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Practice Exam I - Exam II


									Practice Exam                                            Name

                                          FINANCE 3033
                                             Fall 2005

Multiple choice -- Circle the letter of the BEST answer (3 points each)

1. If a stock increases in price from $20 to $30 in seven years, what annual compound rate of
   return would it yield? (approximately)

   a. 6.0%
   b. 7.1%
   c. 21.4%
   d. 50.0%
   e. none of the above

2. You called your broker and told him to buy XYZ stock if and when its price got as low as
   $30.00 per share. It currently trades at a bid of $33.00 per share. This type of order is known
   as a

   a.   Market order
   b.   Sell order
   c.   Limit order
   d.   Block order
   e.   none of the above

3. Jimmy called his broker on 5-3-05 and asked the broker to loan him one-half of the funds
   required to buy 500 shares of Bold Ventures, Inc. On 7-24-05 Jimmy called his broker and
   told her to sell the 500 shares of Bold Venture, Inc., to pay off the loan and cover his
   transaction on 5-3-05. Jimmy has just completed:

   a.   margin purchase
   b.   short sale
   c.   call option exercise
   d.   put option exercise
   e.   none of the above

4. The stock of most U.S. companies is traded in the

   a.   New York Stock Exchange
   b.   American Stock Exchange
   c.   Over-the-counter market
   d.   Money market
   e.   none of the above
5. You are considering investing some of your year-end bonus and are considering several
   stocks from different industries. One of your primary concerns is lowering the risk of your
   portfolio. Below are five industries in which you are considering an investment as well as their
   correlations with your current portfolio. Which industry should you invest in?

   a.   Steel, +1.0
   b.   Transportation, +0.8
   c.   Telecommunications, +0.5
   d.   Health care, +0.2
   e.   Paper products, 0.0

6. If a large corporation wants to issue new common stock, management will probably seek the
   advice and counsel of:

   a.   the SEC
   b.   the governors of the New York Stock Exchange
   c.   a commercial banker
   d.   an investment banker
   e.   a securities dealer

7. If the return to the market is a consistent 14% and the risk-free rate is 6%, what is the
   expected return of a security with a beta of 1.5?

   a.    9%
   b.   18%
   c.   21%
   d.   23%
   e.   none of the above

8. Inflation, recession, and high interest rates are economic events which are characterized as

   a.   firm-specific risk that can be diversified away
   b.   market risk
   c.   unsystematic risk
   d.   diversifiable risk
   e.   none of the above

9. Diversification works because

   a. systematic risk exists.
   b. forming stocks into a portfolio guarantees a positive rate of return on investment.
   c. individual assets may fluctuate in price due to company specific events but these
      fluctuations tend to offset one another in a portfolio.
   d. market risk can be dramatically reduced if not eliminated.
   e. Diversification does not work
10. A firm has several classes of securities outstanding. Which of the following is the MOST risky
    from an investor's viewpoint?

     a.   mortgage bond
     b.   debenture
     c.   preferred stock
     d.   common stock
     e.   the risk is the same if issued by the same company

11. You invested a $20,000 inheritance in a diversified portfolio. The value of the portfolio over
    the years has been the following:

                                   Value of
                    Year           Portfolio
                    2000           $20,000
                    2001           $17,000
                    2002           $15,300
                    2003           $16,065
                    2004           $18,475
                    2005           $22,170

     What average annual rate of return has your portfolio earned since 2000? (5 points)

12. Identify the three forms of the Efficient Markets Hypothesis, how the versions differ from one
    another, and what the evidence suggests about the validity of each. (15 points)
13. The current price of the stock of Exxon Mobil is $65.70 per share, a record high. You feel that
    the market has overpriced the stock and that the effects of hurricanes Katrina and Rita will
    slow the economy, reducing demand for oil and, hence, the price of oil which will in turn result
    in a decrease in the price of Exxon Mobil stock. You have an initial cash account of $50.00
    with your broker and instruct her to sell Exxon Mobil short.

     A. If the price of Exxon Mobil rises to $70.00 per share, what rate of return would you
        realize? (5 points)


     B. If the price of Exxon Mobil falls to $55.00 per share, what rate of return would you realize?
         (5 points)


     C. If your broker's firm requires a maintenance margin of 30%, at what market price of Exxon
        Mobil would you receive a margin call? (5 points)

14. You're considering two potential stocks as investment opportunities. Below are the historical
    returns on the stocks over the past few years:

                           Stock X                Stock Y
            2001             -10%                    - 6%
            2002               5%                      4%
            2003              12%                      8%
            2004               7%                      4%
            2005              10%                      6%

    A.   What average (arithmetic) rates of return have Stock X and Stock Y earned? (5 points)

                                    Stock X = 4.8%

                                    Stock Y = 3.2%

    B.   What is the standard deviation of returns for Stock X and Stock Y? (5 points)

                                    Stock X = 8.7%

                                    Stock Y = 5.4%

    C. Which stock is more risky? (5 points)

    D. Suppose you had owned both stocks with 70% of your money in Stock X and 30% in
       Stock Y. What rate of return would your portfolio have earned? (5 points)

E.   You've calculated the betas of Stock X and Stock Y to be as follows:

                       Stock X        0.50
                       Stock Y        0.75

     Suppose the risk-free rate is 3% and the expected return to the market as a whole is 9%.
     What rate of return should you require for Stock X and what rate of return should you
     require for Stock Y? (5 points)

                       Stock X = 6.0%

                       Stock Y = 7.5%

F.   Explain why the required rate of return that you calculated in Part E for the more risky
     stock could be lower than the required rate of return for the less risky stock as answered
     in Part D. (5 points)

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