1. Which of the following is a random variable?

 

1. the price of a stock in one year
2. the known expected price of a stock in one year
3. the actual price of a stock in one year
4. the average price of a stock throughout a year

 

 

Probability	Value at the end of the year
50%	$10,000
20%	$20,000
30%	$8,000

 

1. Calculate the expected value of the project at the end of the year.

 

1. $12,667
2. $12,600
3. $11,400
4. none of the above

 

 

Probability	Value in one year
20%	$100
10%	$0
60%	$50
10%	$200

1. Calculate the expected value and the standard deviationof the future values for the investment.

 

1. E(v) = $70; Sdv(value) = $50.99
2. E(v) = $70; Sdv(value) = $0.00
3. E(~v) = $87.50; Sdv(value) = $26.00
4. E(v) = $87.50; Sdv(value) = $45.93

 

 

1. An investor who is risk-neutral

 

1. would prefer to invest in only risk-free assets.
2. would be indifferent between investing her money in a savings account at 4% or investing in a bond that has a 50% chance of returning 8% and a 50% chance of returning 0%.
3. will take any fair bet
4. both B and C are true.

 

 

1. The possible one-year returns for three differentinvestments are as follows

 

InvestmentA	InvestmentB	InvestmentC
-5%	+18%	-10%
+1%	+20%	0%
+3%	+50%	+15%
-3%	+22%	-20%
+8%	+35%	+20%

 

The returnsfor each investment are equally likely to occur.  Which investment's returns would have the lowest standard deviation?  Why?  (Note:  No calculations are necessary.)

 

 

 

1. A risk-freeinvestmentof $10,000 will return 8%.  A risky $10,000investment has a 50% chanceof defaulting and returning only $3,000.  How much must the risky investment promise to return?

 

1. 36.2%
2. 37.2%
3. 18.6%
4. 86.0%

 

 

A risk-free investment of $50,000 offers an annual return of 6%.  A risky investment of $50,000 has a 40% probability of default, in which case it will pay only $25,000.

 

1. Refer to the information above. What is the expected rate of return on the risky investment?

 

1. +8.4%
2. -16.4%
3. -22.0%
4. +7.8%

 

 

1. Refer to the information above. What return must the risky investment promise?

 

1. 8.1%
2. 62.0%
3. 43.3%
4. 71.7%

 

 

1. Refer to the information above. What default premium must the risky investment offer?

 

1. 33.3%
2. 43.3%
3. 52.0%
4. 37.3%

 

 

1. What kind of risk is captured in bond ratings?

 

1. liquidity risk
2. interest rate risk
3. default risk

 

1. I and II only
2. II and III only
3. I, II and III
4. III only

 

 

1. A type of investment that gives investorsthe ability to invest in only one aspect of a bond--e.g., time element or defaultelement is called a

 

1. collateralized obligation (CO).
2. credit default swap (CDS).
3. contingent payoff swap (CPS).
4. callable bond.

 

 

 

 

1. Explain the mechanicsof a credit default swap.

Answer: A bondholder buys a credit swap from another market participant who is placing a bet that the bond issuer will not go bankrupt.  If the issuer does go bankrupt,the seller of the credit swap must pay the bondholder the amount designated.  Thus, the credit swap seller has sold an insurance contractto the bondholder and receives a premium for doing so.

 

Event	Probability	Value in one year
Stable economy (no change)	50%	$58,000
Improved economy	20%	$65,000
Worsened economy	30%	$25,000

 

1.  Refer to the information above.  What is the expected value of this investment?

 

1. $53,000
2. $49,333
3. $56,000
4. $49,500

 

 

1. Refer to the information above.  If the appropriate expected return is 12%, what is the investment's present value?  Roundyour answer to the nearest dollar.

 

1. $51,786
2. $44,196
3. $47, 768
4. none of the above

 

 

1. Refer to the information above.  Assumethis investment is purchased for its fair market value.  What is its expectedrate of return under the assumption of a stable economy? Round your answer to the nearest tenth of a percent.

 

1. +31.2%
2. +17.2%
3. +11.7%
4. -11.6%

 

 

 

1. Refer to the information above.  Assumethis investment is purchased for its fair market value.  What is its expectedrate of return under the assumption of an improvedeconomy? Round your answer to the nearest tenth of a percent.

 

1. 30.0%
2. 12.1%
3. 47.1%
4. 31.3%

 

 

1. Refer to the information above.  Assumethis investment is purchased for its fair market value.  What is its expectedrate of return under the assumption of a worsenedeconomy? Round your answer to the nearest tenth of a percent.

 

1. -56.6%
2. -43.4%
3. -46.7%
4. -49.5%

 

 

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