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Lotteries have been around for years.  In fact as you may read on this page Thomas Jefferson ran a lottery.  So why not?  It is free and you might wind $1m..  Of course the odds are VERY VERY low, but....

15 multiple choice (4 points each)
1 essay 20 points
3 short answer: 5,5,10
Good luck!

1. You plan on retiring in 30 years.  If you invest $2000 a year into your IRA, how much will you have when you retire if your earn 10% per year?
  a. $328,980 b.$565,614 c.$787,900 d.$660,000 e.$715,000

2. Suppose you have just won the lottery and must choose one of the following (guaranteed) payoffs.  Which one would you choose?  The interest rate is 9 percent; ignore tax consequences.

a. $100,000 paid today.
b. $140,000 paid four years from today.
c. $ 50,000 paid one year from today and $ 68,000 paid four years from today.
d. $ 14,000 paid per year for ten years, with the first  year’s payment made today.
e. A regular ten-year annuity of $14,600 per year.


3.  Historically which of the following is in correct order of returns? (lowest to highest)

a. T-bills, T-bonds, Corporate Bonds, Large Firms Stock, Small Firms Stock
b. T-bonds, Corporate bonds, T-bills, Large Firms Stock, Small Firms Stock
c. Large Firms Stock, Small Firms Stock, Corporate Bonds, T-bills, T-bonds
d. T-bills, T-bonds, Corporate bonds, Small Firms Stock, Large Firms Stocks
e. more than one of the above is correct


4.  A 10 percent 8-year German bond yields 12 percent.  What is the current price of the bond price? 

a.  74.44 percent of par.
b.  90.06 percent of par.
c.  93.68 percent of par
d.  $403.88
e.  none of the above


5.  You have just taken out a $50,000 mortgage at an interest rate of 8 percent.  If the mortgage calls for 30 equal annual payments, what is the amount of each payment?

a. $4,441 b. $ 7,924 c. $ 6,185 d.  $ 4,970 e.$ 1,666


6. Which of the following is a problem with the CAPM?

a. In testing the model we are also testing the reliability of our market proxies and also the market’s efficiency.
b. The model can not describe the higher than predicted returns for small stocks.
c. Fama and French found that when size and the MB ratio are included, beta is insignificant. 
d. All of the above are problems with CAPM
 7.  Beta _______.
a. is a measure of firm specific risk.
b. is a measure of market risk.
c. is a measure of total risk.
d. is calculated by regressing the market return on the historical market dividend yield.
e. All of the above are true. 


8.  Which of the following is TRUE?

a. Continuous compounding will result in your investment growing more rapidly than if the interest compounded annually.
b. The risk that can be potentially eliminated by diversification is often called market risk.
c. Small Firms tend to out perform their predicted return in the month before a tax-year end.
d. Most people are risk-neutral which means they will invest in any asset that has a high expected-return.
e. All of the above are true.


9.   The beta of the Hadley Hat company is 1.4.  The expected return on the market is 19%.  If the risk free rate is 7%, what is the expected return for the Hadley Hat company?

a. 29%  b. 24.6% c. 26.6% d. 23.8% e. 21%


10.   The expected return on the market portfolio is 20 percent and the risk-free rate of return is 8 percent.  An investment has a beta of 1.4 and offers an expected return of 23 percent.

a. This is a good investment because it earns more than the market rate of return.
b. This investment has a positive net present value.
c. This investment has a negative net present value.
d. Need more information to decide if this is a good or bad investment.
e. This investment is above the Mean-Variance frontier


11.  You find a zero coupon bond that matures in exactly 18 years.  Forgetting about the benefits of diversification, you decide to fund your daughter’s education with the proceeds of these bonds.  You decide that the education can be paid for all at once on her first day of school.  The lump sum will be $96,000.  If the required return is 8.5% and the bond’s have a par value of $1,000 (Assume you can not purchase a fraction of a bond and round up) , how many of these bonds must you purchase?

a. 120  b. 108  c. 96  d. 1200 e. none of the above


Answer the following two questions based on this information: 

Company  Number of shares   Price  Beta 
Austex                           200      13   1.7
Waco Wheels                300       9 1/2  2.1
Beaumont Blimps           100       18       .7 
Plano Airplanes              500       17   1.1 
Assume the current risk-free rate is 6% and the expected return on the market is 15%.

12.  What is the Beta of your portfolio?

a. 1.27  b. 1.34  c. 1.45  d. 1.40  e. .95 
13.  What is the expected return on your portfolio? (note you can calculate this two different ways, so the answer does not depend totally on your answer to question #21)
a. 18%  b. 15%  c. 19.4% d. 14%  e. 16%


14.  What is the expected return on an asset with a beta of 1.3 if the risk free rate is 6% and the market risk premium is 800 basis points?

a. 18.1%  b. 16.4%  c. 14.9% d. 13.0%  e. 17.8%
15. Which of the following is true?
 a. As the economy slows, the risk premium often grows relative to the RF rate.
 b. The required return on Junk Bonds is less than that of T-Bills.
 c. The higher the required return, the higher the price of assets will be.
 d. CAPM only takes into account firm specific risk
 e. Diversification generally moves the investor off of the MVE frontier.


Short answers and essay:

1. Explain what CAPM is, Why is it used? What are the assumptions of CAPM?  What problems are there with CAPM?  What is the current status of CAPM?  (20 points)

2. What is meant by risk?  What are the different types of risk we discussed in class? Why are some risks more important than others?  (Be specific) (10 points)

3. What is meant by the risk-return tradeoff? (5 points)

4.  Explain how to calculate Beta. Include any problems with the calculation and any adjustments that are usually made.  (5 points)
 

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