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Formula Sheet FIN 352 – EXAM 2

1. P0 = D/ k

P0 = D1 / (k -g)

P0 = E1 (1-b) / [k-(ROE*b)]

P0 /E1= (1-b) / [k-(ROE*b)]

P0 = E1/k + PVGO

2.
E(Return)   Prob(r ) * r
i
i i

Var(Return )   Prob(r ) * (r
i
i i  E ( r )) 2

3. E (rC )  yE (rA ) + (1  y ) E ( rf ) � E (rC )  rf + y ( E (rA )  rf )


 C  y A

E ( rA )  r f
S
A

1 E ( rA )  E ( rf )
2 *
4. E (U )  E ( r )  A y 
2

2 A A

5. Risk premium = E(Rp) - Rf

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FIN 352 Exam 2
DR. JING ZHAO

ANSWER SHEET

NAME:_____________________________________________

STUDENT ID:________________________________________

1. 2. 3. 4. 5.

6. 7. 8. 9. 10.

11. 12. 13. 14. 15.

16. 17. 18. 19. 20.

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FIN 352 EXAM 2:
DR. JING ZHAO

INSTRUCTIONS: You are allowed to use: 1. Calculator, 2. Formula Sheet, and 3. A “cheat sheet” of A4
size, one-sided, with only your own handwriting (no printing).

Answer all of the following multiple-choice questions. Only one answer is correct. When finished, please
return both the answer sheet and the exam with your name and student ID on them.

Name __________________________ Student ID _____________________________

For the following 5 questions: You invest $100 in a risky asset with an expected rate of return of 12%
and a standard deviation of 15% and a T-bill with a rate of return of 5% and E (U)= E(r) - 0.5Aσ 2

1. What percentages of your money must be invested in the risk-free asset and risky asset,
respectively, to form a portfolio with an expected return of 9%?
A) 75% and 25%
B) 67% and 33%
C) 57% and 43%
D) 43% and 57%

2. What percentages of your money must be invested in the risky asset and the risk-free asset,
respectively, to form a portfolio with a standard deviation of 9%?
A) 30% and 70%
B) 60% and 40%
C) 40% and 60%
D) cannot be determined

3. A portfolio that has an expected outcome of $115 is formed by


A) investing $100 in the risky asset.
B) investing $80 in the risky asset and $20 in the risk-free asset.
C) borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset.
D) borrowing $33 at the risk-free rate and investing the total amount ($133) in the risky asset.

4. The slope of the CAL formed with the risky asset and the risk-free asset is equal to
A) 0.4667.
B) 0.3457.
C) 0.6543.
D) cannot be determined.

5. Suppose your risk aversion factor is 9. What weight sould you assign to the risk-free asset?
A) 0.4667.
B) 0.3457.
C) 0.6543.
D) cannot be determined.

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6. McIver’s Inc. currently pays a $1.00 annual dividend. Investors believe that the firm will grow
dividends at 15% annually for the next 2 years, 10% annually for the two years after that, and 5%
annually thereafter. Assume the required return is 10%. What is the current price of the stock?
A) $16.77
B) $19.99
C) $27.28
D) $32.98
7. A multiple-growth rate company pays a current dividend of $1 and is expected to grow at the
higher rate of 40% a year for three years, at the end of which time the new growth rate is
expected to be a constant 8% per year. The required rate of return is 12%. Currently the stock is
selling at $65. Which of the following statements is true?
A) The investor should not buy the stock since it is overvalued in the market.
B) The investor should not buy the stock since it is undervalued in the market.
C) The investor should buy the stock since it is undervalued in the market.
D) The stock is correctly priced in the market.

8. Suppose NO Growth, Inc. has just issued a dividend of $1.50/share. Subsequent dividends will
remain at $1.50 indefinitely. Required rate of return for NO Growth Inc. is 12%. What is the
value of one share of the firm’s stock?
A) $2.90
B) $12.50
C) $29.00
D) $31.25

9. A risky portfolio pays a 11% rate of return and a T-bill pays 7%. The risk premium on the risky
investment is
A) 4 percent.
B) 5 percent.
C) 6 percent.
D) 1 percent.

10. Agricultural Equipment Company has an expected ROE of 12%. The dividend growth rate will
be _____________ if the firm follows a policy of paying 40% of earnings in the form of
dividends.
A) 3.0%
B) 4.8%
C) 7.2%
D) 9.0%

11. The best complete portfolio for a particular investor is designated by:
A) The point of highest reward to variability ratio in the opportunity set.
B) The point of tangency with the opportunity set and the capital allocation line.
C) The point of the highest reward to variability ratio in the indifference curve.
D) The point of tangency with indifference curve and the capital allocation line.

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Consider the following scenario analysis and answer the following 3 questions:
Economy Probability Return on Stock A Return on Stock B
Good 1/3 28% -3%
Normal 1/3 12% 7%
Bad 1/3 -7% 17%

12. What are the expected return and standard deviation of stock A?
A) 13.5% and 3.5%
B) 14.5% and 11%
C) 11% and 14.3%
D) 10% and 13.3%

13. What are the expected return and standard deviation of stock B?
A) 7% and 8.2%
B) 17% and 6.5%
C) 7% and 9.0%
D) 17% and 3.1%

14. Grott and Perrin, Inc. has expected earnings of $5 per share for next year. The firm’s ROE is 20%
and its earnings retention ratio is 70%. If the firm's market capitalization rate is 15%, what
percentage of its share price is attributed to the present value of its growth opportunities (PVGO)?
A) 22%
B) 80%
C) 75%
D) 78%

15. Which of the following statements regarding the Capital Allocation Line (CAL) is FALSE?
A) The slope of the CAL is called the reward-to-variability ratio.
B) The slope of the CAL equals the increase in the expected return of a risky portfolio per unit
of standard deviation.
C) The slope of the CAL is also called the Sharpe ratio.
D) The slope of the CAL equals the increase in the standard deviation of a risky portfolio per
unit of expected return.

16. You invest $100 in a risky asset with an expected rate of return of 15% and a standard deviation
of 15% and a T-bill with a rate of return of 5% and E (U)= E(r) - 0.5Aσ2. Suppose your risk
aversion factor is 5. What weight would you assign to the risky asset?
A) 0.1111.
B) 0.8889.
C) 0.2457.
D) 0.2111.

17. Given the capital allocation line, an investor's optimal complete portfolio is the portfolio that
A) maximizes expected profit.
B) minimizes risk
C) maximizes expected utility.
D) none of the above.

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18. A risky portfolio pays a 20% rate of return with probability 60% in a good state or a 5% return with
probability 40% in a bad state, and a T-bill pays 5%. The risk premium on the risky investment is
A) 7 percent.
B) 8 percent.
C) 9 percent.
D) 10 percent.

19. The required rate of on the stock of Aberdeen Wholesale Company is 15%. Its expected ROE is 20%
and its expected EPS is $5.00. If the firm’s plow-back ratio is 40%, its P/E ratio will be?
A) 8.9
B) 5.7
C) 13.3
D) 8.6

20. The change from a straight to a kinked capital allocation line reflects:
A) reward-to-volatility ratio increasing.
B) borrowing rate exceeding lending rate.
C) investors risk tolerance decreasing.
D) increase in the portfolio proportion of the risk-free asset.

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