Sample Practice Questions for Test 1 with Answers Semester 2, 2016/2017 Prepared by Dr. Weina Zhang

Sample Practice Questions for Test 1 with Answers Semester 2, 2016/2017 Prepared by Dr. Weina Zhang 1. You want to purchase GM stock at $10 from your broker using as little of your own money as possible. If initial margin is 60% and you have $2400 to invest, how many shares can you buy? A. 200 shares B. 300 shares C. 400 shares (answer: 2400/0.6 = $4000; $4000/$10 = 400 shares) D. 600 shares E. 800 shares 2. Assume you sold short 100 shares of common stock at $40 per share. The initial margin is 60%. What would be the maintenance margin if a margin call is made at a stock price of $50? A. 40% B. 20% (answer: equity drops from $2000 to $1000. =$1000/($50*100) = 20%) C. 35% D. 25% E. None of the above. (Use the balance sheet: Asset Liability Sale proceeds $4000 $5000 Margin $2000 Equity $1000 Maintenance margin $1000/$5000 = 20%) 3. You are evaluating two investment alternative. One is a passive market portfolio with an expected return of 8% and a standard deviation of 12%. The other is a fund that is actively managed by your broker. This fund has an expected return of 15% and a standard deviation of 16%. The risk-free rate currently is 5%. What is the maximum fee your broker could charge and still leave you as well off as if you had invested in the passive market fund? A. 4.00% B. 4.33% C. 6.00% (answer: (8% - 5%)/12% = (15% - 5%-x) /16% = x = 6%) D. 7.00% E. none of the above The following statement is used for answer Q4 and Q5. Below is the probability distribution for the holding-period return for a stock: State of the Economy Probability HPR Boom 0.40 22% Normal growth 0.35 11% Recession 0.25 -9% 4. What is the expected holding-period return for the stock? A. 11.67% B. 8.33% C. 9.56% D. 12.4% E. 10.4% (Answer: 0.4*22%+0.35*11%+ 0.25*(-9%) = 10.4%) 5. What is the expected standard deviation for the stock? A. 2.07% B. 9.96% C. 7.04% D. 1.44% E. 12.17% (answer: [0.4*(22% - 10.4%)^2+0.35*(11%-10.4%)^2+0.25*(-9% - 10.4%)^2)]^0.5 = 12.17%) The following statement is used for answer Q6 and Q7. Assume an investor with the following utility function: U = E(r) - 3/2(σ2), where E(r) is the return and σ is the standard deviation. 6. To maximize her expected utility, she would choose the asset with an expected rate of return of and a standard deviation of , respectively. A. 12%; 20% B. 10%; 15% C. 10%; 10% D. 8%; 10% E. 10%; 12% (Answer: highest utility for option C: U=0.085; Option A: U = 0.06; option B: U=0.06625; option D: U = 0.065; and option E: U = 0.0784)