Questions and Answers of Fundamentals Investments Valuation

What are the statistical properties of the error term, or e, in a regression model?How should the regression coefficient β be interpreted? How should the intercept α be interpreted from both a
List the underlying classical assumptions in OLS regression analysis. Why are these assumptions important to OLS estimation of regression coefficients?
What does homoskedasticity of error terms mean in regression analysis? Are error terms correlated with one another? What is multicollinearity and can it cause problems in a multiple regression model?
If the CAPM does not hold, how does this affect the market model?
You want to test whether an estimated βj coefficient in an OLS regression model is significant. What is the null hypothesis? What is the statistical test of this hypothesis? What values of the
What is goodness-of-fit mean in regression analysis? How would you estimate it? Show a formula and explain its terms. Can it be adjusted for the degrees of freedom in the estimation of the regression
You want to test whether the market risk of a stock is the same as the market portfolio in CAPM. What is the null hypothesis? What is the alternative hypothesis?Compute the OLS estimates for the
Update the data in Table 4. 1 for Microsoft. Download monthly stock returns for MSFT and the S &P 500 index from Yahoo Finance. Download monthly Treasury bill rates from the Federal Reserve Bank
Black (1972) developed the zero-beta CAPM due to some unrealistic assumptions of the CAPM. What assumptions did he relax?
Black et al. (1972) found that the market model needed to be modified to better fit U.S. stock returns. What did they propose as a better fitting model?
Black (1972) proposed a zero-beta CAPM without and with a riskless rate.Write the equations for these two models. Can investors borrow at the riskless rate in the second model?
In the CAPM, the Security Market Line (SML) defines combinations of the riskless asset and market portfolio M that investors can hold. By contrast, under Black’s zero-beta CAPM, what are two ways
Assume that the investor holds risky efficient portfolio I that is a combination of market portfolio M and its uncorrelated zero-beta portfolio counterpart ZI.How can we write the zero-beta CAPM
Assume that you run a time-series regression of the market model. Next, you run a cross-sectional regression using one-month-ahead returns. In the crosssectional regression, how should you interpret
Fama and French published a series of studies in the 1990s that are important to the validity of the CAPM and zero-beta CAPM. What did they find in these studies? What did they propose as an
What is a market anomaly? What might explain market anomalies? Give two explanations. What does the efficient market hypothesis (EMH) have to say about market anomalies?
Can financial markets be irrational? Give an example from stock market history.
How can the zero-beta CAPM be empirically tested with real-world data? Discuss two tests using equations based on the market model. Which test is more reliable and why?
Show that the GRS statistic F = can be equivalently written as F = T-N-10+2-62 1+07 T-N-1 N N 1+0+2 1+02 1-)
Using 12 industry portfolios from Kenneth French’s data library, replicate the GRS testing for mean-variance efficiency of the market portfolio, available in FF_Research_Data_Factors_CSV. Use
Merton (1973) developed the intertemporal CAPM (ICAPM). What is different about the ICAPM compared to the CAPM? What new assumption does it make?
In the ICAPM, how do investors respond to unfavorable shifts in future investment opportunities? What are state variables?
In the ICAPM, what is the three-fund theorem? In view of this theorem, write the equation for the ICAPM.
In the ICAPM, if correlations ρi N = 0 for all securities i, which also implies that ρNM = 0 (where M is the market portfolio), but rN is perfectly negatively correlated with R f (which is true by
Solnik (1974) proposed an international asset pricing model (IAPM) based on an international three-fund theorem. What is this theorem and how does it change the CAPM? Write the equation for the IAPM
How did Adler and Dumas (1984) define currency risk? How is currency risk different than exchange rate risk? How did they propose to measure the exchange risk exposure of a security? Write an
Jorion (1990) investigated the exchange risk exposure of U.S. stocks. He modified the total exchange risk exposure equation of Adler and Dumas (1984) in what way? What did he find?
Lucas (1978) and Breeden (1979) proposed the consumption CAPM(CCAPM) using the ICAPM framework of Merton (1973). In this model, consumers buy and sell financial assets over time to smooth consumption
Breeden (1979) specified a CCAPM that collapses the multi-beta Merton(1973) ICAPM into a single-beta equation. Write this model and define its variables and parameters. Why did he believe that the
Cochrane (1991, 1996) created a production CAPM (PCAPM). How is the PCAPM different from the consumption CAPM (CCAPM)? He tested it using a single factor model. Write the equation for this model and
Assume that we scale the market factor with an instrumental lagged variable denoted as It−1. Write a conditional (time-varying) linear function for beta and define its terms. Assuming that the
Does time-variation in beta explain the weak evidence for the CAPM? Discuss empirical results of studies testing conditional CAPMs.
Write the ICAPM as a multifactor model with state variables. What could be used to proxy for the state variables?
Write the market model form of Solnik’s IAPM. Solnik ran this model on 10 major industrialized countries from 1966 to 1971. What did he find? What did cross-sectional regression tests find? What
Assume that you are a U.S. investor buying a European stock: 1. You exchange 100 dollars for 90 euros at the exchange rate 1 USD = 0. 90 EUR or 1 EUR = 1. 11 USD. 2. You buy 10 shares of a European
In the CAPM, one of the assumptions is that investors have common (homogeneous)beliefs about the return distribution of assets. What is the common assumption about the asset return generating process
What are the major strengths and weaknesses of the APT in relation to the CAPM?
In the single factor case, given that Ri = E(Ri ) + βi F + ϵi , the APT model specified as E(Ri ) = γ0 + γiβ is called the exact APT model by Huberman and Wang (2017). Huberman (1982) considers
Consider the following APT model:Suppose that the riskless rate Rf = 5%, and we have the following data for three stocks.(a) What are the risk premiums of the factors, i.e., γ1 and γ2?(b) What are
Form the equal-weighted portfolio of the stocks in problem 1.(a) Compute βi ,1 and βi ,2 for the portfolio.(b) Compute the expected return of the portfolio.(c) Compute the portfolio’s risk
Suppose the expected market return E(RM) equals 8%.(a) Compute CAPM betas for the stocks in problem 1.(b) Are the data in problem 1 consistent with both the CAPM and the APT?Data from problem
You have been given the following return information for two mutual funds (Papa and Mama), the market index, and the risk-free rate.Calculate the Sharpe ratio, Treynor ratio, Jensen€™s
If nominal GDP was reported at $124.9 billion and real GDP was reported at $122.8 billion, what was the inflation rate for the period?
If wages grew 3.2 percent, but inflation was 2.8 percent, what was the approximate real increase in wages?
Why do you think that consumer sentiment is considered a leading economic indicator?
Regarding Ms. Smith’s and Mr. Van Eaton’s statements made about the competitive strategy of the South Winery:a. Both are incorrect.b. Both are correct.c. Only one is correct.Mary Smith, a Level
Mr. Van Eaton tells Ms. Smith that he likes the fact that the conclusions in her report are backed up with facts, but he tells her that he is concerned about the section concerning the bargaining
Ms. Smith would likely categorize the French wine industry into which of the following life cycle phases?a. Decline phaseb. Pioneer phasec. Mature phaseMary Smith, a Level II CFA candidate, was
If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the East Winery?a. Make the firm less competitive in the English
Mr. Wall believes he understands the relationship between interest rates and straight bonds but is unclear how callable bonds change as interest rates increase. How do prices of callable bonds react
Mr. Wall is a little confused over the relationship between the embedded option and the callable bond. How does the value of the embedded call option change when interest rate volatility increases?a.
Mr. Johnson asks Mr. Wall to compute the value of the call option. Using the given information, what is the value of the embedded call option?a. $0.00b. $1.21c. $2.04Patrick Wall is a new associate
If Virtual Con had decided to slow its payment of accounts payable by 90 days instead of entering into a financing arrangement with the bank, what would be the impact on its operating cash flow
Which of the following statements about Virtual Con’s securitization of receivables is least accurate?a. Accelerates operating cash flow into the current period.b. Enables the firm to reclassify
Ignoring interest, what is the effect on Virtual Con€™s total cash flow and cash flow from financing (CFF) from its financing arrangement for its accounts payable at the time of payment to
Mr. Franklin wants to know how the put option in Exhibit 1 behaves when all the parameters are held constant except delta. Which of the following is the best estimate of the change in the put
Mr. Franklin is interested in the sensitivity of the put option to changes in the volatility of the underlying equity€™s returns. If the volatility of the underlying equity€™s
Mr. Franklin wants to compute the value of the put option that corresponds to the call value calculated in the previous question. Which of the following is the closest to his answer?a. $4.78b.
Mr. Franklin wants to compute the value of the call option using the information in Exhibit 1. Which of the following is closest to his answer?a. $4.78b. $5.55c. $11.54Ronald Franklin, CFA, is
She would like to compute the value of the corresponding put option for Option 2. Which of the following is closest to Ms. Barlow€™s answer?a. $0.98b. $1.41c. $4.84Rachel Barlow is a recent
Ms. Barlow notices that the stock in the table above does not pay dividends. If the stock begins to pay a dividend, how will the price of the call option be affected?a. It will decrease.b. It will
A stock is currently priced at $53.87 and the futures on the stock that expire in six months have a price of $55.94. The risk-free rate is 5 percent and the stock is not expected to pay a dividend.
Suppose you want to hedge a $400 million bond portfolio with a duration of 8.4 years using 10-year Treasury note futures with a duration of 6.2 years, a futures price of 102, and 85 days to
Suppose you want to hedge a $500 million bond portfolio with a duration of 5.1 years using 10-year Treasury note futures with a duration of 6.7 years, a futures price of 102, and 3 months to
You are short 30 March 2016 five-year Treasury note futures contracts. Calculate your profit or loss from this trading day using Figure 14.1. Figure 14.1 Metal & Petroleum Futures Contract Open
Referring to Figure 14.1, what is the total open interest on the December 2015 Japanese yen contract? Does it represent long positions, short positions, or both? Based on the settle price on the
You went long 20 June 2016 crude oil futures contracts at a price of $42.18. Looking back at Figure 14.1, if you closed your position at the settle price on this day, what was your profit? Figure
You shorted 15 March 2016 British pound futures contracts at the high price for the day. Looking back at Figure 14.1, if you closed your position at the settle price on this day, what was your
A non-dividend-paying stock is currently priced at $16.40. The risk-free rate is 3 percent and a futures contract on the stock matures in six months. What price should the futures be?
The town of South Park is planning a bond issue in six months and Kenny, the town treasurer, is worried that interest rates may rise, thereby reducing the value of the bond issue. Should Kenny buy or
A non-dividend-paying stock has a futures contract with a price of $94.90 and a maturity of two months. If the risk-free rate is 4.5 percent, what is the price of the stock?
A non-dividend-paying stock has a current share price of $42.60 and a futures price of $42.95. If the maturity of the futures contract is four months, what is the risk-free rate?
A stock has a current share price of $49.24 and a dividend yield of 1.5 percent. If the risk-free rate is 5.4 percent, what is the futures price if the maturity is four months?
What are the similarities and differences in taking the short side of a futures contract and short selling a stock? How do the cash flows differ?
A stock futures contract is priced at $27.18. The stock has a dividend yield of 1.25 percent and the risk-free rate is 2.5 percent. If the futures contract matures in six months, what is the current
You are long 10 gold futures contracts, established at an initial settle price of $1,500 per ounce, where each contract represents 100 troy ounces. Your initial margin to establish the position is
Suppose the CAC-40 Index (a widely followed index of French stock prices) is currently at 4,920, the expected dividend yield on the index is 2 percent per year, and the risk-free rate in France is 6
You have been assigned to implement a three-month hedge for a stock mutual fund portfolio that primarily invests in medium-sized companies. The mutual fund has a beta of 1.15 measured relative to the
Suppose the 6-month S&P 500 futures price is 2,281.55, while the cash price is 2,270.42. What is the implied difference between the risk-free interest rate and the dividend yield on the S&P
Suppose the 6-month S&P 500 futures price is 2,399.25, while the cash price is 2,370.48. What is the implied dividend yield on the S&P 500 if the risk free interest rate is 5 percent?
Jed Clampett just dug another oil well, and, as usual, it’s a gusher. Jed estimates that in two months, he’ll have 2 million barrels of crude oil to bring to market. However, Jed would like to
She would like to compute the value of the corresponding put option for Option 1. Which of the following is closest to Ms. Barlow€™s answer?a. $3.79b. $3.94c. $4.41Rachel Barlow is a recent
You are short 15 March 2016 corn futures contracts. Calculate your dollar profit or loss from this trading day using Figure 14.1.Figure 14.1 Metal & Petroleum Futures Contract Open Chg Interest
A mutual fund that predominantly holds long-term Treasury bonds plans on liquidating the portfolio in three months. However, the fund manager is concerned that interest rates may rise from current
In regard to the table that Dr. Miles constructed, which of the following is true?a. The receiving foreign currency position is correct; the action is incorrect.b. The receiving foreign currency
Suppose one of Fidelity’s mutual funds closely mimics the S&P 500 Index. The fund has done very well during the year, and, in November, the fund manager wants to lock in the gains he has made
To hedge the foreign exchange risk relative to the Canadian dollar, Jackson should:a. Buy a futures contract to exchange $7,083,333 for C$8.5 million.b. Buy a futures contract to exchange $6,390,977
You are long 20 November 2015 soybean futures contracts. Calculate your dollar profit or loss from this trading day using Figure 14.1.Figure 14.1 Metal & Petroleum Futures Contract Open Chg Interest
When hedging its exchange rate risk on the freight car sale, Jackson used a futures contract to:a. Sell ‚¬15 million in exchange for $18.75 million.b. Buy ‚¬15 million in exchange
Using Figure 14.1, answer the following questions:a. What was the settle price for March 2016 coffee futures on this date? What is the total dollar value of this contract at the close of trading for
You are constructing a portfolio of two assets. Asset A has an expected return of 12 percent and a standard deviation of 24 percent. Asset B has an expected return of 18 percent and a standard
Calculate Jensen€™s alpha for the fund, as well as its information ratio.You have been given the following return information for a mutual fund, the market index, and the risk-free rate.
What are the Sharpe and Treynor ratios for the fund?You have been given the following return information for a mutual fund, the market index, and the risk-free rate. You also know that the return
You are constructing a portfolio of two assets, asset A and asset B. The expected returns of the assets are 12 percent and 15 percent, respectively. The standard deviations of the assets are 29
Kellogg’s uses large quantities of corn in its breakfast cereal operations. Suppose the near-term weather forecast for the corn-producing states is drought like conditions, so corn prices are
Your portfolio allocates equal amounts to three stocks. All three stocks have the same mean annual return of 14 percent. Annual return standard deviations for these three stocks are 30 percent, 40
Tyler Trucks stock has an annual return mean and standard deviation of 10 percent and 26 percent, respectively. Michael Moped Manufacturing stock has an annual return mean and standard deviation of
A stock has an annual return of 11 percent and a standard deviation of 54 percent. What is the smallest expected loss over the next year with a probability of 1 percent? Does this number make sense?
Most sources report alphas and other metrics relative to a standard benchmark, such as the S&P 500. When might this method be an inappropriate comparison?
The largest expected loss for a portfolio is −20 percent with a probability of 95 percent. Relate this statement to the Value-at-Risk statistic.

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