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PAPER CODE NO: ECON241 DEPARTMENT: ULMS

MOCK EXAM PAPER

Securities Markets
TIME ALLOWED: INSTRUCTIONS TO CANDIDATES: Two Hours

Candidates may use a University approved calculator. Answer all questions. Mark your answers in HB pencil on the answer grid provided. There is only one correct answer per question and negative marking will not be used. Questions 1 to 25 carry equal mark and a total of 80 marks. Question 26 carries 20 marks. For Question 26 only, you are required to develop a line of argument use the Answer Booklet provided for your answer.

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Answer all questions: * denotes the correct answer 1. What is the current / running yield of a ten year 5% Government Bond maturing in four years time if the current market price is 104.00 and it was issued at par (100): Current yield = cy =

Cy = 5/104 = 4.8%
a) b) c) d) e) 6% 5.2% 4.8%* 5.0% 8.9%

C P

2. A share paid last year a dividend of 20 pence. Dividends are expected to grow by 8% per annum indefinitely. The required rate of return on the share is 15% per annum. According to Gordons growth model the share should sell for: a) b) c) d) e) 100.00 pence 200.10 pence 308.57 pence * 299.60 pence 287.20 pence

Answer: PE=D(1+g)/(r-g), or PE=20(1+0.08)/(0.15-0.08)=308.57 pence 3. Long dated government bonds tend to have higher yields than short-dated bonds because: a) b) c) d) e) They carry higher income risk They are less liquid They carry higher capital risk* There is a smaller market for them There is a bigger market for them

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[Type text] 4. The following table represents five buy and sell orders in pence on the SETS order book for Stock A. What are the best buy and sell prices respectively, from the perspective of a potential investor: BID 456 457 458 1/2 455 455 1/2 OFFER 462 463 1/2 465 464 1/2 467

12,670 10,000 24,380 17,500 13,650 a) b) c) d) e)

15,000 24,050 34,900 15,450 18,800

Investor can buy at best at 462 and sell at best at 458 * Investor can buy at best at 458 and sell at best at 462 Investor can buy at best at 467 and sell at best at 455 Investor can buy at best at 457 and sell at best at 463 None of the above

5.

Using the data in the following table, calculate the expected mean return for a portfolio that is 75% invested in Stock A and 25% invested in Stock B: Expected Return Stock A 15% Stock B 5%

Answer: (0.75*0.15)+(0.25*0.05) = 12.5% a) b) c) d) e) 6. 13.0% 7.50% 12.5%* 10.0% 20%

Suppose that three year interest rates rise from 5% to 6% while one-year rates remain at 3%. This suggests : a) b) c) d) e) Three year bonds have become more risky Three year bonds have become less liquid Short term interest rates are likely to rise in the future* Investors have become more risk averse None of the above

7.

The weak form of the efficient markets hypothesis states that: a) b) c) d) e) Successive price changes are dependent Successive price changes are biased Properly specified trading rules are of value Successive price changes are independent* None of the above CONTINUED/END

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[Type text] 8. Sainsburys Plc has approximately 1.85 billion shares outstanding and the stock price is 3.32. The current P/E ratio is 16.16. Calculate the approximate market capitalization for Sainsburys: Answer: Market cap = (1.85)(3.32) = 6.14 Billion a) b) c) d) e) 9. 60 million 60.14 billion 6.14 billion* 600 million 800 million

In March 2011, an investor buys a European call option on British Airways stock with an exercise price of 65 and expiring in June 2011. If the stock price in May 2011 is 60, then the option at that time is which of the following: a) b) c) d) e) In the money Out of the money* At the money All of the above None of the above

10.

The holder of a regular exchange listed put option on a stock in the UK: a) b) c) d) e) Has the right to buy 1000 shares of the underlying stock at the exercise price Has the right to sell 1000 shares of the underlying stock at the exercise price* Has the obligation to buy 1000 shares of the underlying stock at the exercise price Has the obligation to sell 1000 shares of the underlying stock at the exercise price None of the above

11.

With regards the shape of the yield curve and the Expectations Hypothesis, a falling yield curve (downward sloping) indicates: a) Short term interest rates are currently low and market participants expect them to rise in the future b) Investors prefer bonds with shorter maturities c) Short term interest rates are currently high and market participants expect them to fall in the future* d) The liquidity premium associated with bonds of longer matrurity e) Short term interest rates are currently low and market participants expect them to fall further in the future

12.

Utilizing the security market line in the Capital Asset Pricing Model, an investor owning a stock with a beta of -2 would expect the stocks return toin a market that was expected to decline 15 percent: a) b) c) d) e) Rise by 13% Rise by 30%* Rise or fall an indeterminate amount Fall by 30% Fall by 60% CONTINUED/END

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[Type text] 13. As the number of Stocks A, B, and C have the same expected return and standard deviation. The following table shows the correlations between the returns on these stocks.

Given these correlations, the portfolio with the lowest risk is a portfolio: a) Equally invested in stocks A and B. b) Equally invested in stocks A and C. c) Equally invested in stocks B and C.* d) Totally invested in stock C. e) None of the above

14.

Applying the Capital Asset Pricing Model, calculate the expected return for C Inc. which has a beta of 0.80 when the risk free rate of return is 4% and the expected return on the market is 12%: Answer: E(R) = 4% + 0.80*(12% - 4%) = 10.4% a) b) c) d) e) 8.1% 9.6% 10.4%* 11.2% 20%

15.

The most significant influence on the size of the Gilt Edged Market is: a) b) c) d) e) The amount of gilt edged stock being redeemed The current rate of inflation The size of the Central Government Net Cash Requirement* The current yield curve The exchange rate

16. The money markets are the markets where which of the following occurs: PAPER CODE XXXXXXX .. PAGE 5 OF ... CONTINUED/END

[Type text] a) Short term buying and selling of Company shares b) Short term borrowing and lending through the buying and selling of securities with maturities of one year or less* c) New issues of a security are sold to the initial buyers d) Long term debt and equity instruments are traded e) Foreign currency is purchased 17. A defensive stock: a) Consistently outperforms the market portfolio b) Has a beta which exceeds one c) Has a beta equal to 3 d) Has a beta which is lower than one* e) Has a beta equal to 4 Which of the following is not under the control of the UK Financial Services Authority (FSA): a) b) c) d) e) 19. The UK listing authority Banking supervision Policies relating to interest rate changes* Market supervision and enforcement All of the above are under the control of the FSA

18.

In the financial crisis of 2007/09, the following financial institution encountered a bank run on a grand scale: a) b) c) d) e) The Royal Bank of Scotland Lloyds Banking Group Barclays Capital Northern Rock Bank* None of the above

20.

Which of the following is not classified as an Institutional Investor: a) b) c) d) e) A Mutual Fund A high net worth individual* An Insurance Company A Pension Fund All of the above are classified as Institutional Investors

21.

Assets A and B plot on the Security Market Line. Asset A has an expected return of 15% and a beta of 1.7, and asset B has an expected return of 12% and a beta of 1.1. Based on the above information, we can infer that: a) b) c) d) e) The risk-free interest rate is 6.5% * The risk-free interest rate is 9% The risk-free interest rate is 1%. The risk-free interest rate is 2% There is no sufficient information to calculate the risk-free interest rate

Answer: From CAPM_A and CAPM_B, one derives [E(R_A)-E(R_B)]/(beta_A-beta_B)=[E(RM)-Rf]= (15%-12%)/(1.7-1.1)=5%. From CAPM_A, 15%=Rf+1.7*5%, or Rf=6.5%

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22. Which of the following is characteristic of the occurrence of a bank run: a) Savers depositing funds into instant access interest bearing deposit accounts offered by the banks and the banks use a portion of those deposits to fund the granting of long term interest bearing loans to their borrowers b) Savers depositing funds into instant access deposit accounts offered by banks and the banks use a portion of those deposits to invest in short term money market instruments c) Savers invest in interest bearing bond products offered by the bank but which require the saver to leave the funds deposited for a period greater than one year d) Savers withdrawing much of their deposits from a bank at the same time* e) None of the above is characteristic of the occurrence of a bank run 23. A 2-year government bond pays 50 per year in coupon, has a yield of 10% and a face value of 1000. The bonds price is: a) b) c) d) e) 600.22 700.22 800.22 820.22 913.22*

Answer: Bond price=50/(1+0.1)+1050/(1+0.1)2=913.22

24.

A financial analyst believes that the Kapa Company will be worth 100 per share one year from now. How much will she be prepared to pay for one share today if the risk-free rate is 8%, the expected rate of return on the market is 18%, and the companys beta is equal to 2.0? a) b) c) d) e) 78.12 * 80.12 50.12 60.12 77.12

Answer: E(Rt+1)=(St+1-St)/St. Or, St= St+1/[1+E(Rt+1)]. But E(Rt+1)=Rf+beta[E(RM)-Rf]= =8%+(18%-8%)*2=28%. Hence, St=100/(1+0.28)=78.12 25. Which of the following would be classified as a money market security? a) b) c) d) e) A share in Asda. A nine-year Treasury bond A ten-year Treasury bond A Treasury bill * A Eurobond

26. Mr. Lineker has 10 million invested in long-term corporate bonds. The bond portfolios expected annual rate of return is 10%, and the annual standard deviation is 12%. Mr. Linekers financial PAPER CODE XXXXXXX .. PAGE 7 OF ... CONTINUED/END

[Type text] adviser recommends that Mr. Lineker invests in an index fund. The index has an expected return of 16%, and its standard deviation is 18%. The risk-free interest rate is 6%. a) If Mr. Lineker invests all his money in a combination of the index fund and the risk-free interest rate, can he improve on his current 10% expected rate of return without changing the risk of his portfolio? [10 marks] b) In no more than 80 words explain briefly the concept of the Sharpe ratio [10 marks] Answer a) Calculate weights w (in risk-free asset) and (1-w) (in index fund) such that the portfolio risk=p=12%. Solve: Var(Rp)=w212+(1-w)222+2*w(1-w)1212, with 1=0, 2=18%, 12=0, and w=(2-p)/2=0.333 or 33.3%. This means 33.3% in T-bills and 66.7% in the index fund. In this case: E(Rp)=0.333*6%+0.667*16%=12.67%. Hence, Mr. Lineker can improve his current expected return without changing the risk of his portfolio. b) When looking at a particular stock, investors often refer to the Sharpe ratio. The Sharpe ratio is equal to [E(Ri)-Rf]/(Ri). This is a measure of risk-adjusted performance. It compares the excess return to the portfolios risk. Hence, portfolios with high Sharpe ratios perform better than portfolios with low Sharpe ratios.
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