FINA 3103: Final Exam
Instructor: Don Noh
Spring 2025
Name: Student ID:
Instructions
• Check that you have all 17 pages. There are 10 multiple choice questions and 8 free
response questions.
• You have 180 minutes to complete the exam.
• There are no partial credits for multiple choice questions. There is no need to show
your work for multiple choice questions.
• For the free response questions, you must show your work to receive full credit.
• This is a closed book exam. You may use a writing instrument, the reference sheet, and a
non-programmable calculator. The calculator cannot be a phone, a tablet, or a laptop.
• If you do not have enough room for your work, use the back of a nearby page, and be
sure to mark clearly in the regular space provided where the additional work is.
HKUST Honor Code: Honesty and integrity are central to the academic work of HKUST. Stu-
dents of the University must observe and uphold the highest standards of academic integrity
and honesty in all the work they do throughout their program of study. As members of the Uni-
versity community, students have the responsibility to help maintain the academic reputation
of HKUST in its academic endeavors.
Declaration of Academic Integrity: I confirm that I have answered the questions using only
materials specifically approved for use in this examination, that all the answers are my own
work, and that I have not received any assistance during the examination.
Signature: Date:
MC Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8
Points Possible 25 10 10 5 10 10 10 10 10
Points Earned
Multiple Choice Questions [2.5 points each]
Question 1 Suppose that the yield curve is flat at 5% (zero-coupon bond yield for any maturity
is 5%). Given the same face value, which of the following bonds has the highest price?
(A) A 5-year zero-coupon bond.
(B) A 5-year annuity.
(C) A 5-year coupon bond with a coupon rate of 5%.
(D) A 5-year coupon bond with a coupon rate of 10%.
Your answer:
Question 2 Recall the Royal Dutch / Shell example from the lecture. Royal Dutch trades in
Amsterdam, Shell trades in London, and both have American depository receipts (ADRs) that
trade in the US. Royal Dutch was in the S&P500 index, but Shell was not. Which of the following
statements is NOT true about this case?
(A) Law of one price was violated while Royal Dutch was in the S&P500 index.
(B) Later on, the two companies merged, and the law of one price was restored.
(C) When it was announced that Royal Dutch would be removed from the S&P500 index, the
price of Royal Dutch fell relative to that of Shell.
(D) S&P 500 index funds were forced to hold Royal Dutch shares while it was in the index.
Your answer:
Question 3 Suppose that an investor is risk averse, i.e., she has a concave utility function.
Which of the following gambles does she prefer the most?
1 1
(A) 2 chance of winning $100 and 2 chance of losing $100.
1 1
(B) 2 chance of winning $50 and 2 chance of losing $50.
1 1
(C) 2 chance of winning $50 and 2 chance of losing $25.
1 1
(D) 2 chance of winning $150 and 2 chance of losing $150.
Your answer:
Question 4 Which of the following statements is NOT true about diversification?
(A) You can reduce the risk of a portfolio by holding more assets.
(B) You can reduce the risk of a portfolio by holding assets with low correlation.
(C) You will never prefer to add a risky asset with a low Sharpe ratio to your portfolio.
(D) You can reduce the risk of a portfolio by holding assets with negative correlation.
Your answer:
2
Question 5 Which of the following is NOT a good measure to identify value stocks?
(A) Price-to-earnings ratio.
(B) Price-to-book ratio.
(C) Price-to-dividend ratio.
(D) Price-to-compensation ratio.
Your answer:
Question 6 Which of the following is true about market efficiency?
(A) The weak form of the efficient market hypothesis states that stock prices reflect ALL past
information.
(B) The semi-strong form of the efficient market hypothesis states that stock prices reflect
ONLY past price information.
(C) The strong form of the efficient market hypothesis states that stock prices reflect ALL
private AND public information.
(D) The strong form of the efficient market hypothesis states that stock prices reflect ALL
future information.
Your answer:
Question 7 Which of the following is NOT true about behavioral biases discsussed in the
lecture?
(A) Overconfidence can explain why investors trade too much.
(B) Prospect theory can explain the disposition effect.
(C) Extrapolation can explain why investors overreact to recent price movements.
(D) Overreaction can be caused by overweighting prior information.
Your answer:
Question 8 Which of the following is NOT true for bonds?
(A) The break-even inflation rate consists of expected inflation and the inflation risk premium.
(B) The Fisher equation implies that the nominal interest rate moves together with expected
inflation.
(C) When the recovery rate becomes higher during recessions, the credit spread will increase
further.
(D) The nominal cash flow of a TIPS bond is random.
Your answer:
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Question 9 Which of the following is NOT a policy tool of the Federal Reserve?
(A) Open market operations
(B) Forward guidance
(C) Reserve requirement
(D) Interest rate on bank deposits
Your answer:
Question 10 Which of the following leads to a LOWER price of a put option, fixing other
variables?
(A) Higher exercise price.
(B) More time to expiration.
(C) Higher volatility of the underlying asset.
(D) Lower current stock price.
Your answer:
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Free Response Questions
Question 1 [10 points]
The following table lists the continuously compounded zero-coupon yields (in percent) on two
different dates. For this problem, assume you are at year 0.
Maturity (years) Year 0 Year 1 Year 2
1 1.0 2.0 3.0
2 1.05 2.0 2.95
3 1.097 2.0 2.903
4 1.14 2.0 2.86
5 1.181 2.0 2.819
(a) [5 points] What is the price (at year 0) of an annuity with maturity 2 years and face value
$100? Round to the first decimal place (e.g., $70.2)
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(b) [5 points] What was the realized return if you held a 2-year zero-coupon bond from year 0
to year 1?
Question 2 [10 points]
All the payoffs below are to be realized 1 year from now. What is the price of Asset 3 given the
information below?
Asset 1 Asset 2 Asset 3
Price 0.3 0.6 ?
State 1 payoff 1 0 10
State 2 payoff 0 1 10
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(a) [5 points] Assuming no arbitrage, what is the price of Asset 3?
(b) [5 points] What is the yield of a zero-coupon bond with maturity 1 year in this economy?
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Question 3 [5 points]
Consider an investor who has log utility:
U (W ) = ln(W ).
She is presented with a gamble (or lottery) that offers a 50% chance of winning $100 and a 50%
chance of winning $50.
(a) [5 points] The largest amount she was willing to pay for this gamble?
Question 4 [10 points]
Suppose an investor has mean-variance expected utility with unknown risk aversion γ:
γ
E (U ) = E ( R p ) → Var( R p ).
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She is constructing a portfolio with weight w in stocks and (1 → w) in bonds. You can assume
that the bond returns have zero variance. The bond return is Rb = 2%, the expected stock
return is 10%, the standard deviation of stock returns is 10%. Suppose that one of this investor’s
indifference curves looks like the green curve in the figure below.
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(a) [5 points] What is the risk aversion parameter of this investor?
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(b) [5 points] What is the y-intercept of the shown indifference curve? Write in terms of
percentages and round to the second decimal place (e.g., 7.22%).
Question 5 [10 points]
The following table contains the quarter-end stock price and earnings per share for Tesla. As of
December 2024, assume that the annual riskless interest rate is 0%, and the expected annual
return on the overall stock market is 4.0%. Assume that the CAPM holds, and Tesla’s market
beta is 2.
Date Price per share ($) Annual dividend per share ($)
December 2022 300 0.50
December 2023 400 0.70
December 2024 350 1.00
According to the Gordon growth model, the price-dividend ratio of stock i is
Pi 1 + Gi
=
Di Ri → Gi
where Ri is the expected annual return, and Gi is the expected annual dividend growth.
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(a) [5 points] What is Tesla’s expected annual dividend growth rate G as of December 2024?
(b) [5 points] Suppose we are still in December 2024. You run some analysis and find that
Tesla’s market beta going forward should be 2.3 instead of 2. What should be your new
estimate of the price per share of Tesla stock? Assume that everything else remains the
same. Round to the second decimal place (e.g., $7.22).
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Question 6 [10 points]
After the close of trading on June 4, 2018, S&P announced that Twitter (TWTR) will join the S&P
500 index before the start of trading on June 7. You use the data from March 1 through June 4,
and estimate the following regression of Twitter returns on market returns (e.g., expressed as
0.05 instead of 5%):
R TWTR,t = α + εR MKT,t + ϱt .
The regression results are as follows:
Variable Coefficient t-statistic
Intercept 0.01 2.01
Market return 2 3.05
Twitter returns and the market returns for June 7, 8, and 9 are as follows:
Date Twitter return Market return
June 7 0.13 0.05
June 8 0.03 0.00
June 9 0.01 -0.01
(a) [5 points] Are the alpha and beta estimates statistically significant at the 5% level? You
must explain your answer to receive full credit.
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(b) [5 points] What is the cumulative abnormal return of Twitter from June 7 to 9? Round to
the second decimal place (e.g., 7.22%).
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Question 7 [10 points]
The following table contains performance statistics for some ETFs over the last 30 years. Assume
that they are evaluated relative to the CAPM. Assume that the riskless interest rate is 0%.
ETF Mean Volatility Alpha (%) MKT beta
return (%) (%)
S&P 500 (market) 6.00 20.00 0.00 1.0
Tech ETF 10.00 30.00 ? 1.5
Energy ETF 6.00 10.00 ? 0.5
Healthcare ETF 5.00 15.00 ? 0.5
(a) [5 points] Rank the three funds according to the information ratio. Recall that the informa-
tion ratio is defined as
α
IR = .
σϱ
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(b) [5 points] Suppose you are a financial advisor and you have a client who is considering
investing in ETFs. Her goal is to maintain a volatility of 20%, while maximizing the
Sharpe ratio. Which portfolio mix will you recommend to her? You can assume that the
idiosyncratic risks of the three ETFs are uncorrelated, so that the only source of systematic
risk is the market risk.
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Question 8 [10 points]
You are considering possible strategies related to the IBM stock. Suppose that the current stock
price is $150. There are two options available for trading.
1. 4-month maturity call options with strike price $155 are trading at $2.
2. 4-month maturity put options with strike price $155 are trading at $10.
You have done some research on IBM and your analysis shows that the price after 4 months
will be:
• $180 with probability 1/3.
• $120 with probability 1/3.
• $150 with probability 1/3.
(a) [5 points] Compute the returns on the following two option trading strategies (e.g., 7.22%).
Which should you choose?
(i) Long 2 call options and long 2 put options.
(ii) Short 2 call options and short 2 put options.
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(b) [5 points] What is the price of a riskless asset with 4-month maturity per $100 face value?
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