which index is popularly thought to best represent changes in technology companystocks?