Fin 402 Final Exam Answers.docx

Fin 402 Final Exam Answers FINAL EXAM 1) A portfolio with a correlation of 1 is not a well-diversified portfolio. What must you as an investor do to structure a portfolio with negative correlation? To structure a negative correlation portfolio one must add more negative correlated stocks to the portfolio, thus outweighing the positive correlated stocks. This will help to bring the positively correlated stocks into negatively correlated stocks. 2) What macroeconomic variable do you believe has the greatest impact on interest rates? Inflation? Briefly explain. The greatest macroeconomic variable to impact both interest and inflation is money supply. An increase in money supply causes inflation and to try and control inflation the Federal Reserve raises or losers the interest rate. 3) Compare and contrast the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT)? Which model is appropriate for calculating a stock's required rate of return? What is the Securities Market Line and which of the above models is it a product of?  Capital Asset Pricing Model and Arbitrage Pricing Theory both stress on the fact that expected return depends on risk originating from economic influence and is not affected by the unique risk. Market portfolio has a great importance in the CAPM but it does not feature in the APT. APT does not speak about the underlying factors as compared to the CAPM that collapses all microeconomic risks into a single factor called return on market portfolio. 4) How would you determine if a public corporation's financial statements are reliable?  Public corporation's financial statements are reliable if it adheres to all the requirements of the IFRS and SEC 5) What is a straddle? Would you use it when buying/writing options? Why? Straddle is a derivative strategy to minimize risk. Under straddle an investor buys both a call option and a put option with same strike price and expiration date.  Yes I use it when I see a very large movement of the price of stock in either direction. 6) Are the financial markets efficient, and if so, under what form of the Efficient Market Hypothesis model? Yes the financial market is efficient and it is under the form of semi strong efficient market hypothesis model where the historical price and public information both are reflected in the stock price. 7) What is the Bid price for a stock? What is the Ask price for a stock? What is a Stop Loss for a stock? The bid price is the price at which trader will be willing to buy stock. An ask price is the price at which the investor is willing to sell the stock. Stop loss is a benchmark for bearing loss in any particular stock and when the loss goes beyond that the stock is automatically sold off. 8) Briefly compare and contrast the primary market and the secondary markets. What types of investors participate in each market? Briefly describe the investment banking process.  Primary market is the market to issue new stock in the form of IPO and a market for the government and corporate money market instruments. In primary market investor who wants to invest in new stocks or debt instruments takes part in it whereas all the day traders, speculators and a regular investor take part in the primary market. Investment banking is used in the issuance of new security and providing a brokering house for the investor to trade with the broker's help. Fin 402 Final Exam A