CITY UNIVERSITY OF HONG KONG

SDSC3022 (Semester B, 2021)

Midterm Exam

Name:

Student ID:

Instructions (IMPORTANT - please read):

• You have 1.5 hours to complete this exam and additional 15 minutes
to submit.

• You need to make the submission on Canvas at/before 1:45pm on 9

March 2022. You need to upload your answers and the cover page
containing your name and student ID in one .pdf, or .doc file to Canvas.
If you experience difficulty with Canvas, please email your submission
to xiaoqiao@cityu.edu.hk or jingyshi5-c@my.cityu.edu.hk as a backup
option.

• There are two parts in total. In multiple choice questions, please select
the most appropriate one. In short answer questions, please include a
simple procedure and explanation of your results.

• This is an open-book examination. Only lecture notes and scien-

tific calculators are allowed. Materials/aids other than lecture notes
are not permitted. Students will be subject to disciplinary action if any
unauthorized materials or aids are found on them.

• You can also reach the lecturer via Zoom/email for clarifying question(s)
during the exam.

1
 Academic Honesty

The University requires all students to comply with the Rules on Academic
Honesty and regulations promulgated by the University and the academic
units in examinations and coursework. Students are reminded of the impor-
tance of academic honesty and the honesty pledge made when joining CityU.
Failure to adhere to the honesty pledge may have serious consequences.

“I pledge that the answers in this exam are my own and that I will not seek
or obtain an unfair advantage in producing these answers. Specifically,

• I will not plagiarize (copy without citation) from any source;

• I will not communicate or attempt to communicate with any other person

during the exam; neither will I give or attempt to give assistance to
another student taking the exam; and

• I will use only approved devices (e.g., calculators) and/or approved device
models

• I understand that any act of academic dishonesty can lead to disciplinary

action.”

All students sitting for this examination are required to reaffirm the above-
mentioned honesty pledge by writing the below statement with your
signature and date onto the first exam answer sheet. Students who
fail to do so may lead to severe penalties, including the receipt of a zero mark
in the examination.

“I, [Student Name (SID)], pledge to follow the Rules on Academic

Honesty and understand that violations may lead to severe penalties.”

Signature
Date

2
 Page 1 of 3

PART 1: MULTIPLE CHOICE QUESTIONS (5 POINTS EACH)

Question 1: Suppose a company’s return in the past three years has been -30%, 0%, and 30%. What is the
geometric average of these returns?

A. -30%
B. -3.10%
C. 0%
D. 3.10%
E. 30%

Question 2: Suppose we have done mean-variance analysis and drawn the investment opportunity set.
What happens to the Sharpe ratio of the tangency portfolio if we now introduce one more risky asset?

A. It increases
B. It stays the same
C. It decreases substantially if the new asset is highly correlated with one of the old assets
D. It becomes to equal to the expected return of the minimum variance portfolio
E. It stays the same or increases. The outcome depends on the asset’s expected return and its
correlation with existing assets.

Question 3: All things equal, diversification is most effective when

A. Asset returns are uncorrelated

B. Asset returns are positively correlated
C. Asset returns are high
D. Asset returns are negative correlated
E. Both B and C

Question 4: Which one of the following portfolios has the highest Sharpe ratio? The risk-free rate is 3%.

F. E(rA) = 10%, σA = 20%

G. E(rB) = 12%, σB = 24%
H. E(rC) = 14%, σC = 30%
I. E(rD) = 16%, σD = 34%
J. E(rE) = 18%, σE = 40%

Question 5: Your opinion is that a security has an expected rate of return of 10.6%. It has a beta of 1.2.
The risk-free rate is 4% and the market expected rate of return is 10%. According to the Capital Asset
Pricing Model, this security is

A. underpriced.
B. overpriced.
 Page 2 of 3

C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

Question 6: The Arbitrage Pricing Theory (APT)…

A. tells us how to find common factors among returns

B. says that if any two securities have the same exposures to the common factors, they must have
the same expected returns
C. states that the CAPM is wrong
D. assumes there are abundant arbitrage opportunities
E. both A and B are correct

Question 7: The minimum variance portfolio of risky assets

A. has equal covariance with all individual assets

B. always has a lower expected return than the tangency portfolio
C. has the same or lower variance than all individual risky assets
D. all of the above
E. none of the above

Question 8: Discount rates are

A. actual rates of return

B. realized rates of return
C. historical average returns
D. expected returns
E. B and C

Question 9: Suppose you invest $10,000 into S&P 500 with the expectation that S&P will earn 0.8% per
month from now on. What do you expect your investment to be worth in 50 years?

A. About $15 thousand

B. About $470 thousand
C. About $740 thousand
D. About $980 thousand
E. About $1.2 million
 Page 3 of 3

PART 2: SHORT ANSWER QUESTIONS

Question 10: Suppose you invest $10,000 in the S&P 500 with the expectation that it will earn 1% per
month from now on. What do you expect your investment to be worth in 5 years? (8 points)

Question 11: Suppose the world is described by a two factor APT model, that there are no arbitrage
opportunities, and that the returns on three base assets satisfy the equations below. What is the risk-free
rate? (15 points)
r1 = .13 + 2F1 + 2F2 + e1
r2 = .07 + F1 + e2
r3 = .15 + 2F1 + 3F2 + e3

Question 12: According to the CAPM, an asset may have an expected return below the risk-free rate, but
no asset can have an expected return below zero since everyone holds the market portfolio. Is this TRUE,
FALSE, or IT DEPENDS (briefly explain)? (10 points)

Question 13: The expected returns of A, Inc. and B Enterprises are 12% and 14%, respectively.
Furthermore, the variance-covariance matrix for these two stocks is given by the following:

A B
A 0.005 0.002
B 0.002 0.004
The risk-free rate is 6%. Compute the portfolio weights of the two stocks in the minimum variance portfolio.
(10 points)

Question 14: The following table gives you information about stocks A and B, and the risk-less asset

a) What is the expected return of a portfolio that invests 1/3 in A, 1/3 in B, and 1/3 in the risk-less
asset (10 points)

b) What is the standard deviation of the portfolio in part (a) (7 points)?