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(All your answers should be on an Excel sheet. Show your calculation process.)

1. Over the past year you earned a nominal rate of interest of 30 percent on your money. The
inflation rate was 15 percent over the same period. The exact actual growth rate of your
purchasing power was ____________.

2. An investment provides a 2.1% return quarterly, its effective annual rate is ________.

3. You have been given this probability distribution for the holding-period return for KMP
stock:
 
State of the Economy Probability HPR
Boom 0.3 18%
Normal growth 0.5 12%
Recession 0.2 -5%
What is the expected holding-period return for KMP stock? 

4. You invested $1000 in Indonesian stocks at the beginning of 2020, and lost 20% in 2020.
What rate of return is necessary for you to recover to its original value in 2021?

5. The following table shows the annual returns of a certain country’s stock market.
Year 2018 2019 2020
Return 12.3% 5.6% 11.7%
What is arithmetic average annual return?
What is geometric average annual return?
What is standard deviation of annual return?
What is Sharpe ratio, if risk free return is 5%?

6. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-
free rate is 6 percent. An investor has the following utility function: U = E(r) − (A/2)s2. What
value of A makes this investor indifferent between the risky portfolio and the risk-free
asset? 
7. According to the mean-variance criterion, which of the statements below is
correct?  

  
A. Investment B dominates Investment A.
B. Investment B dominates Investment C.
C. Investment D dominates all of the other investments.
D. Investment D dominates only Investment B.
E. Investment C dominates investment A.

8. You are evaluating two investment alternatives. One is a passive market portfolio with an
expected return of 10% and a standard deviation of 16%. The other is a fund that is actively
managed by your broker. This fund has an expected return of 15% and a standard deviation
of 20%. The risk-free rate is currently 7%. Answer the questions below based on this
information.
a. What is the slope of the Capital Market Line?
b. What is the slope of the Capital Allocation Line offered by your broker's fund?
c. What is the maximum fee your broker could charge and still leave you as well off as if you
had invested in the passive market fund? (Assume that the fee would be a percentage of
the investment in the broker's fund, and would be deducted at the end of the year.)

9. Consider the following probability distribution for stocks A and B

State Probability Return on Stock A Return on Stock B
1 0.1 10% 8%
2 0.2 13% 7%
3 0.2 12% 6%
4 0.3 14% 9%
5 0.2 15% 8%

Expected return of Stock A and B are _______% and ________%, respectively.

10. The standard deviation of stocks A and B are _______ and _____ , respectively.

11. Covariance between Stocks A and B is ________.

12. Correlation between Stocks A and B is ________.

13. Suppose that the index model for the excess returns of stock A and B is estimated with the
following results:
 R A =1.0 %+ 0.9 R M +e A
R B=−2.0 % +0.9 RM + e B
σ M =20 %
σ (e¿¿ A)=30 % ¿
σ (e¿¿ B)=10 % ¿

Find the standard deviation of each stock and the covariance between them.
Standard deviation of A___________, Standard deviation of B________, Covariance _____

14. Here are data on two companies. T-bill rate is 4% and market risk premium is 6%.
Company $1 Discount Store Everything $5
Forecasted return 12% 11%
Standard deviation of returns 8% 10%
Beta 1.5 1.0

What would be the fair return for each company, according to the capital asset pricing
model?

15. Suppose that the market can be described by the following three sources of systematic risks
with associated risk premiums.
Factor Risk premium
Industrial production (I) 6%
Interest rate (R) 2%
Consumer confidence 4%

Find the equilibrium rate of return on stock using APT. The T-bill rate is 6%.

16. Assume that both X and Y are well -diversified portfolios and the risk-free rate is 8%.
Portfolio Expected return Beta
X 16% 1.00
Y 12% 0.25

There is an arbitrage opportunity. How would you organize your arbitrage portfolio? (You
do not want to take the market risk. Thus, you have to remove it by selling one stock buying
the other. Assume that you can borrow at risk free rate.)
 (For Question 17~19: Use the following table. You may refer to the Excel Sheet
Chpater8Excel.) A Portfolio manager summarizes the input from the macro and micro
forecasters in the following table:

Micro Forecasts
Asset Expected Return (%) Beta Residual Standard Deviation (%)
Stock A 20 1.3 58
Stock B 18 1.8 71
Stock C 17 0.7 60
Stock D 12 1.0 55

Macro Forecasts

Asset Expected Return (%) Standard Deviation (%)

T-bills 8 0
Passive equity portfolio 16 23

17. Calculate expected excess returns (expected return – risk free return), alpha values and
residual variances for these stocks.

18. Construct the optimal risky portfolio. (Calculate the weight of passive portfolio and active
portfolio.)

19. What is the Sharpe ratio of the optimal risky portfolio and how much of it is contributed by
the active portfolio?

20. Briefly describe the three different efficient market hypotheses and explain what hypothesis
you support and the reason for it.