1. The risk-free rate is currently 3.5%, and one share of stock of a given firm

Question

1. The risk-free rate is currently 3.5%, and one share of stock of a given firm is selling for $50. In one year, the price of the stock is expected to be either $47.50 or $53.75. What is the weighting factor to compute the value of a call on this stock with an exercise price of $50 using the Binomial Model? A: Negative B: 0.34 C: 0.44 D: 0.68 E: 0.88

2. A company is expected to pay $1.75 in annual dividends next year. If the anticipated annual growth rate is 4% and the current price of the stock is $25 per share, what is the expected return on this stock?
A: 4.0% B: 7.0% C: 7.3% D: 11.0% E: 11.3%

3. The financial planning process include all of the following EXCEPT
A: assessing the current status of the financial markets. B: analyzing the client’s financial status. C: monitoring the portfolio. D: developing a policy statement. E: establishing a client-advisor relationship.

4. The efficient frontier
A: contains portfolios with the highest risk for a given return. B: contains portfolios with the lowest return for a given risk. C: contains portfolios with the highest return for a given risk. D: A and B are correct, but C is not. E: A and C are correct, but B is not.

Explanation / Answer

1)

Weighing Factor=probability of up move in the underlying=(exp(r*t)-d)/(u-d)

d =47.5/50=0.95

u =53.75/50=1.075

Weighing Factor=(exp(0.035*1)-0.95)/(1.075-0.095)= 0.0856197/0.125=0.68

Hence Option D

2)

Expected return=Dividend yield + growth rate

Expected return=(1.75/25)+0.04=0.11=11%

Option D

3)

Option D- It does not include developing the policy statement

Financial Planning includes

4)

Option C

The efficient frontier shows the combination of different asset to make different portfolio and reflects the set of portfolio that has highest return for a given risk or the lowest risk for a given return

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