B.A. 130 Practice Final Exam
Fall 1996

1. Explain why investments that carry greater systematic risk have a higher required rate of return.

2. What is 6% of $100 million? What are the annual interest payments on a coupon bond with an interest rate of 6% and a face value of $100 million? 3. Consider two stocks: stock F pays a dividend of $1 a year, and its dividend is not expected to grow or shrink in the future; stock G is expected to pay a dividend of $0.50 next year, and thereafter its dividend is expected to grow at 5% per year. What are the values of these two stocks if the interest rate is 10%? Explain the connection between their dividends and their prices.
4. Suppose we have two stocks, H and J. Each of them will pay $5 a share in dividends next year; each of them reports $10 a share in earnings; the required rate of return is 10% per year. Stock C has a price of $50; stock D has a price of $25. What is the present value of growth opportunities for stock C? What is the present value of growth opportunities for stock D? How can two stocks with identical current earnings and dividends sell for different prices?
5. You believe that there is a 50% chance that stock A will rise by 20% and a 50% chance that stock A will fall by 10%. You also believe that there is a 25% chance that stock B will rise by 20%, and a 75% chance that stock B will remain constant. The correlation coefficient between the two stocks is zero.

(a) What is the expected rate of return on stock A? What is the standard deviation?

(b) What is the expected rate of return on stock B? What is the standard deviation?

(c) Suppose you invest half your wealth in stock A and half your wealth in stock B.

What is the expected return on your portfolio? What is the standard

deviation of your portfolio? 6. Why is diversification important for investors? In what sense is a "diversified" portfolio better than an "undiversified" portfolio? 7. What is a certainty-equivalent value? 8. What is a variance? 9. What is a preferred stock?
10. What is an initial public offering?
11. What is an annuitized annual cost?
12. Suppose that Tyrannosaur Technologies has a beta of -1. Suppose that the market's required rate of return is 12% per year, and that the risk-free rate is 3% per year. What is the required rate of return on this stock? What do you expect the return on this stock to be in a year in which the market return is 12%? What do you expect the return on this stock to be in a year in which the market return is 3%.
13. Suppose that the standard deviation of the market return is 0.3 (30%); the standard deviation of the return on Zizzer Industries is 0.6 (60%), and that the correlation between the excess return on the market and the excess return on Zizzer Industries is 0.5. What is Zizzer Industries' beta? Suppose you constructed a diversified portfolio of stocks with the same beta as Zizzer Industries: what would you expect the standard deviation of your portfolio to be? 14. Just what are the benefits to portfolio diversification, exactly? 15. You have the opportunity to undertake an investment with the following set of cash flows:

Year 0 1 2 3 4 5 6 7

Cash Flow: -$10 $1.2 $6.2 $0.6 $0.6 $0.6 $3.1 $2.8

Your financial advisors say that this investment carries an incremental beta of two. The risk-free rate is 2%; the market's required rate of return is 7%. Will undertaking this project raise or lower your company's total stock market value? By how much? 16. What is the expected net present value to the state lottery agency of a game that has a prize of infinity-a prize of $1,000,000 a year payable for every year in the future until the end of time-for which the state lottery agency expects to sell 18 million one-dollar tickets? The required rate of return is 5% per year. 17. Suppose that the price of Carbonics stock can go up by 15% or down by 13% in the next year from the current stock price of $60, and that only these two outcomes are possible. Suppose, further, that the safe interest rate is 10% per year. What is the option delta of a call option on Carbonics stock with a strike price of $60? 18. Suppose that you hold a call option on a share of stock, and also "owe" a share of stock--that is, you have sold it short. What is the total payoff to your portfolio on the exercise date if the price of the stock is above the strike price? 19. What is a "rights issue"? 20. What is "Monte Carlo analysis"?