FIN 3102B Test 2 - Fall 2008

Fall 2008

Investment Analysis – FIN 3102 B Dr. Emir Hrnjić

Test 2

SECTION ___ PRINT NAME _____________________________ MATRICULATION NUMBER_______________ Rules and directions:

Read questions carefully and answer all parts of the question to the best of your ability.

Only one person may use the restroom at a time. Bring your exam to me or teaching assistant when you need to use the restroom.

You may not share calculators or notecards. If you run out of space on a given page to answer a problem or an essay, draw an arrow

on the bottom of the page and continue the problem on the back of the page. Turn your cell phones off.

1 NUS School of Business

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A. SHORT ANSWER QUESTIONS: Answers in this section should be short and straight to the point. 1. ACTIVE vs. PASSIVE INVESTING (10 pts) Briefly compare and contrast Jegadeesh and Titman (1993) and DeBondt and Thaler (1985)! Which paper supports (presents evidence for) and which paper rejects (presents evidence against) market efficiency?


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2. ACTIVE vs. PASSIVE INVESTING (10 pts) Define value and growth investing! Which style is better? Why?


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3. PORTFOLIO PERFORMANCE MEASURES (10 pts) Describe Fama’s Selectivity measure!


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4. OPTIONS (10 pts) Discuss the relationships between option prices and time to expiration, volatility of the underlying stocks, and the exercise price.


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B. PROBLEMS: Show all supporting calculations in order to receive partial credit. If using the statistical function on a calculator, set the problem up using the formulas. 1. FAMA – FRENCH 3 FACTOR MODEL / CARHART 4 FACTOR MODEL (10 pts) You are evaluating following portfolio. Table shows portfolio returns, risk-free rates of return, returns of Wilshire 5000, returns to the size factor (SMB = RSMALL - RBIG), and returns to B/M factor (HML = RHIGH B/M – RLOW B/M). You recently found out that there is Carhart model which is similar to Fama – French with an addition of a fourth factor called Momentum factor. Returns for factors are in the table.

Year portfolio RF

Wilshire 5000 index value (as

of Dec 31) SMB HML 2004 12.6% 5% 11,968.10 3.9% 1.85% 2005 17.1% 6% 12,517.70 6.1% 2.7% 2006 23.6% 5% 14,257.50 4.6% 1.97% 2007 11.9% 4.5% 14,819.60 2.3% 3.43%

You are also given following betas (risk sensitivities). Beta of portfolio on the Market factor (β1) = 1.23 Beta of portfolio on the size factor (β2) = 0.91 Beta of portfolio on the BV / MV factor (β3) = 0.39 Beta of portfolio on the Momentum factor (β4) = 0.43 You also found out following returns percentiles for the last 2 to 12 months on Dec 31, for each year. 10th percentile: -18 % 20th percentile: -3 % 30th percentile: 5 % 40th percentile: 9 % 50th percentile: 12 % 60th percentile: 15 % 70th percentile: 22 % 80th percentile: 25 % 90th percentile: 33 % You conclude that this information may be useful to answer the question. What is a 2-year cumulative abnormal portfolio return (2006 – 2007) if we use Carhart 4 factor model as the risk adjustment model?


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(blank page)


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2: PORTFOLIO PERFORMANCE MEASURES The annual rates of return for the Mutual Shares fund and the value-weighted return of all stocks on NYSE, AMEX, and Nasdaq for a five-year period are displayed in a table below. Assume the arithmetic mean annual risk-free rate over the period was 3%.

Year VWRETD Mutual Shares

2001 -11.27% -15.90%2002 -20.84% -19.20%2003 33.15% 38.60%2004 13.00% 14.50%2005 7.31% 26.70%

Arithmetic Mean 4.27% 8.94%St. Deviation 21.16% 25.67%

Variance 4.48% 6.59%Covariance 0.041

a) (5 pts) Using the Sharpe Ratio measure of portfolio performance indicate whether Mutual Shares Fund had superior performance over the five year period shown. b) (5 pts) Calculate Jensen’s alpha (the multiple period alpha) for Mutual Shares Fund and state whether it indicates superior performance.


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c) (5 pts) Draw the ex-post CML and the ex-post CAL for the Mutual Shares Fund representing performance over the 5 year period shown.


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3. OPTIONS (10 pts) You have following data. Current stock price is 88, exercise price is 100, time to maturity is 9 months, risk-free rate is 4.5% and annualized σ = .10. Calculate the value of the call option and the put option using Black – Scholes formula. Also, check put-call parity for these two options.


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4. BONDS You have purchased a bond for $973.02. The bond has a coupon rate of 6.4%, pays interest annually, has a face value of $1,000, 4 years to maturity, and a yield to maturity of 7.2%. You expect that interest rates will fall by .3% later today. Round to 4 decimal points to answer this question! a) (5 pts) Use the modified duration to find the approximate percentage change in the bond's price. Find the new price of the bond from this calculation.


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b) (5 pts) Use your calculator to do the regular present value calculations to find the bond's new price at its new yield to maturity. c) (5 pts) What is the amount of the difference between the two answers? Why are your answers different?


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C. MULTIPLE CHOICE: Circle the letter in front of your answer to each question. (3 pts each)

1. Which of the following is false?

i. Fama Fresh 6 factor model is equal to Fama French 3 factor model plus two additional bond factors plus 2 unknown, hidden factors.

ii. DeBondt and Thaler (1985) find that there is a reversal in stock prices in the short run (3 – 12 months).

iii. Jegadeesh and Titman (1993) find that there is a momentum in stock prices in the long run (3 – 5 years).

A. i only. B. ii only. C. i and iii only. D. i and ii only. E. i, ii, and iii.

2. Following statement(s) imply(ies) a belief in efficient markets: i. “We look for positive earnings surprises.” ii. “Investing in target stocks after M&A announcements is profitable strategy.” iii. “Monthly momentum is the most profitable strategy.” A. i only. B. ii only. C. iii only. D. i and iii only. E. None of the above.

3. HighFlyer Stock currently sells for $48. A one-year call option with strike price of $55 sells for $9, and the risk free interest rate is 6%. What is the price of a one-year put with strike price of $55? A. $9.00 B. $12.89 C. $16.00 D. $18.72 E. none of the above.

4. Prior to expiration A. the intrinsic value of a call option is greater than its actual value. B. the intrinsic value of a call option is always negative. C. the actual value of a call option is smaller than the intrinsic value. D. the intrinsic value of a call option is always greater than its fake value. E. none of the above.


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5. Other things equal, the price of a stock call option is positively correlated with the following factors except

A. the stock price. B. the time to expiration. C. the stock volatility. D. the exercise price. E. none of the above.

6. You purchased an annual interest coupon bond one year ago that had 6 years remaining to maturity at that time. The coupon interest rate was 10% and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on holding the bond for that year would have been _________.

A. 7% B. 8%. C. 9% D. 10%. E. none of the above.

7. You have just purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000. What would your rate of return be if you sell the bond 2 years later? Assume the yield to maturity on the bond is 11% at the time you sell.

A. 10.00% B. 20.42% C. 13.8% D. 1.4% E. none of the above

8. Which of the following is false? i. If estimated value > market price, you should buy. ii. If stock is overvalued, you should hold. iii. If stock is undervalued, you should buy. A. i only. B. ii only. C. iii only. D. i and iii only. E. i, ii and iii.


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9. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10%. The intrinsic value of the bond today will be __________ if the coupon rate is 8%. A. $922.78 B. $924.16 C. $1,075.80 D. $1,077.20 E. none of the above 10. Given the time to maturity, the duration of a zero-coupon bond is higher when the discount rate is A. higher. B. lower. C. equal to the risk free rate. D. The bond's duration is independent of the discount rate. E. none of the above.


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FIN 3102B Test 2 - Fall 2008

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