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Quantitative Investment Analysis 3rd edition Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, David E. Runkle - Solutions

The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10. MSCI Germany Index Total Returns, 1993-2002 Year........................................Return
A. Explain the relationship among arithmetic mean return, geometric mean return, and variability of returns. B. Contrast the use of the arithmetic mean return to the geometric mean return of an investment from the perspective of an investor concerned with the investment's terminal value. C.
The following table repeats the annual total returns on the MSCI Germany Index previously given and also gives the annual total returns on the JP Morgan Germany five- to seven-year government bond index (JPM 5-7 Year GBI, for short). During the period given in the table, the International Monetary
The following table repeats the annual total returns on the MSCI Germany Index previously given and also gives the annual total returns on the JP Morgan Germany five- to seven-year government bond index (JPM 5-7 Year GBI, for short). During the period given in the table, the International Monetary
The following table repeats the annual total returns on the MSCI Germany Index previously given and also gives the annual total returns on the JP Morgan Germany five- to seven-year government bond index (JPM 5-7 Year GBI, for short). During the period given in the table, the International Monetary
Suppose a client asks you for a valuation analysis on the eight-stock US common stock portfolio given in the table below. The stocks are equally weighted in the portfolio. You are evaluating the portfolio using three price multiples. The trailing 12 months (TTM) price-to-earnings ratio (P/E) is
The table below gives statistics relating to a hypothetical 10-year record of two portfolios.Based only on the information in the above table, perform the following: A. Contrast the distributions of returns of Portfolios A and B. B. Evaluate the relative attractiveness of Portfolios A and B?
The table below gives statistics relating to a hypothetical three-year record of two portfolios.Based only on the information in the above table, perform the following: A. Contrast the distributions of returns of Portfolios A and B. B. Evaluate the relative attractiveness of Portfolios A and B?
The table below gives statistics relating to a hypothetical five-year record of two portfolios.Based only on the information in the above table, perform the following: A. Contrast the distributions of returns of Portfolios A and B. B. Evaluate the relative attractiveness of Portfolios A and B?
At the UXI Foundation, portfolio managers are normally kept on only if their annual rate of return meets or exceeds the mean annual return for portfolio managers of a similar investment style. Recently, the UXI Foundation has also been considering two other evaluation criteria: the median annual
State the type of scale used to measure the following sets of data. A. Sales in euros. B. The investment style of mutual funds. C. An analyst's rating of a stock as underweight, market weight, or overweight, referring to the analyst's suggested weighting of the stock in a portfolio. D. A measure of
If the observations in a data set have different values, is the geometric mean for that data set less than that data set's: Harmonic mean? Arithmetic mean? A. No No B. No Yes C. Yes No
Is a return distribution characterized by frequent small losses and a few large gains best described as having: Negative skew? A mean that is greater than the median? A. No No B. No Yes C. Yes No
An analyst gathered the following information about the return distributions for two portfolios during the same time period:The analyst stated that the distribution for Portfolio A is more peaked than a normal distribution and that the distribution for Portfolio B has a long tail on the left side
The coefficient of variation is useful in determining the relative degree of variability of different data sets if those data sets have different: A. means or different units of measurement. B. means, but not different units of measurement. C. units of measurement, but not different means?
An analyst gathered the following information:If the risk-free rate of return is 3.0 percent, the portfolio that had the best risk-adjusted performance based on the Sharpe ratio is: A. Portfolio 1. B. Portfolio 2. C. Portfolio 3.
An analyst gathered the following information about a portfolio's performance over the past 10 years:Mean annual return 11.8%Standard deviation of annual returns 15.7%Portfolio beta 1.2If the mean return on the risk-free asset over the same period was 5.0%, the coefficient of variation and Sharpe
The table below gives the deviations of a hypothetical portfolio's annual total returns (gross offees) from its benchmark's annual returns, for a 12-year period ending in 2003.Portfolio's Deviations from Benchmark Return,1992-2003 (%)1992......................................
The table below gives the deviations of a hypothetical portfolio's annual total returns (gross of fees) from its benchmark's annual returns, for a 12-year period ending in 2003. Portfolio's Deviations from Benchmark Return, 1992-2003 (%) 1992......................................
The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10. MSCI Germany Index Total Returns, 1993-2002 Year........................................Return
The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10. MSCI Germany Index Total Returns, 1993-2002 Year........................................Return
The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10. MSCI Germany Index Total Returns, 1993-2002 Year........................................Return
The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10. MSCI Germany Index Total Returns, 1993-2002 Year........................................Return
The table below gives the annual total returns on the MSCI Germany Index from 1993 to 2002. The returns are in the local currency. Use the information in this table to answer Questions 5-10.MSCI Germany Index Total Returns, 1993-2002Year........................................Return
Define the following terms: A. Probability. B. Conditional probability. C. Event. D. Independent events. E. Variance.
You are given the following probability distribution for the annual sales of ElStop Corporation: Probability Distribution for ElStop Annual Sales Probability.....................................Sales ($
Suppose the prospects for recovering principal for a defaulted bond issue depend on which of two economic scenarios prevails. Scenario 1 has probability 0.75 and will result in recovery of $0.90 per $1 principal value with probability 0.45, or in recovery of $0.80 per $1 principal value with
Suppose we have the expected daily returns (in terms of US dollars), standard deviations, and correlations shown in the table below.US, German, and Italian Bond ReturnsA. Using the data given above, construct a covariance matrix for the daily returns on US, German, and Italian bonds. B. State the
The variance of a stock portfolio depends on the variances of each individual stock in the portfolio and also the co-variances among the stocks in the portfolio. If you have five stocks, how many unique co-variances (excluding variances) must you use in order to compute the variance of return on
Calculate the covariance of the returns on Bedolf Corporation (RB) with the returns on Zedock Corporation (RZ), using the following data.
You have developed a set of criteria for evaluating distressed credits. Companies that do not receive a passing score are classed as likely to go bankrupt within 12 months. You gathered the following information when validating the criteria: • Forty percent of the companies to which the test is
On one day in March, 3,292 issues traded on the NYSE: 1,303 advanced, 1,764 declined, and 225 were unchanged. In how many ways could this set of outcomes have happened? (Set up the problem but do not solve it.)?
Your firm intends to select 4 of 10 vice presidents for the investment committee. How many different groups of four are possible?
As in Example 11, you are reviewing the pricing of a speculative-grade, one-year-maturity, zero-coupon bond. Your goal is to estimate an appropriate default risk premium for this bond. The default risk premium is defined as the extra return above the risk-free return that will compensate investors
An analyst developed two scenarios with respect to the recovery of $100,000 principal from defaulted loans:The amount of the expected recovery is closest to: A. $36,400 B. $63,600 C. $81,600
State three mutually exclusive and exhaustive events describing the reaction of a company's stock price to a corporate earnings announcement on the day of the announcement?
The correlation coefficient that indicates the weakest linear relationship between variables is: A. −0.75 B. −0.22 C. 0.35
Label each of the following as an empirical, a priori, or subjective probability. A. The probability that US stock returns exceed long-term corporate bond returns over a 10-year period based on Ibbotson Associates data. B. An updated (posterior) probability of an event arrived at using Bayes'
You are comparing two companies, BestRest Corporation and Relaxin, Inc. The exports of both companies stand to benefit substantially from the removal of import restrictions on their products in a large export market. The price of BestRest shares reflects a probability of 0.90 that the restrictions
Suppose you have two limit orders outstanding on two different stocks. The probability that the first limit order executes before the close of trading is 0.45. The probability that the second limit order executes before the close of trading is 0.20. The probability that the two orders both execute
Suppose that 5 percent of the stocks meeting your stock-selection criteria are in the telecommunications (telecom) industry. Also, dividend-paying telecom stocks are 1 percent of the total number of stocks meeting your selection criteria. What is the probability that a stock is dividend paying,
You are using the following three criteria to screen potential acquisition targets from a list of 500 companies: Fraction of the 500 Companies Criterion.....................................................................Meeting the Criterion Product lines
You apply both valuation criteria and financial strength criteria in choosing stocks. The probability that a randomly selected stock (from your investment universe) meets your valuation criteria is 0.25. Given that a stock meets your valuation criteria, the probability that the stock meets your
A report from Fitch data service states the following two facts:1 • In 2002, the volume of defaulted US high-yield debt was $109.8 billion. The average market size of the high-yield bond market during 2002 was $669.5 billion. • The average recovery rate for defaulted US high-yield bonds in 2002
A European put option on stock conveys the right to sell the stock at a pre-specified price, called the exercise price, at the maturity date of the option. The value of this put at maturity is (exercise price - stock price) or $0, whichever is greater. Suppose the exercise price is $100 and the
In futures markets, profits or losses on contracts are settled at the end of each trading day. This procedure is called marking to market or daily resettlement. By preventing a trader's losses from accumulating over many days, marking to market reduces the risk that traders will default on their
As reported by Liang (1999), US equity funds in three style categories had the following mean monthly returns, standard deviations of return, and Sharpe ratios during the period January 1994 to December 1996:Basing your estimate of future-period monthly return parameters on the sample mean and
As reported by Liang (1999), US equity funds in three style categories had the following mean monthly returns, standard deviations of return, and Sharpe ratios during the period January 1994 to December 1996:Basing your estimate of future-period monthly return parameters on the sample mean and
As reported by Liang (1999), US equity funds in three style categories had the following mean monthly returns, standard deviations of return, and Sharpe ratios during the period January 1994 to December 1996:Assuming fund returns are normally distributed, which fund category minimized the
A client has a portfolio of common stocks and fixed-income instruments with a current value of £1,350,000. She intends to liquidate £50,000 from the portfolio at the end of the year to purchase a partnership share in a business. Furthermore, the client would like to be able to withdraw
A. Describe two important characteristics of the lognormal distribution. B. Compared with the normal distribution, why is the lognormal distribution a more reasonable model for the distribution of asset prices? C. What are the two parameters of a lognormal distribution?
The basic calculation for volatility (denoted σ) as used in option pricing is the annualized standard deviation of continuously compounded daily returns. Calculate volatility for Dollar General Corporation (NYSE: DG) based on its closing prices for two weeks, given in the table below. (Annualize
A. Define Monte Carlo simulation and explain its use in finance. B. Compared with analytical methods, what are the strengths and weaknesses of Monte Carlo simulation for use in valuing securities?
A standard lookback call option on stock has a value at maturity equal to (Value of the stock at maturity - Minimum value of stock during the life of the option prior to maturity) or $0, whichever is greater. If the minimum value reached prior to maturity was $20.11 and the value of the stock at
At the end of the current year, an investor wants to make a donation of $20,000 to charity but does not want the year-end market value of her portfolio to fall below $600,000. If the shortfall level is equal to the risk-free rate of return and returns from all portfolios considered are normally
Suppose X, Y, and Z are discrete random variables with these sets of possible outcomes: X = {2, 2.5, 3}, Y = {0, 1, 2, 3}, and Z = {10, 11, 12}. For each of the functions f (X), g(Y), and h(Z), state whether the function satisfies the conditions for a probability function. A. f (2) = −0.01 f
An analyst stated that normal distributions are suitable for describing asset returns and that lognormal distributions are suitable for describing distributions of asset prices. The analyst's statement is correct in regard to: A. both normal distributions and lognormal distributions B. normal
Define the term "binomial random variable." Describe the types of problems for which the binomial distribution is used?
Over the last 10 years, a company's annual earnings increased year over year seven times and decreased year over year three times. You decide to model the number of earnings increases for the next decade as a binomial random variable. A. What is your estimate of the probability of success, defined
You are examining the record of an investment newsletter writer who claims a 70 percent success rate in making investment recommendations that are profitable over a one-year time horizon. You have the one-year record of the newsletter's seven most recent recommendations. Four of those
By definition, a down-and-out call option on stock becomes worthless and terminates if the price of the underlying stock moves down and touches a pre-specified point during the life of the call. If the pre-specified level is $75, for example, the call expires worthless if and when the stock price
You are forecasting sales for a company in the fourth quarter of its fiscal year. Your low-end estimate of sales is €14 million, and your high-end estimate is €15 million. You decide to treat all outcomes for sales between these two values as equally likely, using a continuous uniform
State the approximate probability that a normal random variable will fall within the following intervals: A. Mean plus or minus one standard deviation. B. Mean plus or minus two standard deviations. C. Mean plus or minus three standard deviations.
Find the area under the normal curve up to z = 0.36; that is, find P(Z ≤ 0.36). Interpret this value?
Peter Biggs wants to know how growth managers performed last year. Biggs assumes that the population cross-sectional standard deviation of growth manager returns is 6 percent and that the returns are independent across managers. A. How large a random sample does Biggs need if he wants the standard
An exchange rate has a given expected future value and standard deviation. A. Assuming that the exchange rate is normally distributed, what are the probabilities that the exchange rate will be at least 2 or 3 standard deviations away from its mean? B. Assume that you do not know the
Although he knows security returns are not independent, a colleague makes the claim that because of the central limit theorem, if we diversify across a large number of investments, the portfolio standard deviation will eventually approach zero as n becomes large. Is he correct?
Why is the central limit theorem important?
What is wrong with the following statement of the central limit theorem?"If the random variables X1, X2, X3, ..., Xn are a random sample of size n from any distribution with finite mean μ and variance σ2, then the distribution of X.̅ will be approximately normal, with a standard deviation of
Suppose we take a random sample of 30 companies in an industry with 200 companies. We calculate the sample mean of the ratio of cash flow to total debt for the prior year. We find that this ratio is 23 percent. Subsequently, we learn that the population cash flow to total debt ratio (taking account
Alcorn Mutual Funds is placing large advertisements in several financial publications. The advertisements prominently display the returns of 5 of Alcorn's 30 funds for the past 1-, 3-, 5-, and 10-year periods. The results are indeed impressive, with all of the funds beating the major market
A pension plan executive says, "One hundred percent of our portfolio managers are hired because they have above-average performance records relative to their benchmarks. We do not keep portfolio managers who have below-average records. And yet, each year about half of our managers beat their
Julius Spence has tested several predictive models in order to identify undervalued stocks. Spence used about 30 company-specific variables and 10 market-related variables to predict returns for about 5,000 North American and European stocks. He found that a final model using eight variables
Hand Associates manages two portfolios that are meant to closely track the returns of two stock indexes. One index is a value-weighted index of 500 stocks in which the weight for each stock depends on the stock's total market value. The other index is an equal-weighted index of 500 stocks in which
Give an example of each of the following: A. Sample-selection bias. B. Look-ahead bias. C. Time-period bias.
Petra Munzi wants to know how value managers performed last year. Munzi estimates that the population cross-sectional standard deviation of value manager returns is 4 percent and assumes that the returns are independent across managers. A. Munzi wants to build a 95 percent confidence interval for
What are some of the desirable statistical properties of an estimator, such as a sample mean?
An analyst stated that as degrees of freedom increase, a t-distribution will become more peaked and the tails of the t-distribution will become less fat. Is the analyst's statement correct with respect to the t-distribution: Becoming more peaked? Tails becoming less fat? A.
An analyst stated that, all else equal, increasing sample size will decrease both the standard error and the width of the confidence interval. The analyst's statement is correct in regard to: A. Both the standard error and the confidence interval B. The standard error, but incorrect in regard to
Assume that the equity risk premium is normally distributed with a population mean of 6 percent and a population standard deviation of 18 percent. Over the last four years, equity returns (relative to the risk-free rate) have averaged −2.0 percent. You have a large client who is very upset and
Compare the standard normal distribution and Student's t-distribution?
Find the reliability factors based on the t-distribution for the following confidence intervals for the population mean (df = degrees of freedom, n = sample size): A. A 99 percent confidence interval, df = 20. B. A 90 percent confidence interval, df = 20. C. A 95 percent confidence interval, n =
Assume that monthly returns are normally distributed with a mean of 1 percent and a sample standard deviation of 4 percent. The population standard deviation is unknown. Construct a 95 percent confidence interval for the sample mean of monthly returns if the sample size is 24?
Ten analysts have given the following fiscal-year earnings forecasts for a stock: Forecast (Xi)............................................. Number of Analysts
Thirteen analysts have given the following fiscal-year earnings forecasts for a stock: Forecast (Xi).....................................Number of Analysts (n
Explain the differences between constructing a confidence interval when sampling from a normal population with a known population variance and sampling from a normal population with an unknown variance?
Define the following terms: A. Null hypothesis. B. Alternative hypothesis. C. Test statistic. D. Type I error. E. Type II error. F. Power of a test. G. Rejection point (critical value).
Reviewing the EPS forecasting performance data for Analysts A and B, you want to investigate whether the larger average forecast errors of Analyst A are due to chance or to a higher underlying mean value for Analyst A. Assume that the forecast errors of both analysts are normally distributed and
Altman and Kishore (1996), in the course of a study on the recovery rates on defaulted bonds, investigated the recovery of utility bonds versus other bonds, stratified by seniority.The following table excerpts their findings.Assume that the populations (recovery rates of utilities, recovery rates
The table below gives data on the monthly returns on the S&P 500 and small-cap stocks for the period January 1960 through December 1999 and provides statistics relating to their mean differences.Let Î¼ d stand for the population mean value of difference between S&P 500 returns
During a 10-year period, the standard deviation of annual returns on a portfolio you are analyzing was 15 percent a year. You want to see whether this record is sufficient evidence to support the conclusion that the portfolio's underlying variance of return was less than 400, the return variance of
You are investigating whether the population variance of returns on the S&P 500/BARRA Growth Index changed subsequent to the October 1987 market crash. You gather the following data for 120 months of returns before October 1987 and for 120 months of returns after October 1987. You have
You are interested in whether excess risk-adjusted return (alpha) is correlated with mutual fund expense ratios for US large-cap growth funds. The following table presents the sample.A. Formulate null and alternative hypotheses consistent with the verbal description of the research goal. B.
All else equal, is specifying a smaller significance level in a hypothesis test likely to increase the probability of a: Type I error? Type II error? A. No.....................No B. No.....................Yes C. Yes....................No
All else equal, is increasing the sample size for a hypothesis test likely to decrease the probability of a: Type I error? Type II error? A. No..............Yes B. Yes.............No C. Yes............Yes
Suppose that, on the basis of a sample, we want to test the hypothesis that the mean debt-to- total-assets ratio of companies that become takeover targets is the same as the mean debt-to-total-assets ratio of companies in the same industry that do not become takeover targets. Explain under what
Suppose we are testing a null hypothesis, H0, versus an alternative hypothesis, Ha, and the p-value for the test statistic is 0.031. At which of the following levels of significance - α = 0.10, α = 0.05, and/or α = 0.01- would we reject the null hypothesis?
Identify the appropriate test statistic or statistics for conducting the following hypothesis tests. (Clearly identify the test statistic and, if applicable, the number of degrees of freedom. For example, "We conduct the test using an x-statistic with y degrees of freedom.") A. H0: μ = 0 versus
For each of the following hypothesis tests concerning the population mean, μ, state the rejection point condition or conditions for the test statistic (e.g., t > 1.25); n denotes sample size. A. H0: μ = 10 versus Ha: μ ≠ 10, using a t-test with n = 26 and α = 0.05 B. H0: μ = 10 versus Ha: μ
For each of the following hypothesis tests concerning the population mean, μ, state the rejection point condition or conditions for the test statistic (e.g., z > 1.25); n denotes sample size. A. H0: μ = 10 versus Ha: μ ≠ 10, using a z-test with n = 50 and α = 0.01 B. H0: μ = 10 versus Ha: μ

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