Question

(11) The real return objective of Mr. Morison’s should reflect the 6.25% spending rate, 1.75% inflation rate and 40 base point cost of earning investment return. Estimate his total return.

            (a) 14.99%

            (b) 9.11%

            (c) 13.02%

(d) 08.54%

Answer questions 10-14 following this information. Mean -variance investor risk aversion (RA) level is 2. The expected return and standard deviation of three assets classes are as bellow,

Assets Class              Expected Return          Standard deviation of return

A                              10%                          25%

B                                8%                         15%

C                                6%                         12%

risk- free rate of return is 3% and the short fall level is 5% select the investors.

(12) Risk adjusted rate of return (Expected utility) is,

            A. 7.98%, 5.97% and 9.94%

            B. 5.97%, 9.94% and 7.98%

            C. 9.94%, 7.98% and 5.97%

            D. none of the above

(13) Sharp (Reward volatility) Ratio is,

            A. 0.33, 0.22 and 0.28

            B. 0.28, 0.33 and0.25

            C. 0.22,0.28 and 0.33

            D. none of the above

(14) Safety-First Ratio is,

            A. 0.083,0.20 and 0.20

            B. 0.20, 0.20 and 0.083

            C. 0.20, 0.083 and 0.20

            D. none of the above

(15) the best asset class is

            A. A

            B. B

            C. C

            D. none of the above

(16)      You purchased a share of stock for $65. One year later you received $2.37 as a     dividend and sold the share for $63. What was your holding-period return?

     A.   0.57%

     B.   -0.2550%

     C.   -0.89%

     D.   1.63%

     E.   none of the options

(17)      You have been given this probability distribution for the holding-period return for

         GM stock:

State of the Economy	Probability	HPR
Boom	.40	30%
Normal growth	.40	11%
Recession	.20	-10%

What is the expected standard deviation for GM stock?

     A.   16.91%

     B.   16.13%

     C.   13.79%

     D.   15.25%

     E.   14.87%

     F.    09.80%

    

(18) Consider a T-bill with a rate of return of 5% and the following risky securities:

   Security A: E(r) = 0.15; Variance = 0.04
   Security B: E(r) = 0.10; Variance = 0.0225
   Security C: E(r) = 0.12; Variance = 0.01
   Security D: E(r) = 0.13; Variance = 0.0625

From which set of portfolios, formed with the T-bill and any one of the four risky securities, would a risk-averse investor always choose his portfolio?

     A.   The set of portfolios formed with the T-bill and security A.

     B.   The set of portfolios formed with the T-bill and security B.

     C.   The set of portfolios formed with the T-bill and security C.

     D.   The set of portfolios formed with the T-bill and security D.

     E.   Cannot be determined.

(19) As the number of securities in a portfolio is increased, what happens to the average

    portfolio standard deviation?

     A.   It increases at an increasing rate.

     B.   It increases at a decreasing rate.

     C.   It decreases at an increasing rate.

     D.   It decreases at a decreasing rate.

     E.   It first decreases, then starts to increase as more securities are added.

(20)     An investor has invested in a portfolio of fixed income and equity securities

         which has a current market value of $500,000. This portfolio has an expected

          return of 14% with an associated standard deviation of 24%. The investor is

         expected to inherit $500,000 soon. He is currently evaluating the following four

         index funds as possible investment opportunities to invest this money:

Index Fund	Expected Return %	Standard Deviation %	Correlation with Investor’s Existing Portfolio
Fund A Fund B Fund C Fund C	11 17 15 21	22 26 22 28	+0.60 +0.90 +0.65 +0.80

The investor has two objectives: (i) increase or maintain the current expected return and (ii) reduce or maintain the current risk.

    

Which fund would you recommend to this investor? Explain why. (No calculations are required.)

1. fund A
2. fund B
3. fund C
4. fund D

Answer 1

Q11) D) 8.54%

Explanation:

Return= (1.0625) × (1.0175) (1.004) - 1

= 1.0854 - 1

= 8.54%

12) D) none of the above

Explanation:

Expected utility = expected return - 0.5 × risk aversion × variance

Expected utility of A = 0.10 - 0.5 × 2 × 0.25^2

= 0.10 - 0.0625

= 0.0375 or 3.75%

Expected utility of B= 0.08 - 0.5 × 2 × 0.15^2

= 0.08 - 0.0225

= 0.0575 or 5.75%

Expected utility of C= 0.06 - 0.5 × 2 × 0.12^2

= 0.06 - 0.0144

= 0.0456 or 4.56%

Q13) B) 0.28, 0.33, and 0.25

Explanation:

Sharpe ratio= Expected return - Risk free rate / standard deviation

Sharpe ratio of A = 0.10 - 0.03 / 0.25

= 0.07 / 0.25

= 0.28

Same goes for both the asset

Q14) B) 0.20, 0.20 and 0.083

Explanation:

Safety ratio = expected return - shortfall level / std deviation

Safety ratio of A= 0.10 - 0.05 / 0.25

= 0.05 / 0.25

= 0.20

Safety ratio of B = 0.08 - 0.05 / 0.15

= 0.03 / 0.15

= 0.20

Q15) B) B

Explanation: It is because, it has highest expected utility, Sharpe ratio and safety ratio.