Midterm Exam-Solutions

Investments (72-372)

Instructor: Dr. Ligang Zhong

Oct 29 10:00-12:00 (2 hours), 2016
(Total: 100 Marks with 10 Pages)

Student Name____________

Student ID_______________

Section __________________

There are 40 multiple choice questions in total.

Provide you solutions on Scantron Sheet (Use NO. 2 pencil only). Only the
solutions on the Scantron Sheet will be marked. NO partial marks will be credited.

 This is a closed book exam. No written materials, except the formula sheet
provided by the instructor, may be used.

 All Wireless devices must be off during exams.

 Students bring their own calculators to exams. Calculators may not be shared.

 Students bring their own NO. 2 pencils. Pencils may not be shared.

 Electronic dictionaries and programmable calculators are not allowed.

 Your must have your University of Windsor ID card with you during the exams.

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Multiple Choices (Total 40 Questions with 100 Marks, each question has the same
weight of 2.5 Marks; No Partial Marks will be provided; Each question has only one
correct answer).

1. Regarding Income Trusts, which of the following description is True? A

A. A structure that allows an operating business to flow a stream of income directly
to investors with little or no corporate income tax (originally).
B. Distributions are fixed.
C. Income trusts are not entitled to residual assets.
D. Income trusts are not entitled to vote.

2. Regarding the following financial instruments, which description is False? D

A. Money market securities are called “cash equivalents” because of their great
liquidity.
B. The prices of money market securities are very stable, and they can be converted
to cash (i.e., sold) on very short notice and with very low transaction costs.
C. Preferred stock is like long-term debt in that it typically promises a fixed
payment each year.
D. With respect to the priority of claims to the assets of the firm in the event of
corporate bankruptcy, preferred stock has a higher priority than bonds but a
lower priority than common equity.

3. A Treasury bill with 182 days to maturity with face value of $1,000 is traded at the
price $960, what is its bond equivalent yield? C
A. 8.10%
B. 8.60%
C. 8.36%
D. 8.00%

4. A U.S. Treasury bill with 90-day maturity and face value of $1,000 sells at a bank
discount yield of 3%. What is the price of the bill? B
A. $985
B. $992.5
C. $970
D. $940.5

Following information is for questions 5&6:

Consider the following data for the three stocks that make up the market:

Stock Initial date (t=0) Final Date (t=1)

Price Shares Outstanding Price
A $10 200 $20
B $20 500 $20
C $30 600 $20
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5. What is the single-period return on the value-weighted index constructed from
the three stocks if stocks A and B were to split 2 for 1 and 4 for 1, respectively,
after period 0? Using a divisor of 100. B
A. -12.50%
B. -13.33%
C. 0.00%
D. -10.00%

6. What is the single-period return on the price-weighted index constructed from the
three stocks if stocks A and B were to split 2 for 1 and 4 for 1, respectively, after
period 0? Using a divisor of 3 for the pre-split calculation. A
A. -12.50%
B. -13.33%
C. 0.00%
D. -10.00%

Given the following expectations on stocks X and Y to answer questions 7&8:

Bear Market Normal Market Bull Market

Probability 0.2 0.5 0.3
Stock X -20% 18% 50%
Stock Y -15% 20% 10%
Calculate:
7. What is the expected return for stocks X and Y? A
A. 20% and 10%
B. 18% and 15%
C. 50% and 10%
D. 20% and 18%

8. Assume you invest your $10,000 portfolio in $9,000 of stock X and $1,000 of
stock Y. what is the expected return on your portfolio? C
A. 17%
B. 18%
C. 19%
D. 20%

9. According to CAPM, when plotting a security risk-return profile, if the risk-return

profile is above the Security Market Line (SML), the security is A
A. undervalued.
B. overvalued.
C. neither under- nor over- valued.
D. none of the above.
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10. Which of the following statement is FALSE regarding the effect of the following
events on the level of real interest rates? A
A. If businesses increase their capital spending they are likely to increase their
demand for funds. This will shift the demand curve to the left and decrease the
equilibrium real rate of interest.
B. Increased household saving will shift the supply of funds curve to the right
and cause real interest rates to fall.
C. An open market sale of Treasury securities by the Bank of Canada is
equivalent to a reduction in the supply of funds (a shift of the supply curve to
the left). The equilibrium real rate of interest will rise.
D. The after tax real rate of return falls as the inflation rate rises.

11. During a period of severe inflation, a bond offered a nominal Holding period
return of 80% per year, the inflation rate was 70% per year? What was the Real
holding period return on the bond during that year? B
A. 5.60%
B. 5.88%
C. 7%
D. 8%

12. What is the beta of a portfolio with E(rp)=18%, if rf=6% and the expected market
return is 14%? C
A. 0.5
B. 1.0
C. 1.5
D. 2.0

13. Regarding CAPM (Capital Asset Pricing Model), which of the following is true?
C
A. Stock with a beta of zero offer an expected rate of return of zero.
B. The CAPM implies that investors require a higher return to hold highly
volatile securities.
C. You can construct a portfolio with a beta of 0.75 by investing 0.25 of the
budget in bills and the remainder in the market portfolio.
D. Beta is the measure of risk for a single security portfolio.

14. According to CAPM, the expected rate of return of a portfolio are best explained
by C
A. Economic Factor.
B. Specific Risk.
C. Systematic Risk.
D. Diversification.
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15. If the risk free rate of interest = 5% and the expected Market index return = 15%.
A share of stock sells for $50 today. It will pay a dividend of $2 per share at the
end of the year. Its beta is 2.0. What do investors expect to sell for at the end of
the year? A
A. $60.5
B. $75.0
C. $65.0
D. $55.0

16. Suppose that there is one company which will pay one terminal dividend at the
end of year one, then go out of business. The dividend is as yet unknown but
based on a thorough analysis of all public information, investors agree on the
following distribution: B

Possible Dividend Probability

$10 0.4
$5 0.4
$1 0.2

Suppose investors rationally use the CAPM to discount

In addition, based on all public information, it is believed that Beta (β) of the
stock is 1.5, the market index return is 15.0%, and riskless rate is 5.0%. Using this
information to calculate the current stock price of the company?
A. $5.00
B. $5.17
C. $6.20
D. $4.20

17. Consider the following limited-order book of a market marker/dealer: C

Bid Ask
Price ($) Shares Price ($) Shares
49.750 500 50.250 100
49.500 800 51.500 100
49.250 500 54.750 300
49.000 200 58.250 100
48.500 600

If you place a market sell order for 1000 shares, at what average price will it be
filled?
A. $49.750
B. $50.250
C. $49.625
D. $49.500
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 USE THE FOLLOWING INFORMATION FOR PROBLEM 18&19&20:
Windsor Stock is currently selling at $100 per share, you have a margin account
with your own wealth of $150,000. If the initial margin requirement is 50%.

18. How many shares (maximum) of Windsor Stock can you purchase with this
margin account? B
A. 5,000
B. 3,000
C. 1,800
D. 1,500

19. If the maintenance margin is 30%, to what price can Windsor Stock fall before
you receives a margin call? A
A. $71.43
B. $70.00
C. $68.56
D. $35.22

20. If the share price increase to $110 immediately after you establish the position,
what is your rate of return? D
A.13.33%
B. 16.67%
C. 10%
D. 20%

USE THE FOLLOWING INFORMATION FOR PROBLEM 21&22&23:

You decide to sell 100 shares of Davis Industries short when it is selling at its yearly
high of $40 per share. Your broker tells you that your margin requirement is 50%.

21. What is your rate of return on the investment if share prices decrease to $30 per
share after one year? A
A. 50%
B. 25%
C. 33%
D. 67%

22. If the maintenance margin is 30%, to what price can Davis Industries increase to
before you receive a margin call? B
A. $33.33
B. $46.15
C. $50.00

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 D. $55.67

23. While you are short, Davis pays a $2 per share dividend at year end, what is your
rate of return if the year-end price changes to $30 per share. B
A. 50%
B. 40%
C. 30%
D. 20%

24. Regarding Broker and Dealer, which of the following description is False? B
A. A broker acts on behalf of an investor who wishes to execute orders and a
broker’s profit is the commission.
B. The broker’s function includes providing opportunities to trade immediately.
C. The dealer holds in inventory the financial asset traded and her profit is the
bid-ask spread.
D. The dealer offers price information and serves as auctioneer.

25. Regarding market order and limited order, which of the following description is
False? D
A. Market order can be executed immediately.
B. Market order does not guarantee the transaction price.
C. Limited order can be used when traders want a specific price or better.
D. Buy limited order will be filled when prices hit the designated price or higher.

26. Suppose you have the following price quotes for BMO:

Bid Asked
BMO $28.0 $29.0

Which of the following description is False? A

A. if you place a stop-loss order to sell at $28.5, your order will get executed at
price of $28.5 immediately.
B. If you place a limited buy order at $28.5, your order may not be executed
immediately; However, your order will be highly likely to be executed as
your price is better than the quoted bid price.
C. If you place a limited sell order at $28.5, your order may not be executed
immediately; However, your order will highly likely to be executed as your
price is better than the quoted asked price.
D. None of the above.

27. Regarding the definition of different types of bond, which of the following is
False? D
A. Zero-coupon bond is a bond that makes no coupon payments.
B. Junk bond is a bond with a low credit rating due to its high default risk.
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 C. Callable bond is a bond which allows the issuer to repurchase the bond at a
specified call price before the maturity date.
D. Puttable bond is a bond which allows the issuer to sell the bond at a specified
put price before the maturity date to bondholder.

28. An investor believes that a bond may temporarily increase in credit risk. Which of
the following would be the most liquid method of exploiting this? A
A. The purchase of a credit default swap.
B. The sale of a credit default swap.
C. the short sale of the bond.
D. the purchase of the bond.

USE THE FOLLOWING INFORMATION FOR PROBLEM 29&30&31:

Assume the current yield curve for default-free zero-coupon bonds is as follows:

Maturity (Years) YTM (%)

1 5
2 6
3 7
4 8

29. What is the final wealth in the end of year 4, if you invest $100 today? B
A. $108.00
B. $136.05
C. $126.00
D.$132.00

30. What is the price of a 4-year coupon bond with 8% coupon paid annually and face
value of $1,000? A
A. $1006.53
B. $1080.00
C. $1000.00
D.$777.50

31. What is the implied one-year forward rate starting at the beginning of year two?
(so the resulted rate is the one-year forward rate for year 2). C
A.5.00%
B. 6.00%
C. 7.01%
D. 8.01%

32. Which of the following is true according to the pure expectation theory? Forward
Rate A
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 A. exclusively represent expected future spot rates.
B. are biased estimates of market expectations.
C. always overestimate future short rates.
D. none of the above.

33. Regarding the bond indenture, which one of the following description is False? B
A. With sinking fund provisions, the issuer may repurchase a fraction of the
outstanding bonds in the open market each year.
B. With subordination of future debt provisions, the issuer’s ability of raising
future debt is strictly prohibited, Hence, no further borrowing is allowed for
the issuer.
C. Dividend restrictions limit the amount of dividend the issuer can pay their
shareholders.
D. Convertible bond gives the bondholders an option to exchange the bond for a
specified number of shares of common stock of the firm.

34. Regarding the relationship between interest rates, bond yields, and yield to call，
which one of the following description is False? D
A. If interest rates fall, price of straight bond can rise considerably.
B. The price of the callable bond is flat over a range of low interest rates
because the risk of repurchase or call is high.
C. When interest rates are high, the risk of call is negligible and the values of
the straight and the callable bond converge.
D. When interest rates are low, the risk of call is negligible and the values of the
straight and the callable bond diverge.

35. Which of the following bonds are considered investment-grade bonds? A

A. Rated BBB or above by S&P
B. Rated BB+ or above by S&P
C. Rated BB- or above by S&P
D. Rated Ba or above by Moody’s

36. For a premium bond, which of the following relationship is TRUE? A

A. Coupon rate is higher than current yield
B. Coupon rate is lower than yield to maturity
C. Current yield is lower than yield to maturity
D. None of the above

37. In which one of the following cases is the bond selling at par? B
A. Coupon rate is greater than current yield, which is greater than yield to
maturity.
B. Coupon rate, current yield, and yield to maturity are all the same.
C. Coupon rate is less than current yield, which is less than yield to maturity.
D. Coupon rate is less than current yield, which is greater than yield to maturity.

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38. The call feature of a bond means the C
A. Investors can call for payment on demand.
B. Investors can only call if the firm defaults on an interest payment.
C. Issuer can call the bond issue before the maturity date.
D. Issuer can call the issue during the first three years.

39. The yield to maturity on a bond is B

A. Below the coupon rate when the bond sells at a discount and above the
coupon rate when the bond sells at a premium.
B. The interest rate that makes the present value of the payments equal to the
bond price.
C. Based on the assumption that all future payments received are reinvested at
the coupon rate.
D. Based on the assumption that all future payments received are reinvested at
future market rate.

40. Assume you have a one-year investment horizon and you purchased a 10 year-
zero coupon bond that pays $1,000 at maturity. If the current yield to maturity of
the bond is 8% when you purchased the bond, and you expect that the yields to
maturity will change to 7% at the beginning of next year, what is your after-tax
rate of return one year from now? Assume your tax bracket is 30% on ordinary
income and 20% on capital gains income. B
A. $70.89
B. $60.89
C. $65.55
D. $68.12

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