IELM 7016

2017-2018 First Semester

Friday 6/10/2017
MIDTERM TEST - Solution

Name and UID#:

Signature:

Grade: -see back of page-

Time: 120 minutes

ˆ All answers much be in ENGLISH. Answers in other language will receive zero marks.
ˆ CLOSED BOOK EXCEPT for Calculator
ˆ Please answer only on test pages, you may use the back side
ˆ DO NOT attach extra paper on the test
ˆ SHOW all your calculations and/or INDICATE your REASONING on all questions
ˆ Please PRINT and SIGN your name on the cover page and PRINT your name on top
of every page

GOOD LUCK!

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 Page 1

NAME:

1. (20 marks)
a) (10 marks) How many years will it take an amount (P ) to double (F = 2P ) if the interest rate
is 12% per year?
Answer:

P (1 + 0.12)y = 2P ⇒ (1.12)y = 2 ⇒ y log 1.12 = log 2 ⇒ y = log 2/ log 1.12 ≈ 6.12(year)

b) (10 marks) Find the annual equivalent worth of the following cash flow diagram if the interest
rate = 12% per year.

Answer:

1 1 1 1
P V = −8750 ( − 5
) + 250 × − 13000 × − 15500 = −55177
0.12 0.12 × (1.12) 1.12 (1.12)4
1 1
C1 ( − ) = −55177 ⇒ C1 = −13420 = AW.
0.12 0.12 × (1.12)6

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 Page 2

NAME:
2. (20 marks)
a) (10 marks) You purchase a new $1,000 bond with a 12% coupon rate/year that is paid
semiannually. You will hold this bond for 3 years and receive 6 coupon payments. What is the
most you should pay for this bond if you want a yield of 14% compounded semiannually?
Answer:

60 60 60 1060
PV = + + ⋅⋅⋅ + + = 952.3346.
1.07 1.072 1.075 1.076

b) (10 marks) If you bought a new $1,000 bond for $1,020 with a 12%/year coupon rate paid
quarterly, kept it for 3 years and received 12 coupon payments. Then you sold it for $950. What
was you quarterly yield?
Answer:
Solve
950 30 30 30
12
+ 12
+ 11
⋅⋅⋅ + = 1020
(1 + r) (1 + r) (1 + r) (1 + r)
950 30 1 − 1/(1 + r)12
12
+ × = 1020
(1 + r) 1+r 1 − 1/(1 + r)
950 30 30
12
+ − − 1020 = 0.
(1 + r) r r(1 + r)12

We obtain r ≈ 0.0244 which is the quarterly yield.

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 Page 3

NAME:
3. (20 marks)
On January 1, 2015 your savings account had $200,000 in it and for every month thereafter you
deposit $676 into your savings account. What annual rate of interest must be earned for your
account to have $400,000 in it on January 1, 2020?
Answer:
Solve

400000 = 200000(1 + r)60 + 676 + 676(1 + r) + ⋅ ⋅ ⋅ + 676(1 + r)5 9

(1 + r)60 − 1
= 200000(1 + r)60 + 676 × .
r
We obtain r ≈ 0.00919 which is the monthly yield. So annual rate of interest would be

0.00919 × 12 = 0.11028.

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 Page 4

NAME:

4. (20 marks)
Find the IRR(s) for the following series of cash flows.

EOY CASH FLOWS ($)

0 −4, 000
1 +16, 400
2 −22, 320
3 +10, 080

Answer:
Solve

0 = −4000 + 16400/(1 + r)1 − 22320/(1 + r)2 + 10080/(1 + r)3 .

We obtain r = 0.2, 0.4 and 0.5 which are the annual yields.

200

150

100

50

-50

-100

-150
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

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 Page 5

NAME:
5. Suppose portfolio P ’s expected return is 12%, its volatility is 20% and the risk-free rate is 3%.
Suppose further that a particular mix of asset i and P yields a portfolio P ′ with an expected
return of 18% and a volatility of 30%.

a) (7 marks) What is the Sharpe ratio of P ?

Answer:

0.12 − 0.03
Ratio = = 0.45.
0.2

b) (7 marks) What is the Sharpe ratio of P ′ ?

Answer:

0.18 − 0.03
Ratio = = 0.5.
0.3

c) (6 marks) Construct a portfolio using a risk-free asset and P ′ so that this portfolio performs
better than P . Specify the portfolio weights and quantitatively explain why it performs better
than P .
Answer:
Form a portfolio of P ′ and the risk-free asset with respective weights 60% and 40%. This
new portfolio will have an expected return of 0.60(18%) + 0.40(3%) = 12%, the same as portfolio
P . This new portfolio’s volatility is 0.60(0.30) = 0.18 = 18%. Thus, this new portfolio has the
same expected return but with a lower volatility than P .

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