Professional Documents
Culture Documents
The Investment Setting True False Questions
The Investment Setting True False Questions
TRUE/FALSE QUESTIONS
(t) 1 The rate of exchange between certain future dollars and certain current
dollars is known as the pure rate of interest.
(f) 3 A dollar received to day is worth less than the same dollar received in the
future.
(f) 5 The three components of the required rate of return are the nominal interest
rate, an inflation premium, and a risk premium.
(t) 6 Risk is the uncertainty that an investment will earn its expected rate of
return.
(f) 7 A manager with a passive asset allocation strategy will try to increase
allocation of assets that he believes will outperform other classes in the next
period.
(t) 8 People invest with one or more of the following three basic needs in mind:
income, capital preservation, capital appreciation.
(t) 9 As the level of risk increases an investor will require an expected return that
will compensate for this additional risk.
(f) 10 An internally efficient market is one where stocks trade at low prices.
(t) 11 The required rate of return is the minimum rate of return that will induce an
investor to invest.
(t) 12 Participants in primary capital markets that gather funds and channel them
to borrowers are called financial intermediaries.
(t) 13 A manager with an active security selection philosophy will try to identify
securities that will do well over the coming period.
1
MULTIPLE CHOICE QUESTIONS
(a) 3 The statement – ‘risk drives expected returns’ refers to the notion that
a) an investor will require a higher rate of return the higher the perceived
riskiness of an asset.
b) an investor will require a lower rate of return the higher the perceived
riskiness of an asset.
c) markets over-react to news.
d) markets under-react to news.
e) none of the above.
(c) 12 A portfolio manager with an active asset allocation decision philosophy will
manage a portfolio by
a) Tracking a well known market index
b) Stock picking using a top-down or bottom-up approach
c) Using market timing
d) Maintaining predetermined allocation with periodic rebalancing
e) None of the above
(d) 14 A portfolio manager with a passive asset allocation decision philosophy will
manage a portfolio by
a) Tracking a well known market index
b) Stock picking using a top-down or bottom-up approach
c) Using market timing
d) Maintaining predetermined allocation with periodic rebalancing
e) None of the above
(d) 1 If the nominal risk rate is 5% per year, the risk premium is 6% per year and
the expected rate of inflation over the next year is 3%, an investment of
$1000 today worth one year from today.
a) $1000
b) $1081.50
c) $1091.80
d) $1113
e) $1146.39
(c) 2 If the nominal risk free rate is 8%, the expected rate of inflation is 2.5%,
and the risk premium is 5%, the required rate of return is
a) 10.5%
b) 7.5%
c) 13.4%
d) 16.24%
e) 10.7%
(a) 3 Assume that nominal risk free interest rate is 6%, the expected rate of
inflation is 2%, the risk premium is 3% and the required rate of return is
9.18%. What would be the value at the end of 25 years of $100 invested
today at the required rate of return?
a) $898.62
b) $343.51
c) $1474.28
d) $704.13
e) $918
(b) 4 The before tax value of the tax deferred investment, assuming all savings
are removed at the end of 10 years is
a) $4414.17
b) $5918.41
c) $2943.42
d) $8663.71
e) $4987.26
(c) 5 The after tax value of the tax deferred investment, assuming all savings are
removed at the end of 10 years is
a) $4987.26
b) $5918.41
c) $3846.97
d) $2943.42
e) None of the above
(e) 6 The value of the taxable investment, assuming all savings are removed at
the end of 10 years is
a) $8663.71
b) $6943.42
c) $3846.97
d) $5918.41
e) $5626.46
a) 15.5%
b) -10.0%
c) 8.5%
d) -7.75%
e) 7.75%
a) 15.5%
b) 10.0%
c) 5.0%
d) 7.75%
e) None of the above
CHAPTER 1
ANSWERS TO PROBLEMS
1 1000(1.05)(1.06) = 1113
2 (1.08)(1.05) – 1 = 11.34%
3 1.091825(100) = 898.62
4 1.0910(2500) = 5918.41
TRUE/FALSE QUESTIONS
(f) 1 An investor should expect to receive higher returns from taking on lower
risks
(f) 3 The holding period return (HPR) is equal to the return relative stated as a
percentage.
(t) 4 The geometric mean is the nth root of the product of the annual holding
period returns for N years minus one.
(f) 5 The geometric mean of a series of returns is always larger than the
arithmetic mean and the difference increases with the volatility of the series.
(t) 6 When rates of return are the same for all years,
the geometric mean and the arithmetic mean will be the same.
(f) 7 The coefficient of variation is the expected return divided by the standard
deviation of the return.
(f) 8 Historically return relatives are used to measure the risk for a series of
historical rates of return.
(f) 10 The risk premium is a function of sales volatility, financial leverage, and
inflation.
(b) 2 When rates of return on a security have a high standard deviation then
(c) 4 The real risk free rate is influenced by the following factors:
a) Inflationary expectations and capital market conditions.
b) Business risk and financial risk.
c) Investment opportunities and time preference for consumption.
d) All of the above.
e) None of the above.
(c) 5 If a significant change is noted in the yield of a T-bill, the change is most
likely attributable to:
a) A downturn in the economy.
b) A static economy.
c) A change in the expected rate of inflation.
d) A change in the real rate of interest.
e) A change in risk aversion.
(a) 6 The nominal risk free rate is influenced by the following factors:
a) Inflationary expectations and capital market conditions.
b) Business risk and financial risk.
c) Investment opportunities and time preference for consumption.
d) All of the above.
e) None of the above.
(b) 8 If U.S. firms increase their debt/total capital ratios, it will very likely cause
required returns to
a) Increase and change the slope of the capital market line (CML).
b) Increase and cause a movement up along the capital market line (CML).
c) Remain unchanged and cause a parallel shift of the capital market line
(CML).
d) Decrease and change the slope of the capital market line (CML).
e) Decrease and cause a movement down along the capital market line
(CML).
(d) 9 An increase in the slope of the Capital Market Line (CML) is caused by
a) Changes in business risk.
b) Changes in financial risk.
c) Changes in liquidity risk.
d) Changes in systematic risk.
e) Changes in unsystematic risk.
(d) 10 A parallel shift in the capital market line (CML) is caused by changes in the
following factors:
a) Expected real growth in the economy.
b) Capital market conditions.
c) Expected rate of inflation.
d) All of the above.
e) None of the above.
(a) 1 The HPR on a security is 6.5%. If the holding period is 1 month, the
annualized HPR is
a) 113%
b) 78%
c) 65%
d) 6.5%
e) 1.129%
(c) 2 The HPR on a security is 3%. If the holding period is 4 weeks month, the
annualized HPR is
a) 39.15%
b) 78.87%
c) 46.87%
d) 158.25%
e) 52.25%
(d) 3 At the beginning of the year an investor purchased 100 shares of common
stock from ABC Corporation at $10 per share. During the year, the firm
paid dividends of $1 per share. At the end of the year, the investor sold the
100 shares at $11 per share. What is the HPR?
a) 1.20%
b) 5.50%
c) 12.00%
d) 20.00%
e) 30.00%
(d) 4 Assume that you invest $1000 for 15 years in an account that pays an
interest rate of 7% per year with annual compounding. Calculate the
proportion of the total value of the account that can be attributed to interest-
on-interest, at the end of 15 years.
a) 100%
b) 38.06%
c) 36.24%
d) 25.70%
e) 0%
(b) 5 Given the following returns and return relatives over the past four years,
compute the arithmetic mean (AM) and geometric mean (GM) rates of
return.
Assume that you invest $5000 for 30 years in an account that pays an interest rate of
8.5% per year with annual compounding.
(c) 6 The total value of your investment at the end of 30 years is?
a) $67,750
b) $52,791
c) $57,791
d) $40,041
e) $60,000
(e) 9 Consider a stock that has an expected return of 10% and standard deviation
of 14%. Assuming that future returns will resemble past returns, an investor
can expect 95% of actual future returns to lie between
a) -10% and 24%
b) 10% and 14%
c) -32% and 52%
d) -4% and 24%
e) -18% and 38%
CHAPTER 2
ANSWERS TO PROBLEMS
4 1000(1.07)15 = 2759.03
TRUE/FALSE QUESTIONS
(f) 1 The U.S. equity and bond markets have grown in terms of their relative size
of the world equity and bond market.
(t) 2 Diversification with foreign securities can help reduce portfolio risk.
(f) 3 The total domestic return on German bonds is the return that would be
experienced by a U.S. investor who owned German bonds.
(t) 4 If the exchange rate effect for Japanese bonds is negative, it means that the
domestic rate of return will be greater than the U.S. dollar return.
(t) 5 Investors who limit themselves to the U.S. equity market experienced rates
of return below those in many other countries.
(f) 6 It is very important when diversifying that the correlation between rates of
return for various countries be high and very stable over time.
(f) 9 Yields on money market funds are often lower than yields available to
individuals investing in CD's because of the fees involved.
(f) 10 Income bonds are considered as safe as debentures because they pay higher
rates of interest.
(t) 11 Warrants are options issued in connection with the sale of fixed income
securities.
(f) 13 For a U.K. based investor with stock investments in the U.S. a weakening
dollar will enhance returns in terms of pounds.
(t) 14 For a U.S. based investor with stock investments in the U.K. a weakening
dollar will enhance returns in dollar terms.
MULTIPLE CHOICE QUESTIONS
(d) 1 If you are considering investing in German stocks as a means to reduce the
risk of your portfolio, the initial factor that you should examine is:
a) The average rate of return of the portfolio when you combine U.S.
and German stocks.
b) The standard deviation of the German stocks.
c) The standard deviation of the German stocks compared to the
standard deviation of U.S. stocks.
d) The correlation between the rates of return for German stocks and
U.S. stocks.
e) The coefficient of variation (CV) of rates of return for German stocks
versus the CV of rates of return for U.S. stocks.
(c) 2 Correlations of returns between U.S. bonds and those of foreign countries
differ because of differences in
a) Culture.
b) Political systems.
c) International trade patterns.
d) Language.
e) None of the above.
(c) 3 The legal document setting forth the obligations of a bond's issuer is called
a) A debenture.
b) A warrant.
c) An indenture.
d) A rights certificate.
e) A trustee deed.
(b) 4 The correlation between U.S. equities and U.S. government bonds has been
a) Strongly positive.
b) Weakly positive.
c) Strong negative.
d) Weakly negative.
e) Indeterminate.
(d) 6 In order to diversify risk an investor must have investments that that have
correlations with other investments in the portfolio that are
a) low positive
b) zero
c) negative
d) any of the above
e) none of the above
(a) 7 Correlations between stock markets in different countries have been rising
over time because
(c) 5 If the annual rate of inflation during the period was 4 percent, what was the
real rate of return on long-term corporate bonds?
a) 1.16%
b) 1.85%
c) 1.73%
d) 3.50%
e) 4.90%
(d) 6 You are trying to decide between a par value corporate bond carrying a
coupon rate of 6.25% per year and a par value municipal bond that pays an
annual coupon rate of 4.75%. Assuming all other factors are the same and
you are in the 28% tax bracket, which bond should you choose and why?
a) Corporate bond because the after tax yield is 6.25%.
b) Corporate bond because the after tax yield is 4.5%.
c) Municipal bond because the equivalent taxable yield is 6.3%.
d) Municipal bond because the equivalent taxable yield is 6.6%.
e) You will be indifferent between the two because the after tax yields are
the same.
(e) 8 What price would you pay in dollars to purchase this bond?
a) $62
b) $9.954
c) $48.08
d) $99.544
e) $995.44
(d) 12 Consider a U.S. based investor who purchases German stocks on January 1,
2002. One year later, on January 1, 2003 he sells the German stocks. The
total return in local currency is 10%. The exchange rate on January 1, 2002
is $1.05/euro. The exchange rate on January 1, 2003 is $0.90/euro.
Calculate the return in dollar terms.
a) 10.83%
b) -28.33%
c) 5.71%
d) -5.71%
e) 10.0%
(a) 13 Consider a Germany based investor who purchases U.S. stocks on January
1, 2002. One year later, on January 1, 2003 he sells the German stocks. The
total return in local currency is -5%. The exchange rate on January 1, 2002
is $1.05/euro. The exchange rate on January 1, 2003 is $0.90/euro.
Calculate the return in euro terms.
a) 10.83%
b) -28.33%
c) 5.71%
d) -5.71%
e) 5.0%
(b) 14 An investor based in the U.S. has security investments in the U.K. The
exchange over a one year period has gone from $1.85 per pound to $2 per
pound. During this same period the investor’s return in dollar terms is
calculated to be 10%. Calculate the local currency returns for the U.K.
securities ( i.e. in pound terms).
a) 8.11%
b) 1.75%
c) -1.35%
d) -7.5%
e) 10.81%
(c) 15 Assume the exchange rate is $1.85 per pound at the beginning of the year
and $2 per pound at the end of the year. For an investor based in the U.K.
with security investments in the U.S. the exchange rate change is
a) 8.11%
b) 15%
c) -7.5%
d) -8.11%
e) -15%
Treasury Bills
Maturity Days to Mat Bid Asked Chg Ask Yld
May 12 05 181 2.25 2.24 - ?
(c) 16 Use the information provided above to calculate the ask price for this
Treasury bill.
a) $9997.75
b) $9997.76
c) $9887.37
d) $10002.25
e) $10002.24
(a) 17 Use the information provided to calculate the ask yield (also known as the
investment rate or the bond equivalent rate.
a) 2.30%
b) 2.25%
c) 2.24%
d) 3.75%
e) 4.49%
CHAPTER 3
ANSWERS TO PROBLEMS
6 The municipal bond has an equivalent taxable yield of 0.475/(1 – 0.28)= 0.066. This is
higher than the bond yield of 0.0625.
15 First restate exchange rates as 1/1.85 = pounds 0.5405 per $ and 1/2.0 = pounds 0.50
per dollar.
Exchange rate change = (0.50/0.5405) – 1 = -0.075 or -7.5%
QUESTIONS
Experts
(t) suggest
1 life insurance coverage should be seven to ten times an individual's annual
salary.
(t) 2 The gifting phase is similar to, and may be concurrent with, the spending phase.
(f) 7 Marginal tax rate is defined as a person's total tax payment divided by their total
income.
(t) 8 Investment returns of an IRA investment, including any income, are deferred
until
the funds are withdrawn from the account.
(f) 9 Liquidity needs, time horizon, tax concerns and risk tolerance are all investment
constraints.
(t) 10 Average tax rate is defined as a person's total tax payment divided by their total
income.
(a) 1 Asset allocation is defined as the process of deciding how to allocate an investor’s
wealth among
a) Asset classes, sectors, and countries.
b) Asset classes, sectors and real estate.
c) Asset classes, sectors and derivatives.
d) Asset classes.
e) Sectors.
(a) 2 Which of the following is not a life cycle phase?
a) Discovery phase
b) Accumulation phase
c) Consolidation phase
d) Spending phase
e) Gifting phase
(e) 3 Which of the following is not a step in the portfolio management process?
(c) 5 An individual in the consolidation phase of the investment life cycle would
a) Have retired and would seek to preserve the real value of their investments.
b) Have enough income to cover expenses and excess assets would be used to
benefit charities and family.
c) Be past the midpoint of their careers and have excess earnings that can be
invested in moderately risky investments.
d) Be in the early to middle stage of their career, have a small net worth and long
investment time horizon.
e) None of the above.
(e) 8 Research has shown that the asset allocation decision explains % of the
variation in fund returns across all funds, and % of the variation in returns for a
particular fund over time.
a) 90 and 100.
b) 100 and 40.
c) 90 and 40.
d) 40 and 100.
e) 40 and 90.
(d) 10 Investors can manage risk confronting their wealth using the following
a) risk avoidance
b) risk anticipation
c) risk transfer
d) all of the above
e) none of the above
(d) 11 An individual in the accumulation phase of the investment life cycle would
a) Have retired and would seek to preserve the real value of their investments.
b) Have enough income to cover expenses and excess assets would be used to
benefit charities and family.
c) Be past the midpoint of their careers and have excess earnings that can be
invested in moderately risky investments.
d) Be in the early to middle stage of their career, have a small net worth and long
investment time horizon.
e) None of the above.
MULTIPLE CHOICE PROBLEMS
(d) 1 The nominal rate of return for a security is 12.5% per year. If the relevant tax rate
is 35% and the rate of inflation is 3.75% per year, calculate the after tax real rate
of return for the security.
a) 8.75%
b) 5.69%
c) 8.43%
d) 3.06%
e) 2.95%
As part of a retirement planning exercise, you are comparing a regular IRA with a
Roth IRA. The regular IRA contribution is tax deductible. In both cases the
contribution amount is $2000. Your time horizon is 25 years and you expect to
earn 9.5% percent per year on both types of IRA accounts. Your current tax rate
is
20% but you expect you tax rate at retirement to be 15%.
(b) 2 Calculate the tax savings generated by the regular IRA at the time of investment.
a) $300
b) $400
c) $700
d) $100
e) $200
(c) 3 Calculate the future value, at the end of 25 years, of the tax savings.
a) $2,900.51
b) $3,867.35
c) $2,496.70
d) $1,248.35
e) $4,369.23
(c) 4 Calculate the total after tax future value, at the end of 25 years, of the regular IRA
contribution and the tax savings.
a) $19,336.73
b) $21,833.43
c) $18,932.92
d) $16,840.03
e) $16,436.23
(a) 5 Calculate the total after tax future value, at the end of 25 years, of the Roth IRA
contribution.
a) $19,336.73
b) $21,833.43
c) $18,932.92
d) $16,840.03
e) $16,436.23
(e) 6 Your portfolio currently has an asset allocation that is 15% cash, 35% bonds, and
50% stocks. The returns over the past years for cash was 3.5%, bonds
5.75%, and stocks –8.5%. The return on your portfolio for the past year was
a) -5.04%
b) 5.47%
c) 0.25%
d) 5.91%
e) -1.71%
(a) 7 The future value of $25,000 invested today, at the end of 20 years assuming an
interest rate of 11.5% per year, with semiannual compounding, is
a) $233,976
b) $220,515
c) $250,515
d) $500,673
e) $213,321
(b) 8 Assume that you invest $1000 at the end of each quarter for the next 15 years in a
mutual fund. The annual rate of interest that you expect to earn in
the this account is 8.75%. The amount in the account at the end of 15 years
a) $28,790
b) $121,749
c) $60,000
d) $315,000
e) $115,637
(d) 9 Assuming the investor's marginal tax rate is 28% and he is considering
investing in a municipal bond yielding 7%. What is the equivalent taxable
yield?
a) 5.04%
b) 5.47%
c) 8.96%
d) 9.72%
e) 9.80%
Assume that you have just retired with $1,000,000 in savings in an investment
account. You expect to earn 10% per year on your investments. You plan to
withdraw 25% annually at the beginning of each year with interest credited on the
remaining balance at the end of the year.
(d) 10 Calculate the amount withdrawn at the beginning of the second year.
a) $148,739
b) $250,000
c) $170,156
d) $206,250
e) $186,320
(d) 11 Calculate the balance in the investment account at the end of the second year
(prior to any withdrawals)
a) $750,000
b) $618,750
c) $825,000
d) $680,625
e) $510,468
(b) 12 Someone in the 15 percent tax bracket can earn 8% on his investments in a tax-
exempt IRA account. What will be the value of a $10,000 investment after 5
years (assuming annual compounding)?
a) $ 6,805
b) $14,693
c) $15,528
d) $20,114
e) $50,000
(c) 13 Suppose you invest money in a taxable account earning 8% per year. What will be
the after-tax value of a $10,000 investment after 5 years if you are in the 15% tax
bracket (assuming annual compounding)?
a) $10,680
b) $11,765
c) $13,895
d) $14,693
e) $15,528
CHAPTER 5
= -0.0171 or –1.71%
(1 .02187560 ) 1
8. FV = 1000 =$121,749
.021875
11. The remaining balance at the end of the first year = 825,000 – 206,250 = $618,750
This earns interest of 10% and at the end of year 2 is worth = 618,750(1.1) = $680,625
13. After-tax yield = Before-tax yield (1 - Tax rate) = 0.08(1 - 0.15) = 0.068 or 6.8%
a) True
b) False
(b) 2 Cash flows for nonlife insurance companies, such as property and casualty, are
similar to cash flows of life insurance companies.
a) True
b) False
(b) 3 The portfolio mixes of institutional investors around the world are approximately
the same.
a) True
b) False
a) the plan does not promise to pay the retiree a specific income stream after
retirement.
b) the plan does promise to pay the retiree a specific income stream after
retirement.
c) the employee's retirement income is not an obligation of the firm.
d) the company carries the risk of paying future pension benefits to retirees.
e) Choices a and c
TRUE/FALSE QUESTIONS
(t) 1 A continuous market that has price continuity requires depth of buyers and
sellers.
(f) 4 The primary market is where existing issues are traded between current and
potential owners.
(t) 5 A general obligation (GO) bond is backed by the full taxing power of the
municipality.
(t) 6 Negotiated, competitive bids, and best efforts are three forms of
underwriting arrangements.
(f) 8 In a call market, trades occur at any time while the market is open.
(t) 9 The U.S. over-the-counter market is the largest segment of the U.S.
secondary market in terms of number of issues traded.
(f) 10 The third market describes direct trading of securities between parties with
no broker intermediary.
(f) 11 The fourth market is mainly used by individual investors because it is much
cheaper than using a broker.
(t) 12 A short seller can only trade on an uptick (or zero uptick) and must pay any
dividends to the lender of the stock.
(t) 15 In the United States commons stocks are quoted in decimals not fractions.
(f) 16 Decimalization has increased spread size and caused an increase in
transaction costs.
(a) 4 In a negotiated bid, the underwriter carries out the following service(s)
a) Origination, risk-bearing, and distribution.
b) Origination and risk-bearing.
c) Risk-bearing and distribution.
d) Origination and distribution.
e) Risk-bearing and distribution.
(d) 5 Municipal bonds are sold using the following method or methods
a) Competitive bid
b) Negotiated sale
c) Private placement
d) All of the above
e) None of the above
(b) 8 The impact of changing the system for quoting share prices from fractions
to decimals has been to
a) Increase spread size, increase transaction costs, and increase the number
of transactions.
b) Decrease spread size, decrease transaction costs, and increase the
number of transactions.
c) Decrease spread size, decrease transaction costs, and decrease the
number of transactions.
d) Decrease spread size, increase transaction costs, and increase the
number of transactions.
e) Decrease spread size, decrease transaction costs and decrease the
number of transactions..
(d) 12 With a best-efforts offering, the investment banker performs all of the
following roles:
(e) 17 The term ‘third market’ describes the market where dealers and brokers:
a) Trade in stocks listed on regional stock exchanges.
b) Trade in stocks through electronic communication networks.
c) Trade in stocks listed on the London Stock Exchange.
d) Trade in stocks through electronic crossing systems.
e) Trade in exchange listed stocks away from the exchanges.
(e) 19 The member of the New York Stock Exchange who acts as a dealer on
assigned stocks is known as a
a) Registered trader.
b) Commission broker.
c) Registered dealer.
d) Floor dealer.
e) Specialist.
a) Use their membership to buy and sell for their own account.
b) Are employees of a member firm and buy and sell for customers of the
firm.
c) Act as brokers for other members.
d) Handle limit and other special orders placed by other brokers on the
floor.
e) Maintain a fair and orderly market.
a) Acting as a broker who handles the limit orders or special orders placed
with member brokers
b) Buying and selling securities in order to stabilize the market
c) Acting as a dealer in assigned stocks to maintain a fair and orderly
market
d) Maintain a minimum of $1 million or the value of 15,000 shares of each
stock assigned, whichever is greater
e) Speculating only for themselves, they do not execute traders for the
public nor for other brokers
Assume you deposit $100,000 in a margin account. The margin requirement is 50 percent and
commissions are ignored. Shares in Sisco Corp currently sell for $80 per share:
(c) 2 What is your profit if the price of Sisco Corp rises to $90?
a) $50,000
b) $12,500
c) $25,000
d) $100,000
e) $120,000
(c) 3 If the maintenance margin is 25 percent, to what price can Sisco Corp fall
before you receive a margin call?
a) $51.25
b) $43.25
c) $53.33
d) $45.33
e) $83.33
(d) 4 Calculate your percentage rate of return if the shares of Sisco Corp falls to
$65.
a) -15.00%
b) -25.00%
c) -23.07%
d) -37.50%
e) -30.50%
(b) 5 Suppose you buy a round lot of a stock on 55 percent margin when it is
selling at $35 a share. The broker charges a 10 percent annual interest rate
and commissions are 3 percent of the total stock value on both the purchase
and the sale. If at year end you receive a $0.90 per share dividend and sell
the stock for 32, what is your rate of return on the investment?
a) -29.38%
b) -28.00%
c) -26.23%
d) -25.00%
e) -35.00%
You decide to sell 100 shares of a stock short when it is selling at its yearly high of $22.25.
Your broker tells you that your margin requirement is 55% and that the commission on the sale
is $55. While you are short, the stock, Tuna Boat pays a $0.75 per share dividend. At the end of
one year you buy shares of the stock to cover your short sale at $18.38 and are charged a
commission of $45 and a 9% interest rate on the funds you borrowed.
You decide to sell short 200 shares of XCorp stock at a price of $75. Your margin deposit is
65%. Commission on the sale is 1.25%. During the year the stock pays a $1.75 per share
dividend. Interest on margin debt is 5.25% per year.
a) $15,000
b) $5,250.75
c) $9,750.25
d) $9,937.50
e) $15,187.50
(a) 9 At the end of one year you close out your short position by purchasing
shares of XCorp at $45 per share. The commission is 1.25%. Calculate your
dollar profit.
a) $5,074.38
b) -$4,038.13
c) $5250.00
d) -$5074.38
e) $4,038.13
(c) 10 If at the end of one year you close out your short position by purchasing
share of XCorp at $45 per share with commission of 1.25%, what is your
rate of return on the investment?
a) -55.92%
b) 10.31%
c) 51.06%
d) 23.1%
e) -33.05%
(b) 11 Suppose at the end of one year XCorp is selling at $90 per share and you
cover your short position at this price. What is your dollar profit on the
investment? (Assume a 1.25% commission on the purchase)
a) $5,074.38
b) -$4,038.13
c) $5250.00
d) -$5074.38
e) $4,038.13
(a) 12 If you cover your short position at $90 per share. What is your rate of return
on the investment? (Assume a 1.25% commission on the purchase)
a) -40.64%
b) -25.53%
c) 5.21%
d) 72.7%
e) –71.2%
Shares of RossCorp stock are selling for $45 per share. Brokerage commissions are 2% for
purchases and 2% for sales. The interest rate on margin debt is 6.25% per year. The
maintenance margin is 30%.
(e) 13 At the end of one year shares of RossCorp stock are selling for $55 per
share and the company paid dividends of $0.85 per share. Assuming that
you paid the full cost of the purchase, what is your rate of return if you sell
RossCorp stock?
a) 18.08%
b) 23.51%
c) 22.32%
d) 14.96%
e) 19.28%
(b) 14 At the end of one year shares of RossCorp stock are selling for $35 per
share and the company paid dividends of $0.85 per share. Assuming that
you paid the full cost of the purchase, what is your rate of return if you sell
RossCorp stock?
a) -33.05%
b) -23.42%
c) 23.42%
d) 33.05%
e) –25.35%
(c) 15 At the end of one year shares of RossCorp stock are selling for $55 per
share and the company paid dividends of $0.85 per share. Assuming that
you borrowed 25% of cost of the purchase, what is your rate of return?
a) -23.51%
b) 29.35%
c) 23.51%
d) 5.21%
e) 10.06%
(b) 16 At the end of one year shares of RossCorp stock are selling for $35 per
share and the company paid dividends of $0.85 per share. Assuming that
you borrowed 25% of cost of the purchase, what is your rate of return?
a) 33.05%
b) -33.05%
c) -23.51%
d) -25.35%
e) –40.64%
(d) 17 Assume that you purchase 150 shares of RossCorp stock by making a
margin deposit of 75%. At what price would you receive a margin call?
a) $29.39
b) $26.48
c) $50.39
d) $16.07
e) $50.10
CHAPTER 6
Price = $53.33
= 23.51%
= -33.05%
P = $16.07
CHAPTER 7
SECURITY-MARKET INDICATOR SERIES
TRUE/FALSE QUESTIONS
(f) 2 A price-weighted index is the geometric average of the current prices of the
sampled securities.
(f) 4 The DJIA has been criticized because when a stock in the index splits there
are more shares outstanding and the importance of the stock in the
index increases.
(t) 5 Security market indexes have been used to create index funds and exchange
traded funds.
(f) 6 In a value-weighted index the highest priced stock carries the greatest
weight.
(t) 10 The low correlations between the U.S. and the U.K., and the U.S. and
Japan, confirm the benefit of global diversification.
(t) 11 The correlations among the U.S. investment-grade-bond series were very
high because all rates of return for investment-grade bonds over time are
impacted by common macroeconomic variables.
MULTIPLE CHOICE QUESTIONS
(c) 1 Which of the following is not a use of security market indicator series?
a) To use as a benchmark of individual portfolio performance
b) To develop an index portfolio
c) To determine unsystematic risk
d) To determine factors influencing aggregate security price movements
e) To determine systematic risk
(c) 2 A properly selected sample for use in constructing a market indicator series
will consider the sample's source, size and
a) Value.
b) Average beta.
c) Breadth.
d) Variability.
e) Dividend record.
(a) 3 What effect does a stock substitution or stock split have on a price-weighted
series, such as DJIA?
a) Divisor will increase/decrease, index remains the same.
b) Index will increase/decrease, divisor remains the same.
c) Index and divisor will remain the same.
d) Index and divisor will both reflect the changes (immediately).
e) Not enough information provided.
(d) 5 Which of the following indexes includes the most comprehensive list of
stocks?
(e) 7 Which of the following are factors that make it difficult to create and
maintain a bond index?
a) The universe of bonds is broader than stocks.
b) The universe of bonds is constantly changing due to new issues, bond
maturities, calls, and bond sinking funds.
c) There can be difficulties in correctly pricing bond issues.
d) Choices a and c.
e) Choices a, b and c.
(a) 8 Low correlations between the S&P 500 stock index and the MSCI EAFE
suggest
a) That investors should diversify investment portfolios.
b) That investors should invest only in U.S. stocks.
c) That investors should invest only in Europe.
d) That investors should invest only is Asia.
e) Nothing.
(a) 10 Correlations between U.S. investment grade bonds and high yield bonds are
a) Low because of the equity characteristics of high yield bonds.
b) Low because yields on investment grade bonds are determined by
systematic interest rate variables.
c) High because of the equity characteristics of high yield bonds.
d) High because yields on investment grade bonds are determined by
systematic interest rate variables.
e) None of the above.
MULTIPLE CHOICE PROBLEMS
Stocks W and X had 3 for 1 splits on December 31, 2003 at the end of trading.
(c) 1 Calculate the price weighted series for Dec 31, 2003, prior to the splits.
a) 103.57
b) 100.0
c) 72.5
d) 121.25
e) 119.25
(a) 2 Calculate the price weighted series for December 31, 2003 after the splits.
a) 72.5
b) 100.0
c) 119.25
d) 121.25
e) 103.57
(e) 3 Calculate the price weighted series for Dec 31, 2004.
a) 121.25
b) 119.25
c) 100.0
d) 72.5
e) 103.57
(a) 4 Calculate the percentage return in the price weighted series for the period
Dec 31, 2003 to Dec 31, 2004.
a) 42.86%
b) 20.00%
c) 21.76%
d) 33.33%
e) 40.00%
(d) 5 Calculate the value weighted index for Dec 31, 2003, prior to the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a) 147.5
b) 81.69
c) 72.5
d) 100.0
e) 121.25
(c) 6 Calculate the value weighted index for Dec 31, 2003, after the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a) 72.5
b) 81.69
c) 100.0
d) 147.5
e) 121.25
(e) 7 Calculate the value weighted index for Dec 31, 2004. Assume a base index
value of 100. The base year is Dec 31, 2003.
a) 121.25
b) 100.0
c) 81.69
d) 72.5
e) 147.5
(b) 8 Calculate the percentage return in the value weighted index for the period
Dec 31, 2003 to Dec 31, 2004.
a) 12.68%
b) 47.50%
c) 21.76%
d) 33.33%
e) 40.00%
(a) 9 Calculate the unweighted index for Dec 31, 2003, prior to the splits.
Assume a base index value of 100. The base year is Dec 31, 2003.
a) 100.0
b) 200.0
c) 150.0
d) 120.0
e) 175.0
(c) 10 Calculate the unweighted index for Dec 31, 2003, after the splits. Assume a
base index value of 100. The base year is Dec 31, 2003.
a) 110.0
b) 200.0
c) 100.0
d) 120.0
e) 150.0
(a) 11 Calculate the unweighted index (geometric mean) for Dec 31, 2004.
Assume a base index value of 100. The base year is Dec 31, 2003.
a) 146.05
b) 121.25
c) 151.25
d) 148.75
e) 100.25
(a) 12 Calculate the percentage return in the unweighted index (geometric mean)
for the period Dec 31, 2003 to Dec 31, 2004. Assume a base index value of
100. The base year is Dec 31, 2003.
a) 46.05%
b) 21.25%
c) 51.25%
d) 48.75%
e) 100.25%
a) 1.20%
b) 20.00%
c) 21.76%
d) 33.33%
e) 40.00%
Price Shares
COMPANY A B C A B C
Day 1 12 23 52 500 350 250
Day 2 10 22 55 500* 350 250
Day 3 8 26 51 1000 350 250**
Day 4 9 25 19 1000 350 750
(e) 18 Calculate a Standard & Poor's Index for Day 3 if the base period is Day 1
with an initial index value is 100.
a) 90.351
b) 91.035
c) 95.234
d) 101.628
e) 110.351
CHAPTER 7
750000 750000
750000 750000 500000
500000 1000000
1000000
x100 100
750000 750000
1500000 975000500000
7000001000000
1250000
x100 147.5
8 SINCE THE BASE VALUE IS 100 AND THE CURRENT INDEX VALUE IS
147.5, the percentage return is 47.5%.
13 Given a three security series and a price change from period T to T+1, the percentage
change in the price weighted series would be
14 Period T
Stock Price/Share # of Shares Market Value
A $50 1,000,000 $50,000,000
B 30 10,000,000 300,000,000
C 20 25,000,000 500,000,000
Total $850,000,000
Period T+1
Stock Price/Share # of Shares Market Value
A $60 1,000,000 $60,000,000
B 35 10,000,000 350,000,000
C 25 25,000,000 625,000,000
Total $1,035,000,000
15 Period T
Stock Price/Share # of Shares Market Value
A $50 20.00 $1,000.00
B 30 33.33 1,000.00
C 20 50.00 1,000.00
Total $3,000.00
Period T+1
Stock Price/Share # of Shares Market Value
A $ 60 20.00 $1,200.00
B 35 33.33 1,166.55
C 25 50.00 1,250.00
Total $3,616.55
CHAPTER 8
AN INTRODUCTION TO PORTFOLIO MANAGEMENT
TRUE/FALSE QUESTIONS
(t) 2 A basic assumption of the Markowitz model is that investors base decisions solely
on expected return and risk.
(t) 3 The yield spread between yields on AAA bonds and BAA bonds is evidence that
investors are risk averse.
(t) 4 Standardizing the covariance by the individual standard deviation yields the
correlation coefficient.
(t) 5 The covariance is a measure of the degree to which two variables (e.g., rates of
return) move together over time relative to their means.
(f) 6 For a two stock portfolio containing Stocks i and j, the correlation coefficient of
returns (ri,j) is equal to the square root of the covariance (covi,j).
(t) 8 Increasing the correlation among assets in a portfolio results in an increase in the
standard deviation of the portfolio.
(f) 9 A basic assumption of portfolio theory is that an investor would want to maximize
risk subject to a given level of return.
(t) 10 Most investors hold a diversified portfolio in order to reduce portfolio risk.
(f) 11 Most assets of the same type have negative covariances of returns with each
other.
MULTIPLE CHOICE QUESTIONS
(a) 1 The optimal portfolio is identified at the point of tangency between the
efficient frontier and the
a) highest possible utility curve.
b) lowest possible utility curve.
c) middle range utility curve.
d) steepest utility curve.
e) flattest utility curve.
(d) 2 An individual investor’s utility curves specify the tradeoffs he or she is willing to
make between
a) high risk and low risk assets.
b) high return and low return assets.
c) covariance and correlation.
d) return and risk.
e) efficient portfolios.
(c) 3 As the correlation coefficient between two assets decreases, the shape of the
efficient frontier
a) approaches a horizontal straight line.
b) bends out.
c) bends in.
d) approaches a vertical straight line.
e) none of the above.
(d) 4 A portfolio manager is considering adding another security to his portfolio. The
correlations of the 5 alternatives available are listed below. Which security
would enable the highest level of risk diversification
a) 0.0
b) 0.25
c) -0.25
d) -0.75
e) 1.0
(c) 6 A positive relationship between expected return and expected risk is consistent
with
a) investors being risk seekers.
b) investors being risk avoiders.
c) investors being risk averse.
d) all of the above.
e) none of the above.
(d) 7 What information must you input to a computer program in order to derive the
portfolios that make up the efficient frontier
a) Expected returns, covariances and correlations.
b) Standard deviations, variances and covariances.
c) Expected returns, standard deviations and variances.
d) Expected returns, variances and correlations.
e) Covariances, correlations and variances.
(a) 9 As the correlation coefficient between two assets increases, the shape of the
efficient frontier
a) approaches a horizontal straight line.
b) bends out.
c) bends in.
d) approaches a vertical straight line.
e) none of the above.
(a) 13 With low, zero or negative correlations it is possible to derive portfolios that have
a) Lower risk than the individual securities in the portfolio.
b) Lower risk than the highest risk individual security in the portfolio.
c) Higher risk than the individual securities that make up the portfolio.
d) Higher risk than the highest risk individual security in the portfolio.
e) None of the above.
(a) 15 In a two stock portfolio, if the correlation coefficient between two stocks were to
decrease over time everything else remaining constant the portfolio's risk would
a) Decrease.
b) Remain constant.
c) Increase.
d) Fluctuate positively and negatively.
e) Be a negative value.
(d) 16 Given the following correlations between pairs of stocks, a portfolio constructed
from which pair will have the lowest standard deviation?
Correl(A,B) = 0, Correl(C,D) = 1, Correl(E,F) = 0.75, Correl(G,H) = -0.75,
Correl(I,J) = -0.50.
a) Pair A,B
b) Pair C,D
c) Pair E,F
d) Pair G,H
e) Pair I,J
(c) 17 Given a portfolio of stocks the envelope curve containing the set of best possible
combinations is known as the
a) Efficient portfolio.
b) Utility curve.
c) Efficient frontier.
d) Last frontier.
e) Capital asset pricing model.
(d) 18 Estimation error refers to potential errors that arise from estimating
a) Expected security returns.
b) Standard deviations of expected returns.
c) Correlations of expected returns.
d) All of the above.
e) None of the above.
(d) 1 Consider two securities, A and B. Security A and B have a correlation coefficient of 0.65. Security A has standard
deviation of 12, and security B has standard deviation of 25. Calculate the covariance between these two securities.
a) 300
b) 461.54
c) 261.54
d) 195
e) 200
(a) 2 Calculate the expected return for a three asset portfolio with the following
a) 11.71%
b) 11.12%
c) 15.70%
d) 14.25%
e) 6.75%.
(c) 3 Given the following weights and expected security returns, calculate the expected
return for the portfolio.
Weight Expected Return
.20 .06
.25 .08
.30 .10
.25 .12
a) .085
b) .090
c) .092
d) .097
e) None of the above
(d) 4 the standard deviation for stock A is 0.15 and for stock B, it is 0.20. The
covariance between returns for these stocks is 0.01. The correlation coefficient
between these two stocks is:
a) -0.125
b) 0.195
c) -0.285
d) 0.333
e) 0.405
(c) 6 Calculate the expected standard deviation of the two stock portfolio when the
correlation is 0.40.
a) .0016
b) .0160
c) .0395
d) .1558
e) .3950
(a) 7 Calculate the expected return a two stock portfolio when w 1 = 0.75.
a) 0.13
b) 0.136
c) 0.14
d) 0.125
e) 0.16
(d) 8 Calculate the expected standard deviation of a two stock portfolio when w 1 =
0.75
and the covariance between stock 1 and stock 2 is -0.009.
a) 0.1025
b) 0.0705
c) 0.0906
d) 0.0404
e) 0.0623
(b) 9 Calculate the expected return a two stock portfolio when w 1 = 0.60.
a) 0.13
b) 0.136
c) 0.14
d) 0.125
e) 0.16
(c) 10 Calculate the expected standard deviation of a two stock portfolio when w 1 =
0.60
and the covariance between stock 1 and stock 2 is 0.8.
a) 0.1025
b) 0.0705
c) 0.0906
d) 0.0404
e) 0.0623
CHAPTER 8
TRUE/FALSE QUESTIONS
(t) 1 One of the assumptions of Capital Market Theory is that investors can borrow or
lend at the risk-free rate.
(f) 2 An assumption of Capital Market Theory is that buying or selling of assets entails
no taxes, but entails significant transaction costs.
(t) 3 A risky asset is an asset with uncertain future returns, and uncertainty (or risk) is
measured by the variance or standard deviation of returns.
(t) 4 The standard deviation of a portfolio that combines the risk-free asset with risky
assets is the linear proportion of the standard deviation of the risky asset portfolio.
(t) 5 The Capital Market Line (CML) is the line from the intercept point that represents
the risk-free rate tangent to the original efficient frontier.
(f) 7 All portfolios on the CML are perfectly negatively correlated, which means that
all portfolios on the CML are perfectly negatively correlated with the
completely diversified market portfolio since it lies on the CML.
(f) 9 The Capital Asset Pricing Model (CAPM) is a technique for determining the
expected risk on an asset.
(t) 11 Multifactor models of risk and return can be broadly grouped into models that use
macroeconomic factors and models that use microeconomic factors.
(f) 12 Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and
their identity
MULTIPLE CHOICE QUESTIONS
(d) 1 Which of the following is not an assumption of the Capital Market Theory?
a) All investors are Markowitz efficient investors.
b) All investors have homogeneous expectations.
c) There are no taxes or transaction costs in buying or selling assets.
d) There are no risk-free assets.
e) All investors have the same one period time horizon.
(d) 4 When identifying undervalued and overvalued assets, which of the following
statements is false?
(b) 5 Utilizing the security market line an investor owning a stock with a beta of (-2)
would expect the stock's return to in a market that
was expected to decline 10 percent.
a) Rise or fall an indeterminate amount
b) Rise by 20.0%
c) Fall by 20.0%
d) Rise by 10.2%
e) Fall by 10.2%
(d) 6 The Capital Market Line (CML) refers to the efficient formed by creating
portfolios that
a) Invest solely in the market portfolio M.
b) Lend at the risk free asset and invest in the market portfolio.
c) Borrow at the risk free asset and invest in the market portfolio.
d) Lend and borrow at the risk free rate and invest in the market portfolio.
e) Short sell the market portfolio.
(a) 8 The Security Market Line (SML) represents the relation between
a) Risk and required return on an asset.
b) Systematic risk and required return on an asset.
c) Risk and return on a diversified portfolio of assets.
d) Unsystematic risk and required return on an asset
e) Systematic risk and required return on a diversified portfolio of assets.
(a) 9 In a macro-economic based risk factor model the following factor would be one
of many appropriate factors
a) Confidence risk.
b) Maturity risk.
c) Expected inflation risk.
d) Call risk.
e) Return difference between small capitalization and large capitalization stocks.
(e) 12 In a micro-economic based risk factor model the following factor would be one
of many appropriate factors
a) Confidence risk.
b) Maturity risk.
c) Expected inflation risk.
d) Call risk.
e) Return difference between small capitalization and large capitalization stocks.
(b) 1 Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5%
and the expected return on the stock index is 15%. The estimated return on the
asset is 20%. Calculate the alpha for the asset.
a) 19.25%
b) 0.75%
c) –0.75%
d) 9.75%
e) 9.0%
(b) 2 The table below provides factor risk sensitivities and factor risk premia for
a three factor model for a particular asset where factor 1 is MP the growth
rate in U.S. industrial production, factor 2 is UI the difference between
actual and expected inflation, and factor 3 is UPR the unanticipated change
in bond credit spread.
Factor Risk
Risk Factor Sensitivity(β) Premium(λ)
MP 1.76 0.0259
UI -0.8 -0.0432
UPR 0.87 0.0149
a) 12.32%
b) 9.32%
c) 4.56%
d) 6.32%
e) 8.02%
(a) 3 The variance of returns for a risky asset is 25%. The variance of the error
term, Var(e) is 8%. What portion of the total risk of the asset, as measured
by variance, is unsystematic?
a) 32%
b) 8%
c) 68%
d) 25%
e) 75%
a) 5.2%
b) 8.0%
c) 3.2%
d) 4.0%
e) 1.2%
(d) 7 A stock has a beta of the stock is 1.1. The risk free rate is 2.5% and the return on
the market is 12%. The estimated return for the stock is 14%. According to the
CAPM you should
1.0
a) 0.0
b) -1.0
c) 0.5
d) -0.5
e)
The expected return for a stock, calculated using the CAPM, is 10.5%. The
(a) 9 market return is 9.5% and the beta of the stock is 1.50. Calculate the
implied risk-free rate.
7.50%
a) 13.91%
b) 17.50%
c) 21.88%
d) 14.38%
e)
The expected return for a stock, calculated using the CAPM, is 25%. The
(d) 10 risk free rate is 7.5% and the beta of the stock is 0.80. Calculate the implied
return on the market.
7.50%
a) 13.91%
b) 17.50%
c)
d) 21.88%
e) 14.38%
(c) 11 The expected return for Zbrite stock calculated using the CAPM is 15.5%.
The risk free rate is 3.5% and the beta of the stock is 1.2. Calculate the
implied market risk premium.
a) 5.5%
b) 6.5%
c) 10.0%
d) 15.5%
e) 12.0%
(d) 12 Calculate the expected return for Express Inc. which has a beta of .69 when
the risk free rate is.09 and you expect the market return to be .14.
a) 0.05%
b) 13.91%
c) 10.92%
d) 12.45%
e) 14.25%
You expect the risk-free rate (RFR) to be 5 percent and the market return to be 9 percent. You
also have the following information about three stocks.
(b) 13 What are the expected (required) rates of return for the three stocks (in the
order X, Y, Z)?
(a) 14 What are the estimated rates of return for the three stocks (in the order X, Y, Z)?
a) 7.95%, 11.25%, 11.11%
b) 6.20%, 2.20%, 8.20%
c) 16.50%, 5.50%, 22.00%
d) 11.00%, 7.00%, 13.00%
e) 15.00%, 3.50%, 7.30%
(a) 16 Compute the beta for GBC Company using the historic returns presented above.
a) 0.4255
b) 0.5929
c) 5.6825
d) 9.4163
e) 0.3333
(e) 17 Compute the correlation coefficient between GBC and the Market Index.
a) 0.4255
b) 0.5929
c) 5.6825
d) 9.4163
e) 0.3333
CHAPTER 9
ANSWERS TO PROBLEMS
For problems 13 - 15
For problems 16 – 19