Answers to Quiz 1:
1 Portfolio B is better: The Sharpe ratio of Portfolio A is 0.25 whereas for Portfolio B it is 0.30. This means that for a unit of risk taken by the portfolio B, the return is 0.30 which is higher than 0.25
2 Jensen’s Ratio
3 Treynor’s Ratio
4 USD 1858.63
5 a
6 The locus of the risk-return curve tends to move towards the vertical axis: The locus of the risk-return curve tends to move towards the vertical axis because the risk of the portfolio tends to decrease.
7 All investors will hold the same mix of stocks from the efficient set and borrow or lend to attain their preferred risk class: Separation Theorem suggests that “All investors will hold the same mix of stocks from the efficient set and borrow or lend to attain their preferred risk class”
8 Investors make their investment decisions based on multi-period horizon: Investors make their investment decisions based on a single period horizon i.e., the next immediate time period.
9 80%
10 Business Risk: The only source of risk in the unlevered firm is the inherent business risk of the assets themselves.
11 (a) and (c): Security market line states that, in equilibrium, the return on security ‘i’ is equal to the risk-free rate (Rf) plus the excess return on the market portfolio times the beta of security ‘i’. So when the slope of the security market line is zero, then the risk-free return becomes equal to the market return and the expected return becomes equal to risk free return
12 True: Value of the firm will be maximum where the overall cost of capital (WACC) is minimum.
13 (b) and (c): Individuals prefer present consumption, so nominal amount of currency is worth less in future.
14 12.18 %, 12.01 %: Assume an investment of $100 is made.
Total Proceeds = 100+(11.5*91/360)=102.907
Effective Rate of Return (Actual/365) = (Total Proceeds/Initial Investment) ^ (365/days) – 1
= (102.907/100)^(365/91) – 1
= 0.1218 or 12.18%
Effective Rate of Return (Actual/360)= 12.18% *(360/365)
=12.01%
15 A bear spread