Economics 435 Economics by fionan

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									                                                                                                Economics 435
                                                                                                  Spring 2008

                                                Final Exam

This is a closed-book exam. You must remain in the room when you write your examination. You may not
refer to any books, notes, or other material, but you may use a calculator (but not a “programmable” one).
Look over the entire exam before you start. There is a total of 185 points.

PART I: Clearly mark the correct answer on scantron sheet. There are 45 questions , each
question counts for 3 points each. There are a total of 135 points in this section.

1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is
         A) unique risk.
         B) beta.
         C) standard deviation of returns.
         D) variance of returns.
         E) none of the above.

2. A put option on a stock is said to be in the money if
         A) the exercise price is higher than the stock price.
         B) the exercise price is less than the stock price.
         C) the exercise price is equal to the stock price.
         D) the price of the put is higher than the price of the call.
         E) the price of the call is higher than the price of the put.

3. According to the Capital Asset Pricing Model (CAPM), underpriced securities
        A) have positive betas.
        B) have zero alphas.
        C) have negative betas.
        D) have positive alphas.
        E) none of the above.

4. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta
        of the resulting portfolio is
        A) 1.40
        B) 1.00
        C) 0.36
        D) 1.08
        E) 0.80

5. The market portfolio has a beta of
        A) 0.
        B) 1.
        C) -1.
        D) 0.5.
        E) none of the above

6. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant
         information including historical stock prices and current fundamental information about the firm, but
         not information that is available only to insiders.
         A) semistrong
         B) strong
         C) weak
         D) A, B, and C
         E) none of the above
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7. You are considering acquiring a common stock that you would like to hold for one year. You expect to
        receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The
        maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.
        A) $30.23
        B) $24.11
        C) $26.52
        D) $27.50
        E) none of the above

8. In an efficient market the correlation coefficient between stock returns for two non-overlapping time periods
         should be
         A) positive and large.
         B) positive and small.
         C) zero.
         D) negative and small.
         E) negative and large.

9. At maturity date, market price of a share of Disney stock is $30. If a call option on this stock has a strike
        price of $35, the call
        A) is out of the money.
        B) is in the money.
        C) should be exercised.
        D) A and C.
        E) B and C.

10. A security has an actual expected rate of return of 0.10 and a beta of 1.1. The market expected rate of
        return is 0.08 and the risk-free rate is 0.05. The alpha of the stock is
        A) 1.7%.
        B) -1.7%.
        C) 8.3%.
        D) 5.5%.
        E) none of the above.

11. A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to
        maturity of 10%. The price of the bond today will be ______ if the coupon rate is 7%.
        A) $712.99
        B) $620.92
        C) $1,123.01
        D) $886.28
        E) $1,000.00

12. If a 6% coupon bond is trading for $950.00, it has a current yield of ____________ percent.
          A) 6.5
          B) 6.3
          C) 6.1
          D) 6.0
          E) 6.6

13. A coupon bond that pays interest annually is selling at par value of $1,000, matures in 5 years, and has a
        coupon rate of 9%. The yield to maturity on this bond is:
        A) 8.0%
        B) 8.3%
        C) 9.0%
        D) 10.0%
        E) none of the above


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14. You write one AT&T February 50 put for a premium of $5. Ignoring transactions costs, what is the
        breakeven price of this position?
        A) $50
        B) $55
        C) $45
        D) $40
        E) none of the above

15. All of the following factors affect the price of a stock option except
         A) the risk-free interest rate.
         B) the volatility of the stock.
         C) the stock price
         D) the expected rate of return on the stock.
         E) none of the above.

16. The ______ is a common term for the market consensus value of the required return on a stock.
        A) dividend payout ratio
        B) intrinsic value
        C) market capitalization rate
        D) plowback rate
        E) none of the above

17. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-
free rate is currently 5%. You observe that Matthews had an annualized stock return yesterday of 17%.
Assuming that markets are efficient, this suggests that
         A) bad news about Matthews was announced yesterday.
         B) good news about Matthews was announced yesterday.
         C) no news about Matthews was announced yesterday.
         D) interest rates rose yesterday.
         E) interest rates fell yesterday.

18. You purchased one AT&T March call (strike price X=$50) and sold one AT&T March call (strike
        price=$55). Your strategy is known as
        A) a covered call.
        B) a bear put spread.
        C) a bear call spread.
        D) a bull call spread.
        E) none of the above.

19. You expect to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend
        of $3 in the upcoming year while Stock D is expected to pay a dividend of $4 in the upcoming year.
        The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C ______.
        A) will be greater than the intrinsic value of stock D
        B) will be the same as the intrinsic value of stock D
        C) will be less than the intrinsic value of stock D
        D) cannot be calculated without knowing the market rate of return
        E) none of the above is a correct answer.

20. A trader who has a __________ position in wheat futures believes/speculates that the price of wheat will
         __________ in the future.
         A) long; increase
         B) long; decrease
         C) short; increase
         D) long; stay the same
         E) short; stay the same


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21. A ___________ bond is a bond where the bondholder has the right to cash in the bond before maturity at a
        specified price after a specific date.
        A) callable
        B) coupon
        C) puttable
        D) Treasury
        E) zero-coupon

22. An 8% coupon U. S. Treasury note pays interest on May 30 and November 30 and is traded on August 15.
        The accrued interest on the $100,000 face value of this note is _________.
        A) $491.80
        B) $800.00
        C) $983.61
        D) $1,661.20
        E) none of the above

23. Of the following four investments, ________ is considered the safest.
         A) commercial paper
         B) corporate bonds
         C) U. S. Agency issues
         D) Treasury bonds
         E) Treasury bills

24. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays
        interest of $120 annually. Bond A will mature in 5 years while bond B will mature in 6 years. If the
        yields to maturity on the two bonds change from 12% to 10%, ____________.
        A) both bonds will increase in value, but bond A will increase more than bond B
        B) both bonds will increase in value, but bond B will increase more than bond A
        C) both bonds will decrease in value, but bond A will decrease more than bond B
        D) both bonds will decrease in value, but bond B will decrease more than bond A
        E) none of the above

25. Music Doctors just announced yesterday that its 1st quarter sales were 35% higher than last year's 1st
       quarter. You observe that Music Doctors stock price go down yesterday. This suggests that
       A) the market is not efficient.
       B) Music Doctors stock will probably rise in value tomorrow.
       C) investors expected the sales increase to be larger than what was actually announced.
       D) investors expected the sales increase to be smaller than what was actually announced.
       E) earnings are expected to decrease next quarter.

26. The current yield on a bond is equal to ________.
        A) annual coupon divided by the current market price
        B) the yield to maturity
        C) annual coupon divided by the par value
        D) the yield to maturity
        E) none of the above

27. The ______ is a measure of the average rate of return an investor will earn if the investor buys the bond
        now and holds until maturity.
        A) current yield
        B) dividend yield
        C) P/E ratio
        D) yield to maturity
        E) discount yield



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28. You purchase one IBM put for a put premium of $6, strike price=$100. What is the maximum profit that
            you could gain from this strategy?
        A) $100
        B) $106
        C) $94
        D) $90
        E) none of the above

29. A collar with a net premium of zero is an options strategy that
        A) combines a put and a call to lock in a price range for a security.
        B) uses the gains from sale of a call to purchase a put.
        C) uses the gains from sale of a put to purchase a call.
        D) both A and B.
        E) both A and C.

30. HighFlyer Stock currently sells for $48. A one-year call option with strike price of $55 sells for $9, and
        the risk free interest rate is 6%. What is the premium of a one-year put with strike price of $55?
        A) $9.00
        B) $12.89
        C) $16.00
        D) $18.72
        E) $15.60

31. You purchased a call option for $3.45 seventeen days ago. The call has a strike price of $45 and the stock
        is now trading for $51. If you exercise the call today, what will be your holding period return? If you
        do not exercise the call today and it expires, what will be your holding period return?
        A) 173.9%, -100%
        B) 73.9%, -100%
        C) 57.5%, -173.9%
        D) 73.9%, -57.5%
        E) 100%, -100%

32. Given a stock index with a value of $1,000, an anticipated dividend of $30 and a risk-free rate of 6%, what
        should be the value of one year futures contract on the index if market is efficient?
        A) $940
        B) $1000
        C) $1030
        D) $1060
        E) $970

33. A stock will pay a dividend of $2.75 in the upcoming year, and every year thereafter, i.e., dividends are not
         expected to grow. You require a return of 10% on this stock. Use the zero growth model to calculate
         the intrinsic value of this preferred stock.
         A) $0.275
         B) $27.50
         C) $31.82
         D) $56.25
         E) none of the above

34. If you determine that the S&P 500 Index futures is overpriced relative to the spot S&P 500 Index you
         could make an arbitrage profit by
         A) buying all the stocks in the S&P 500 and selling put options on the S&P 500 index.
         B) selling short all the stocks in the S&P 500 and buying S&P Index futures.
         C) selling all the stocks in the S&P 500 and buying call options on the S&P 500 index.
         D) selling S&P 500 Index futures and buying all the stocks in the S&P 500.
         E) none of the above.

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35. You purchased one silver future contract at $3 per ounce. What would be your profit (loss) at maturity if
        the silver spot price at that time is $4.10 per ounce? Assume the contract size is 5,000 ounces and
        there are no transactions costs.
        A) $5.50 profit
        B) $5,500 profit
        C) $5.50 loss
        D) $5,500 loss
        E) none of the above.

36. Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at
       the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market
       portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on
       the stock is ________.
       A) 10%
       B) 18%
       C) 30%
       D) 42%
       E) none of the above

37. High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%.
        An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the
        dividend in the coming year should be
        A) $1.00
        B) $2.50
        C) $2.69
        D) $2.81
        E) none of the above

38. The market price of a share of CAT stock at maturity date is $76. If a put option on this stock has a strike
        price of $80, the put
        A) is out of the money.
        B) is in the money.
        C) should be exercised.
        D) A and C.
        E) B and C.

39. The maximum loss a buyer of a stock call option can suffer is equal to
        A) the strike price minus the stock price.
        B) the stock price minus the value of the call.
        C) the call premium.
        D) the stock price.
        E) none of the above.

40. The intrinsic value of an in-of-the-money call option is equal to
        A) the call premium.
        B) zero.
        C) the stock price minus the exercise price.
        D) the striking price.
        E) none of the above.




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41. Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at
       the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market
       portfolio is 14%. The stock of low Fly Airline has a beta of 3.00. The intrinsic value of the stock is
       ______.
       A) $46.67
       B) $50.00
       C) $56.00
       D) $62.50
       E) none of the above

42. Buyers of put options anticipate the value of the underlying asset will __________ and sellers of call
        options anticipate the value of the underlying asset will ________.
        A) increase; increase
        B) decrease; increase
        C) increase; decrease
        D) decrease; decrease
        E) cannot tell without further information

43. A covered call position is
        A) the simultaneous purchase of the call and the underlying asset.
        B) the purchase of a share of stock with a simultaneous sale of a put on that stock.
        C) the short sale of a share of stock with a simultaneous sale of a call on that stock.
        D) the purchase of a share of stock with a simultaneous sale of a call on that stock.
        E) the simultaneous purchase of a call and sale of a put on the same stock.

44. According to the put-call parity theorem, the premium of a put option on a non-dividend paying stock is
        equal to:
        A) the call value plus the present value of the exercise price plus the stock price.
        B) the call value plus the present value of the exercise price minus the stock price.
        C) the present value of the stock price minus the exercise price minus the call price.
        D) the present value of the stock price plus the exercise price minus the call price.
        E) none of the above.

45. If the stock price decreases, the price of a put option on that stock __________ and that of a call option
          __________.
          A) decreases, increases
          B) decreases, decreases
          C) increases, decreases
          D) increases, increases
          E) does not change, does not change




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PART II: Answer these questions in the supplied exam booklet. Show your work. There are a total of 50
points in this section


1) (20 points) The risk-free rate of return is 6%, the expected rate of return on the market portfolio is
   12%, and the stock of Econ435IsSweet Corporation (EISC) has a beta coefficient of 1.5. EISC pays
   out 2/5 (40%) of its earnings in dividends, and the latest earnings announced were $5 per share.
   Dividends were just paid and are expected to be paid annually. You expect EISC will earn an ROE of
   18% per year on all reinvested earnings forever.
   a) (4 points) What is the intrinsic value of EISC stock?
   b) (2 points) What is the P/E ratio?
   c) (3 points) What is the PVGO of EISC stock?
   d) (6 points) If EISC raises the plowback ratio to 4/5 (80%), what happens to the intrinsic value of
       EISC stock? What happens to the PVGO? As an investor, are you happy about the increase in the
       plow back ratio ? Why ? Give an intuitive answer.
   e) (2 points) EISC announces the change in the plowback ratio one year after you buy the stock. If
       you purchase EISC for the intrinsic value in part (a) and sell it a year later, what is your rate of
       return?
   f) (3 points) If you are the manager if EISC and you know in advance about the increase in the plow
       back ratio, using options how could you profit from this insider information (one strategy is
       sufficient)? Is insider trading allowed in practice ?

2) (10 points) Suppose it is now June 2008. The current interest rate is 6%. The December 2008 future price
   for silver is $340, whereas the June 2010 future price is $355.
   a. (3 points) Is there an arbitrage opportunity here ? Explain.
   b. (7 points) If so, how would you exploit it ? Please specify the detailed steps you would take.

3) (20 points) A long straddle is an option strategy that bets on volatility of the stock ( investors will be
   earning profit if the stock price is really high or really low). A long straddle comprises of buying a call and
   buying a put. For simplicity, assume that the strike prices of the put and of the call are the same.
   a. (5 points) Construct a payoff/profit table for the strategy. Make sure you include the payoff of buying
   the call, the payoff of buying the put, the total payoff and the total profit.

    b. (5 points) Draw a payoff/profit diagram, label the diagram thoroughly. Explain (from the diagram) how
    the investors earn positive profit when the stock price is very high or very low.

    Now we play with numbers. Now suppose you buy one Xerox call (strike price=$100) and one Xerox put
    (strike price=$100). The call premium is $5 and the put premium is $3.

    c. (6 points) What is your maximum gain and maximum loss from this position ? What is your profit/loss
    if at expiration, market price ST is $102.
    d. (4 points) At what stock prices that you will break even ? ( hint: there are two values).




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