Capital Markets Final Exam
INSTRUCTIONS: Read these carefully before beginning the exam.
代考Capital Markets For the multiple choice questions, please circle the correct answer clearly. There is only one correct answer.
NAME:
Section: (001 = 9:00am; 002 = 10:45am; 003 = 2:15pm; 004 = 4pm; 005 = 5:45pm)
Please indicate the section in which you are registered.
This final exam is taken under the honor code. This means that the exam is to be done individually; no help can be accepted, solicited or given during the exam, and you may not discuss the exam with classmates of yours that have not yet taken it. The exam is open book and notes, so please use any class-related materials. You can also use a calculator, MS Excel spreadsheets, and PDF notes; but you cannot use communication (e.g., Internet, IM, or e-mail) software or other communication methods (e.g., texting). 代考Capital Markets
For the multiple choice questions, please circle the correct answer clearly. There is only one correct answer. No partial credit will be given for these questions.
For the short answer questions, be sure to show all of your work. You will not receive credit unless work is shown on the test, but you will receive most of the credit if your methodology is correct even if your final answer is not. Use the extra pages at the end of the test if you need more space to show your work. If you use Excel or a calculator to solve the problems, ensure that you write the corresponding mathematical formulas and the inputs used on the physical test.
The exam has 150 points + 5 bonus points = 155 points.
Solutions will be posted on Canvas.
Good luck.
Multiple Choice Questions 代考Capital Markets
(11 questions; 7 points each; 77 points)
Assumptions: Unless specified otherwise, assume all assets’ returns are annualized, all options are European, all stocks pay no dividends, the risk-free rate is annualized and continuously compounded, and there are no risk-free arbitrage opportunities.
1.Suppose you estimate a CAPM market beta (β) of 1.2 for Shake Shack stock. You also estimate the Fama-French (FF) three-factor model for the stock and obtain a FF market beta (β) of 1.2, a size factor exposure (s) of 0.2, and a value factor loading (h) of –0.4. Assume that the size and value premiums are 2.5% and 6.0%. Which statement characterizes the relationship between the CAPM and Fama-French models’ predictions for Shake Shack’sreturns?
a. CAPM predicts a higher return by9%
b.The CAPM predicts a higher return by1%
c.The FF model predicts a higher return by9%
d.The FF model predicts a higher return by1%
2.Consider the same estimation results for Shake Shack stock as in the previous problem.Based on the factor loadings, what is the main reason why the CAPM and FF return predictions differ? 代考Capital Markets
a.Shake Shack’s risks are typical for a growthstock
b.Shake Shack’s risks are typical for a valuestock
c.Shake Shack’s risks are typical for a smallstock
d.Shake Shack’s risks are typical for a largestock
3.Suppose you believe that Shake Shack stock is overpriced. Which of thefollowing circumstances will make it easier for you to eliminate the mispricing?
a.Short selling Shake Shack is relativelycostly
b.You have no money in your bank account and no rich friends or familymembers
c.Shake Shack has high idiosyncraticrisk
d.None of theabove
4.Consider two recently launched S&P 500 index funds with the same expense ratios. Since its launch on January 1, Fund A has returned 2.47%. Since its launch on January 12, Fund B has returned 7.56%. Which of these two funds is a better investment for investorstoday?
a.FundA
b.FundB
c.Investors should be roughly indifferent between the twofunds
d.The choice of fund depends on what you expect to happen to the S&P in thefuture
5.Which of the following empirical observations would support a behavioral as opposed toa risk-based explanation for the value anomaly? 代考Capital Markets
a.Value stocks’ reported earnings usually exceed investors’expectations
b.Value stocks’ reported earnings are usually below investors’expectations
c.Value stocks have higher return volatility than growthstocks
d.Value stocks underperform growth stocks during economiccrises
6.Which of the following best explains why Barber and Odean (2000) found that certain individual (retail) investors’ stock portfolios exhibited average net returns that were significantly lower than the stock market as awhole? 代考Capital Markets
a.Poor stock picking: Many individuals picked growth stocks instead of valuestocks
b.Poor diversification: Some individuals held only a fewstocks
c.Trading costs: Some individuals traded alot
d.Fear of risky stocks: Some individuals did not invest all of their wealth instocks
For Questions #7 to #10, consider a four-week put option on Shake Shack stock with a strike price of $34. Shake Shack stock is priced at $37. Your forecast of the annualized volatility of Shake Shack stock is 55%. Suppose the continuously compounded risk-free rate is 0.25%. The put option’s bid price is $0.90, and it’s ask price is $1.10. Assume that Shake Shack will not pay dividends in the next four weeks. Assume there are 20 trading days in the four-week period.
7.Suppose a four-week call option on Shake Shack stock with a strike of $34 is priced at $4. Based on put-call parity, you conclude that the putoption is .
a.Underpriced (i.e., the put option’s ask price is lower than the option’svalue)
b.Correctly priced (i.e., the put option value lies between the option’s bid and askprices)
c.Overpriced (i.e., the put option’s bid price is higher than the option’svalue) 代考Capital Markets
8.Based on the put option’s Black-Scholes value, you conclude the putis _ .
a.Underpriced (i.e., the put option’s ask price is lower than the option’svalue)
b.Correctly priced (i.e., the put option value lies between the option’s bid and askprices)
c.Overpriced (i.e., the put option’s bid price is higher than the option’svalue)
9.To construct a portfolio that replicates this put option’s payoff, how many sharesof Shake Shack stock would you need to hold? Assume that you also hold the necessary bond
a. -0.7338
b.0.2662
c. 0.2662
d.0.7338
10.Which event would reduce the value of the putoption?
a.A decrease in Shake Shack’s current stockprice
b.An increase in Shake Shack’svolatility
c.A decrease in the risk-freerate
d.The passage of time
11.Some hedge funds write (i.e., short sell) market-neutral straddles based on the S&P 500. Which of the following statements most accurately characterizes the return from this strategy as compared to the risk-free rate ofreturn? 代考Capital Markets
a.Higher average return; higher return in calm times and lower return incrises
b.Higher average return; lower return in calm times and higher return incrises
c.Lower average return; higher return in calm times and lower return incrises
d.Lower average return; lower return in calm times and higher return incrises
Short Answer Question 1 (38 points): 代考Capital Markets
Your financial advisor recommends investing in an active fund, Active Rally United (ticker: ARU). You are also considering three passive exchange-traded funds (ETFs) with excess returns that equal the three Fama-French factors’ excess returns: MktRf (Market minus Risk-free), SMB (Small Minus Big), and HML (High Minus Low). You analyze these four assets’ excess returns, which incorporate expense ratios and trading costs, to obtain the following information:
Table of Fund Excess Returns
| ARU | MktRf | SMB | HML | |
| Average | 11.00% | 5.00% | 2.00% | 4.00% |
| Std. Dev. | 48.62% | 20.00% | 16.00% | 14.00% |
Note: Fund excess returns = fund returns – trading costs – fees – risk-free rate, where risk-free is the appropriate T-bill yield. The Average and Std. Dev. of excess returns are annualized.
Table of Two Regression Analyses
All coefficient estimates above are statistically significantly different from zero at the 5% level. The Intercept and Std. Dev. of Error are annualized.
Maintained Simplifying Assumptions
- The risk-free rate is constant at 0.25%, historically and in the future.
- You can borrow at the risk-free rate of interest and costlessly short sell the ETFs. 代考Capital Markets
- The factors’ expected returns are equal to their average historical returns.
- The three factors are uncorrelated with each other.
- ARU fund’s alphas and factor loadings are equal to their historical estimates. Based on the information and assumptions above, answer the following questions.
a.(5 points) What are the Sharpe ratios of the four assets: the active fund (ARU) and the three passive funds (MktRf, SMB, andHML)?
b.(4 points) If you could hold one of the four assets as the only risky asset in yourportfolio, which would you hold? Explain your reasoning in one sentence.
c.(3 points) What is the CAPM information ratio of the ARU fund?
d.(3 points) What is the Fama-French information ratio of the ARU fund?
e.(4 points) What is the highest Sharpe ratio you can obtain by combining the ARU fund with just the MktRf passive fund? [Assume the rest of the portfolio is invested in T-bills. Hint: you do notneed to find the weights in the optimal portfolio in this case.]
f.(8 points) What is the highest Sharpe ratio you can obtain by combining the threepassive funds? [Assume the rest of the portfolio is invested in T-bills.]
g.(4 points) What is the highest Sharpe ratio you can obtain by combining the three passive funds with the ARU fund? [Assume the rest of the portfolio is invested in T-bills. Hint: you do notneed to find the weights in the optimal portfolio in this case.] 代考Capital Markets
h.(5 points) In a paragraph, summarize research on whether active funds persistently outperform relevant benchmarks as it applies to your decision to invest in this active fund.
Short Answer Question 2 (35 points + 5 bonus points): 代考Capital Markets
Suppose that Nordstrom’s stock (ticker: JWN) is initially priced at $52, pays no dividends, and has an annualized continuously compounded volatility of 35%. You will analyze a European call option based on JWN stock that expires in one month. The call has a strike price of $50. Assume that the annualized semi-annually compounded risk-free rate is 0.25%.
a)(10 points) Compute the Black-Scholes value of this one-month JWN call option.
b)(5 points) Suppose the actual price of the call is $3.10, what is the implied volatilityof Nordstrom stock over the next month?
c)(10 points) If JWN stock’s beta is 0.92 and the market risk premium is 5%, accordingto the CAPM, what is the expected return of the JWN call option?
d)(10 points) Suppose the actual price of the call is $3.10. Believing in your estimate of Nordstrom’s volatility, you try to exploit the mispricing. How many dollars of Nordstromstock would you need to buy or sell today in your dynamic arbitrage strategy?
e)(5 bonus points) Suppose the bid price of the Nordstrom call option is $2.90 and theask price is $3.30. Would this bid-ask spread make the arbitrage trade in part (d) unprofitable? Explain why or why not in a sentence or two.
Extra space for short answer question 1
Extra space for short answer question 2
Extra space for short answer questions
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