1) The table below shows expected rates of return for three stocks and their weight in a portfolio: Stock A Stock B Stock C Portfolio weights 0.3 0.2 0.5 State Probability Expected returns...

1) The table below shows expected rates of return for three stocks and their weight in a portfolio: Stock A Stock B Stock C Portfolio weights 0.3 0.2 0.5 State Probability Expected returns Recession 0.3 0.05 0.03 0.12 Boom 0.7 0.1 0.05 0.13 What is the approximate expected portfolio return? a) 8% b) 9% c) 10% d) 11% e) 12% f) Other, specify 2) The fact that less than half of all equity fund managers beat the market in most years indicates that the stock market is _____. a) profitable for more competent managers b) largely efficient c) largely inefficient d) ripe for disruption e) rife with insider trading f) Other, specify. 3) When WACC is used to evaluate new project ideas, the capital structure weights to be used in the WACC calculation should ideally reflect _____. a) observed book values b) target market values c) target book values d) observed market values e) historical values f) Other, specify. 4) Suppose that an investor holds a stock which has a rate of return based on a single-factor model. The model equation can be presented as: r = E(r) + βF + e, where F is the unanticipated growth in GDP. The market consensus about the GDP growth rate is 4%. The investor currently expects to earn a 9.4% return. The stock's β value is 1.2. The next day you learn that new macroeconomic information suggests that GDP growth will be 5%, which is higher than the market consensus. What will be the revised approximate estimate of the stock's expected rate of return? a) 9% b) 10% c) 11% d) 12% e) 13% f) Other, specify. 5) Combination Algebraic/Short Essay a) (2 points) Assume CAPM is correct (the market is the tangency portfolio), and all securities are priced correctly. Fill in the blanks. Security Expected Variance Standard Correlation BETA Returns Deviation (with Market) Market 0.08 ________ 0.30 ________ ________ Risk-free 0.04 ________ _______ 0.0 ________ Stock D ________ ________ 0.50 ________ 0.9 Stock E ________ ________ 0.70 0.40 ________ b) (1 pt. - 1 page) While on Spring break visiting New Zealand, you encounter a little man with hairy feet, named Bilbo. He takes a liking to you and can not resist peppering you with questions about the world of finance. He asks, what is CAPM? What is APT? Does wizardry make the firm specific risk go away? Where does it go? Before you can answer, another strange fellow appears, murmuring about “his precious” and Bilbo disappears. Assuming Bilbo will return: Compose your answer in an essay or table as follows: Compare and contrast CAPM and APT, focusing on these four areas: 1) major assumptions, 2) conceptual similarities and differences, and 3) empirical usefulness. 4) Explain where the firm specific risk goes.