RSM332 - Final Exam - Winter 2011 - solutions
120 marks

Stocks a) $208.33 million (2 marks) b) NPV of project = $8.1 million (3 marks), new price per share = $21.64 (3 marks) c) any good 3, examples listed (2 marks each, 6 marks total) d) any three listed (2 marks each, 6 marks total)

Bonds a) strip coupons payments from 18,000 of the 10 year 4% coupon bonds (4 marks), strip the $12,000,000 par payment from the year-7 coupons of 300,000 10-year bonds (4 marks), sell off all the remaining cash flows as zero coupon bonds (or keep them in inventory) (4 marks) b) the return on the coupon is greater than the capital loss (2 marks) c) reduced risk means a reduced YTM (3 marks) d) Rogers is at a higher risk of default that the Canadian Government and thus has a higher YTM (2 marks), a higher YTM means a lower Duration (1 mark)

Portfolios 1 a) WB = 1-WA (2 marks), solved portfolio vol up to quadratic equation (2 marks), WA = 0.79762 or 0.05413 (2 marks), WA = 0.79762 (2 marks) b) E(rp) 14.19% (4 marks), give full marks in follow-through errors from a, or if a rate is assumed and calculate E(rp) c) country specific risks can be diversified away (4 marks) d) Overweighing of home country (2 marks), more risk, no extra return (2 marks) Portfolios 2 a) correlation = -1 (3 marks) b) solved portfolio vol up to quadratic equation (3 marks), WA = 0.375 (3 marks), E(rp) = 18.25% (2 marks) c) arithmetic mean does not consider the effect of compounding, through which equal sized gains and losses are not equivalent (4 marks) d) the number of covariance terms is much higher (5 marks)

The CAPM a) Market risk premium = 5.64% (4 marks) b) yes, the tangency point moves (2 marks), its composition changes (2 marks), good diagram (2 marks) c) Wmegaton = 1.36 (3 marks), Bportfolio = 1.56 (3 marks) d) tangency offers the best risk-reward trade-off (4 marks)

The APT a) E(Rp) = 9% (4 marks) b) correct system (2 marks), correct weights (3 marks), E(rp) = 6.566% (1 mark) c) correct system (3 marks), correct weights (3 marks) d) No (1 mark), other risks are not accounted for in the model (3 marks)

Market Efficiency a) identify any two (2 marks each, 4 marks total) b) weak form prices in historical market data (2 marks), semi-strong prices in all public data (2 marks) c) identified one (2 marks), explained/discussed clearly (2 marks) d) identified one (2 marks), explained/discussed clearly (2 marks) e) EMH says the market is informationally efficient (2 marks), even the weakest definition of efficiency says historical market data is already priced in (2 marks)

Arbitrage Pricing Theory

Market Efficiency