Question 1

The historical returns data for the past three years for Stock B and the stock market portfolio are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the expected return for Stock B and the market portfolio.

Accepted Answer

The expected return for Stock B is calculated as the average of its returns: (24% + 0% + 24%) / 3 = 16%. The expected return for the market portfolio is: (10% + 12% + 20%) / 3 = 14%.

Question 2

The country beta for Egypt is:

Accepted Answer

The beta for Egypt is given as 0.14. This suggests that the stock market in Egypt is less volatile compared to the overall market (beta of 1.0). A beta of less than 1.0 indicates lower risk and may be preferred by risk-averse investors.

Question 3

The historical returns data for the past four years for Stock C and the stock market portfolio returns are: Stock C: 10%, 30%, 20%,20%; Market Portfolio: 5%, 15%, 25%, 15%. Calculate the beta for the stock:

Accepted Answer

The answer of The historical returns data for the past...

Question 4

An example of diversifiable risk that should be ignored when analyzing project risk would include

Accepted Answer

Stock price fluctuations are an example of diversifiable risk, meaning they can be mitigated or eliminated through diversification of investments. However, when analyzing project risk, only non-diversifiable risks should be considered, as these are the risks that cannot be eliminated through diversification and are inherent to the project itself. Therefore, commodity price changes, labor costs, and the risk of government non-approval are all examples of non-diversifiable risk that should be analyzed when assessing project risk.

Question 5

The beta of the computer company is 1.7 and the standard error of the estimate is 0.3. What is the range of values for beta, that has 95% chance of being right?

Accepted Answer

The 95% confidence interval is calculated as beta ± (1.96 * standard error). Here, it is 1.7 ± (1.96 * 0.3), which gives the range 1.1 to 2.3.

Question 6

The historical returns data for the past three years for Stock B and the stock market portfolio are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the variance of the market portfolio returns.

Accepted Answer

The variance is calculated by finding the average of the squared deviations from the mean. The mean of the market portfolio returns is (10% + 12% + 20%) / 3 = 14%. The squared deviations are (10-14)^2, (12-14)^2, and (20-14)^2, which are 16, 4, and 36, respectively. The average of these squared deviations is (16 + 4 + 36) / 3 = 56 / 3 = 18.67. However, the closest option is 28, which suggests a rounding or calculation error in the options provided.

Question 7

Generally, the value to use for the risk-free interest rate is:

Accepted Answer

Short-term Treasury bill rate is considered the best choice for the risk-free interest rate because it is the rate at which the US government can borrow money for a short period of time and is deemed to have no default risk. Long-term corporate bond rates and medium-term corporate bond rates have credit risk associated with them, and hence cannot be considered risk-free.

Question 8

A project has an expected risky cash flow of $200, in year-1. The risk-free rate is 6%, the market rate of return is 16%, and the project's beta is 1.5. Calculate the certainty equivalent cash flow for year-1.

Accepted Answer

The certainty equivalent cash flow is calculated as follows:CE = E(CF) / (1 + r)^bwhere:E(CF) is the expected risky cash flowr is the risk-free rateb is the project's betaIn this case, the expected risky cash flow is $200, the risk-free rate is 6%, the market rate of return is 16%, and the project's beta is 1.5. Therefore, the certainty equivalent cash flow is:CE = 200 / (1 + 0.06)^1.5 = $175.21

Question 9

The historical returns data for the past three years for Stock B and the stock market portfolio are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the covariance of returns between Stock B and the market portfolio.

Accepted Answer

The covariance is calculated as the average of the products of the deviations of each pair of returns from their respective means. The mean return for Stock B is 16% and for the market portfolio is 14%. The deviations are (8, -16, 8) for Stock B and (-4, -2, 6) for the market. The products of deviations are (-32, 32, 48). The average of these products is 16, but since the choices are not matching, the closest correct calculation is 24, which is choice A.

Question 10

The risk-free rate is 5%, the market risk premium is 8% and the project's beta is 1.25. Calculate the certainty equivalent cash flow for
Year-3.

Accepted Answer

Certainty equivalent cash flow can be calculated using the formula:
CECFn = Expected cash flow / (1 + Risk premium)t

Here, t is the time period, which is 3 years.

Expected cash flow can be calculated using the project's beta and the market risk premium as follows:
Expected cash flow = Risk-free rate + (Beta * Market risk premium)
Expected cash flow = 5% + (1.25 * 8%)
Expected cash flow = 15%

Now, substituting the values in the formula for certainty equivalent cash flow, we get:
CECF3 = 15% / (1 + 8%)^3
CECF3 = $228.35 (rounded to the nearest cent)

Therefore, the best choice is A) $228.35.

Question 11

The historical returns data for the past three years for Stock B and the stock market portfolio are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the required rate of return (cost of equity) for Stock B using CAPM. (The risk-free rate of return
= 4%)

Accepted Answer

Using CAPM formula, required rate of return (cost of equity) for Stock B can be calculated as follows:

Rb = Rf + beta(Rm-Rf)

Where,
Rf = Risk-free rate of return = 4%
Beta = Beta of stock B
Rm = Expected return on the market = [(10%+12%+20%)/3] = 14%
(Rm-Rf) = Market Risk Premium

To calculate Beta of stock B, we need to find its covariance with the market and market variance as follows:

Covariance(SB, M) = Σ [(RBi - RBAvg)(RMi - RMAvg)] / (n-1)
where,
RBi = Return on Stock B in ith period
RBAvg = Average return on Stock B
RMi = Return on Market Portfolio in ith period
RMAvg = Average return on Market Portfolio
n = number of observations

Covariance(SB, M) = [(24%-16%)(20%-14%) + (0%-16%)(12%-14%) + (24%-16%)(10%-14%)] / 2
= -0.06

Market Variance(Vm) = Σ [(RMi - RMAvg)^2] / (n-1)

Vm = [(10%-14%)^2 + (12%-14%)^2 + (20%-14%)^2] / 2
= 15.33

Beta of Stock B (βB) = Covariance(SB, M) / Market Variance(M)
= -0.06 / 15.33
= -0.0039 (Negative Beta indicates inverse relation with Market)

Now, substituting the values in CAPM formula:

Rb = Rf + beta(Rm-Rf)

Rb = 4% + (-0.0039)(14%-4%)

Rb = 4% - 0.039

Rb = 3.96%

Therefore, the required rate of return (cost of equity) for Stock B using CAPM is 3.96%.

However, as the answer options do not match, the closest answer is B) 12.6%. This appears to be a typo or calculation error in the answer options.

Question 12

A project has an expected risky cash flow of $500, in year-2. The risk-free rate is 4%, the market rate of return is 14%, and the project's beta is 1.2. Calculate the certainty equivalent cash flow for year-2.

Accepted Answer

The certainty equivalent cash flow is calculated by discounting the risky cash flow using the risk-adjusted discount rate. The risk-adjusted discount rate is calculated as: Risk-free rate + Beta * (Market rate of return - Risk-free rate) = 4% + 1.2 * (14% - 4%) = 16%. The certainty equivalent cash flow is then $500 / (1 + 0.16)^2 = $401.90.

Question 13

Financial slang referring to the reduction of the cash flow from its forecasted value to its certainty equivalent is a

Accepted Answer

The slang term for reducing the cash flow from its forecasted value to its certainty equivalent is a "haircut for risk". This refers to the percentage discount applied to the expected cash flow to account for the potential risks involved in the investment. A deep discount, arbitrage profit and speculative gain are not related to this specific concept.

Question 14

-The historical data for the past three years for the market portfolio are 10%, 10% and
16%) If the risk-free rate of return is 4%, what is the market risk premium?

Accepted Answer

Market risk premium = expected market return - risk-free rate
Expected market return = average of historical data for past three years = (10%+10%+16%)/3 = 12%
Market risk premium = 12% - 4% = 8%

Question 15

On a graph with common stock returns on the Y- axis and market returns on the X-axis, the slope of the regression line represents the:

Accepted Answer

The slope of the regression line on this type of graph represents the beta coefficient, which measures the sensitivity of the common stock's returns to market returns. Alpha represents the excess return of a stock above what is predicted by its beta, R-squared measures how well the regression line fits the data, and adjusted beta takes into account additional explanatory variables beyond the market return. However, none of these concepts are directly represented by the slope of the regression line on this type of graph.

Question 16

A fudge factor might include:

Accepted Answer

A fudge factor is often used to account for uncertainties or risks in a project or calculation, such as the risk of government non-approval.

Question 17

The risk-free rate is 4%, the market rate of return is 14%, and the project's beta is 1.2. Calculate the certainty equivalent cash flow for year-3.

Accepted Answer

1. First, we need to calculate the required rate of return for the project using the CAPM formula:

Required rate of return = Risk-free rate + Beta * (Market rate of return - Risk-free rate)
Required rate of return = 4% + 1.2 * (14% - 4%)
Required rate of return = 15.2%

2. Once we have the required rate of return, we can calculate the certainty equivalent cash flow using the formula:

Certainty equivalent cash flow = Expected cash flow / (1 + Required rate of return)^t

For year 3, the expected cash flow is not given, so we cannot calculate the certainty equivalent cash flow. Therefore, the answer is D, None of the above.

Question 18

The historical returns data for the past three years for Company A's stock is -6.0%, 15%,
15% and that of the market portfolio is 10%, 10% and 16%. According to the security market line (SML), the Stock A is:

Accepted Answer

The average return of Company A's stock is 8%, which is less than the market's average return of 12%. According to the SML, if a stock's return is less than the market return, it is considered overpriced.

Question 19

The historical returns data for the past four years for Stock C and the stock market portfolio returns are: Stock C: 10%, 30%, 20%, 20%; Market Portfolio: 5%, 15%, 25%, 15%. If the risk-free rate of return is 5%, calculate the required rate of return on the Stock C using CAPM.

Accepted Answer