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FIN 4365 Investments

Fall 2022 Final Review

The final exam will be cumulative. Exam 1 and Exam 2 were 75 minutes. The final will follow a similar format but be 120 minutes. You should be able to:

(1) Go through every slide (the annotated copies) and be able to pick out the most important point.

(2) Do every homework problem, with and without excel as applicable.

(3) Review the old exam problems.

The following are supplemental review problems. We will go over them in our last class on December 6^th.

1. Suppose non-diversifiable risk is the only risk investors care about. Portfolio manager Joe earned 16% return last year, while portfolio manager Jackie earned 12%. Joe’s  was 2 and Jackie’s  was 1. Assuming the market return was 10% last year and the Treasury return was 2%, did either manager outperform?

2. The expected returns on treasury bills, the market, SMB and HML are given by:

You estimate expected returns on two mutual funds. You also estimate the funds’ factor exposures via the Fama-French 3-factor model regression: .

A. Which fund has better performance measured by CAPM alpha?

B. What is the expected benchmark return based on the Fama-French three-factor model?

C. Which fund has better performance measured by Fama-French 3-factor alpha?

3. Suppose the t-statistic for Fund 2’s  for the null hypothesis that  is 30. What is the t-statistic for the null hypothesis that

4. There is a mid-day TV show called Sad Money, where the host Kim Jramer recommends stocks to purchase. Interestingly, stocks that Kim picks reliably decline in value at a steady rate from the time of the recommendation for a whole week.

a. If true, would this be a violation of market efficiency?

b. Even if Kim’s announcement revealed information, what would investors do in theory immediately following the announcement and what impact would this have on subsequent price drift?

5. A corporate bond promises to pay a $100 coupon at the end of the year and if it does not default, the price of the bond will be $1000. The bond will default with probability 0.2, in which case the coupon received will be 0 and the bond will instead be worth $800. Given a market  of 0.3,  and , how much should the bond sell for today?

6. You are considering adding small-cap (SC) stocks to your portfolio that currently consists only of the S&P 500. You run the following regression with annual data: . You find the following:

How much of your portfolio should you allocate to SC if you trust the estimated parameters and want to maximize your Sharpe ratio?

7. When interest rates recently increased by 0.25%, your bond mutual fund fell in value by 2%. Approximately what is the modified duration of your fund?

8. A bond that pays semi-annual coupons has a par value of $100 and coupon rate of 6%. The last coupon payment was 45 days ago and the quoted price in Bloomberg is $101. What is the price you would pay to buy the bond?

9. A hedge fund currently invests in $100 million of mortgage-backed securities (MBS) that have a modified duration of 15 and convexity of -500 (negative five hundred). How much money would the fund gain or lose if interest rates decreased by 1%...

a. …using the duration approximation?

b. …using the duration-with-convexity approximation?

10. The hedge fund in the previous problem finances 50% of its MBS with short-term borrowing (that has a duration of 0). What is the duration of its equity? Ignore convexity.

11. Corporation XYZ’s income statement shows EBITDA of $500 million in EBITDA and $50 million in interest expense per year. Moreover, their balance sheet shows Assets of $3.3 billion and debt of $1.4 billion. The yield on XYZ suggests that the market is pricing XYZ senior bonds similarly to (Moody’s) Baa-rated bonds. If this is true, does the bond look like a good deal or a bad deal to buy?