Questions and Answers

1. The net wealth of the aggregate economy is equal to the sum of.
A. All real assets.
B. All financial assets.
C. All physical assets.
D. All real and financial assets.
E. None of the above
2. Asset allocation refers to ____________.
A. Choosing which securities to hold based on their valuation
B. Investing only in "safe" securities
C. The allocation of assets into broad asset classes
D. Bottom-up analysis
E. All of the above
3. Financial intermediaries differ from other businesses in that both their assets and their liabilities are mostly
A. Illiquid.
B. Owned by government.
C. Real.
D. Financial.
E. Regulated.
4. Although derivatives can be used as speculative instruments, businesses most often use them to
A. Hedge. is a technique that is meant to reduce potential loss (and not maximize potential gain).
B. Offset debt.
C. Appease stockholders.
D. Attract customers.
E. Enhance their balance sheets.
5. Financial assets..........
A. Contribute to the country's productive capacity both directly and indirectly.
B. Do not contribute to the country's productive capacity either directly or indirectly
C. Directly contribute to the country's productive capacity.
D. Indirectly contribute to the country's productive capacity.
E. Are of no value to anyone.
6. In what roles do investment bankers perform?
A. Design securities with desirable properties
B. Market new stock and bond issues for firms
C. Provide advice to the firms as to market conditions, price, etc
D. None of them
E. All of them
7. The bid price of a T-bill in the secondary market is
A. The price at which the dealer in T-bills is willing to sell the bill.
B. The price at which the dealer in T-bills is willing to buy the bill.
C. Greater than the asked price of the T-bill.
D. The price at which the investor can buy the T-bill.
E. Never quoted in the financial press.
8. Which of the following are characteristics of preferred stock?I) It pays its holder a fixed amount of income each year, at the discretion
of its managers.II) It gives its holder voting power in the firm.III) Its dividends are usually cumulative.IV) Failure to pay dividends may
result in bankruptcy proceedings.
A. I, III, and IV
B. I, II, and III
C. I and III
D. I, II, and IV
E. I, II, III, and IV
9. With regard to a futures contract, the long position is held by
A. The trader who bought the contract at the largest discount.
B. The trader who has to travel the farthest distance to deliver the commodity
C. The trader who plans to hold the contract open for the lengthiest time period
D. The trader who commits to purchasing the commodity on the delivery date
E. The trader who commits to delivering the commodity on the delivery date
10. Which one of the following statements regarding open-end mutual funds is false?
A. The funds redeem shares at net asset value.TRUE
B. The funds offer investors professional management TRUE
C. The funds offer investors a guaranteed rate of return
D. B and C.
E. A and B.
11. Which one of the following statements regarding closed-end mutual funds is false?
A. The funds always trade at a discount from NAV.
B. The funds redeem shares at their net asset value.
C. The funds offer investors diversification. TRUE
D. A and B.
E. None of the above
12. Which of the following functions do mutual fund companies perform for their investors?
A. Record keeping and administration
B. Professional management
C. Diversification and divisibility
D. Lower transaction costs
E. All of the above
13. Skewness is a measure of ____________.
A. How fat the tails of a distribution are
B. The downside risk of a distribution
C. The normality of a distribution
D. The dividend yield of the distribution
E. A and C
14. When a distribution is positively skewed, ____________.
A. Standard deviation overestimates risk
B. Standard deviation correctly estimates risk
C. Standard deviation underestimates risk
D. The tails are fatter than in a normal distribution
E. None of the above
15. In words, the real rate of interest is approximately equal to
A. The nominal rate times the inflation rate.
B. The inflation rate minus the nominal rate.
C. The nominal rate minus the inflation rate.
D. The inflation rate divided by the nominal rate.
E. The nominal rate plus the inflation rate.
16. DFI, Inc. has the following probability distribution of holding period returns on its stock.

State of Economy Probability HPR

Boom .25 25%
Normal Growth .45 15%
Recession .30 9%

The expected return on DFI's stock is

A. 15.7%.PROBABILITY *HPR ADD ALL STATE OF ECONOMY
B. 12.4%
C. 16.5%
D. 17.8%
E. 11.6%
17. An investment provides a 3% return semi-annually, its effective annual rate is
A. 3%
B. 6%
C. 6.06%
D. 6.09%=1+0.03squared-1
E. None of above
18. Which of the following statements regarding risk-averse investors is true?
A. They only accept risky investments that offer risk premiums over the risk-free rate.
B. They accept investments that are fair games.
C. They only care about rate of return.
D. They are willing to accept lower returns and high risk.
E. A and B.
19. Olivia is a risk-averse investor. Alex is a less risk-averse investor than Olivia. Therefore,
A. For the same risk, Alex requires a higher rate of return than Olivia.
B. For the same return, Alex tolerates higher risk than Olivia.
C. For the same risk, Olivia requires a lower rate of return than Alex.
D. For the same return, Olivia tolerates higher risk than Alex.
E. Cannot be determined.
20. Which statement about portfolio diversification is correct? Used to explain single index model after calculation
A. Proper diversification can reduce or eliminate systematic risk.
B.The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities
have been purchased.
C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.
D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a
decreasing rate.
E. None of the above statements are correct.
21. All things equal, diversification is most effective when...
A. Securities' returns are positively correlated.
B. Securities' returns are uncorrelated.
C. Securities' returns are high.
D. Securities' returns are negatively correlated.
E. A and C.
22. When an investment opportunity set is formed with two securities that are perfectly negatively correlated, the global minimum
variance portfolio has a standard deviation that is always.....
A. Equal to zero.
B. Greater than zero.
C. Equal to the sum of the securities' standard deviations
D. Equal to -1.
E. None of the above

23. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the Capital Allocation Line must....
A. Lend some of her money at the risk-free rate and invest the remainder in the optimal risky portfolio.
B. Borrow some money at the risk-free rate and invest in the optimal risky portfolio.
C. Such a portfolio cannot be formed
D. Invest only in risky securities.
E. B and D
24. Portfolio theory as described by Markowitz is most concerned with
A. The elimination of systematic risk.
B. The identification of unsystematic risk
C. The effect of diversification on portfolio risk.
D. Active portfolio management to enhance returns.
E. None of the above
25. A statistic that measures how the returns of two risky assets move together is
A. Correlation.
B. Standard deviation.
C. Covariance.
D. Variance.
E. A and C.
26. The individual investor's optimal portfolio is designated by
A. The point of tangency with the opportunity set and the capital allocation line.
B. The point of highest reward to variability ratio in the opportunity set.
C. The point of tangency with the indifference curve and the capital allocation line.
D. The point of the highest reward to variability ratio in the indifference curve.
E. None of the above
27. Security C has expected return of 12% and standard deviation of 20%. Security D has expected return of 15% and standard deviation
of 27%. If the two securities have a correlation coefficient of 0.7, what is their covariance?
A. 0.038
B. 0.070
C. 0.018
D. 0.013
E. 0.054
28. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is
A. Unique risk.
B. Beta.
C. Standard deviation of returns.
D. Variance of returns.
E. None of the above.
29. Which statement is not true regarding the market portfolio?
A. It includes all publicly traded financial assets.
B. It lies on the efficient frontier.
C. All securities in the market portfolio are held in proportion to their market values.
D. It is the tangency point between the capital market line and the indifference curve.
E. All of the above are true.
30. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to
A. Rf + β [E(RM)].
B. Rf + β [E(RM) – Rf].
C. β [E(RM) – Rf].
D. E(RM) + Rf.
E. None of the above.
31. The market risk, beta, of a security is equal to
A. The covariance between the security's return and the market return divided by the variance of the market's
returns.
B. The covariance between the security and market returns divided by the standard deviation of the market's
returns.
C. The variance of the security's returns divided by the covariance between the security and market returns
D. The variance of the security's returns divided by the variance of the market's returns.
E. None of the above.
32. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect a stock with a beta of 1.3 to offer a rate
of return of 12 percent, you should
A. Buy the stock because it is overpriced.
B. Sell short the stock because it is overpriced.
C. Sell the stock short because it is underpriced.
D. Buy the stock because it is underpriced.
E. None of the above, as the stock is fairly priced.
33. In a well diversified portfolio
A. Market risk is negligible.
B. Unsystematic risk is negligible.
C. Systematic risk is negligible.
D. Nondiversifiable risk is negligible.
E. None of the above
34. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13 and the
risk-free rate is 0.04. The beta of the stock is
A. 1.25
B. 1.7
C. 1.0
D. 0.95
E. None of the above
35. Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios?(relevent risk
factors)
A. The multifactor APT.
B. The CAPM.
C. Both the CAPM and the multifactor APT.
D. Neither the CAPM nor the multifactor APT.
E. None of the above is a true statement.
36. An investor will take as large a position as possible when an equilibrium price relationship is violated. This is an example of
_________.
A. A dominance argument
B. The mean-variance efficiency frontier
C. A risk-free arbitrage
D. The capital asset pricing model
E. None of the above
37. A zero-investment portfolio with a positive expected return arises when
A. An investor has downside risk only.
B. The opportunity set is not tangent to the capital allocation line.
C. A risk-free arbitrage opportunity exists.
D. The law of prices is not violated.
E. None of the above
38. The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the
_____________ implies that this relationship holds for all but perhaps a small number of securities.
A. APT, CAPM
B. APT, OPM
C. CAPM, APT
D. CAPM, OPM
E. None of the above
39. The APT differs from the CAPM because the APT...
A. Places more emphasis on market risk.
B. Recognizes multiple systematic risk factors.
C. Recognizes multiple unsystematic risk factors.
D. Minimizes the importance of diversification.
E. All of the above
40. The following factors might affect stock returns:
A. Interest rate fluctuations.
B. The business cycle.
C. Inflation rates.
D. A and B
E. All of the above
41. To take advantage of an arbitrage opportunity, an investor wouldI) short sell the asset in the low-priced market and buy it in the high-
priced market.II) construct a zero investment portfolio that will yield a sure profit.III) make simultaneous trades in two markets without
any net investment.IV) construct a zero beta investment portfolio that will yield a sure profit.
A. I and IV
B. I and III
C. II and III
D. I, III, and IV
E. II, III, and IV
42. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk premium on the first factor
portfolio is 4% and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and.8 on the
second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 9.2%
D. 13.0%
E. 13.2%
43. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical
stock prices and current public information about the firm, but not information that is available only to insiders.
A. Semistrong
B. Strong
C. Weak
D. All of them
E. None of them
44. UiProponents of the EMH typically advocate
A. An active trading strategy.
B. Investing in an index fund.
C. A passive investment strategy.
D. A and B
E. B and C
45. __________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
E. All of the above
46. _________ above which it is difficult for the market to rise.
A. Book value is a value
B. Resistance level is a value
C. Support level is a value
47. The debate over whether markets are efficient will probably never be resolved because of ________.
A. The lucky event issue.
B. The magnitude issue.
C. The selection bias issue.
D. All of the above.
E. None of the above
48. In an efficient market, __________.
A. Security prices react quickly to new information
B. security prices are seldom far above or below their justified levels
C. Security analysts will not enable investors to realize superior returns consistently
D. One cannot make money
E. A, B, and C
49. Conventional theories presume that investors ____________ and behavioral finance presumes that they ____________.
A. Are irrational; are irrational
B. Are rational; may not be rational
C. Are rational; are rational
D. May not be rational; may not be rational
E. May not be rational; are rational
50. ____________ may be responsible for the prevalence of active versus passive investments management.
A. Forecasting errors
B. Overconfidence
C. Mental accounting
D. Conservatism
E. Regret avoidance
51. If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors.
A. Framing
B. Selection bias
C. Overconfidence
D. Conservatism
E. Forecasting
52. Arbitrageurs may be unable to exploit behavioral biases due to ____________.I) fundamental riskII) implementation costsIII) model
riskIV) conservatismV) regret avoidance
A. I and II only
B. I, II, and III
C. I, II, III, and V
D. II, III, and IV
E. IV and V
53. __________ was the grandfather of technical analysis.
A. Harry Markowitz
B. William Sharpe
C. Charles Dow
D. Benjamin Graham
E. None of the above
54. A long-term movement of prices, lasting from several months to years is called _________.
A. A minor trend
B. A primary trend
C. An intermediate trend
D. Trend analysis
55. The Dow theory posits that the three forces that simultaneously affect stock prices are ____________.I) primary trendII)
intermediate trendIII) momentum trendIV) minor trendV) contrarian trend
A. I, II, and III
B. II, III, and IV
C. III, IV and V
D. I, II, and IV
E. I, III, and V
56. The current yield on a bond is equal to ________.
A. Annual interest divided by the current market price
B. The yield to maturity
C. Annual interest divided by the par value
D. The internal rate of return
E. None of the above
57. To earn a high rating from the bond rating agencies, a firm should have
A. A low times interest earned ratio.
B. A low debt to equity ratio.
C. A high quick ratio.
D. B and C.
E. A and C.
58. Ceteris paribus, the price and yield on a bond are
A. Negatively related.
B. Positively related.
C. Sometimes positively and sometimes negatively related.
D. Not related.
E. Indefinitely related.
59. The most widely used monetary tool is
A. Open market operations.
B. Altering the reserve requirements
C. Altering the discount rate.
D. Altering marginal tax rates.
E. None of the above.
60. Supply-side economists wishing to stimulate the economy are most likely to recommend
A. A decrease in the money supply.
B. A decrease in the tax rate.
C. An increase in the real interest rate.
D. A decrease in production output.
E. None of the above
61. The process of estimating the dividends and earnings that can be expected from the firm based on determinants of value is called
A. Business cycle forecasting.
B. Macroeconomic forecasting.
C. Fundamental analysis.
D. Technical analysis.
E. None of the above
62. If interest rates decrease, business investment expenditures are likely to ______ and consumer durable expenditures are likely to
_________.
A. Increase, increase
B. Increase, decrease
C. Decrease, increase
D. Decrease, decrease
E. Be unaffected, be unaffected
63. You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the
upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C _____.
A. Will be greater than the intrinsic value of stock D
B. Will be the same as the intrinsic value of stock D
C. Will be less than the intrinsic value of stock D
D. Cannot be calculated without knowing the rate of return on the market portfolio
E. None of the above is a correct statement.
64. The goal of fundamental analysts is to find securities
A. With high market capitalization rates.
B. With a positive present value of growth opportunities.
C. Whose intrinsic value exceeds market price.
D. All of the above
E. None of the above
65. A European put option allows the holder to
A. Buy the underlying asset at the striking price on or before the expiration date.
B. Sell the underlying asset at the striking price on or before the expiration date.
C. Potentially benefit from a stock price decrease with less risk than short selling the stock.
D. Sell the underlying asset at the striking price on the expiration date.
E. C and D.
66. An American call option allows the buyer to
A. Sell the underlying asset at the exercise price on or before the expiration date.
B. Buy the underlying asset at the exercise price on or before the expiration date.
C. Sell the option in the open market prior to expiration.
D. A and C.
E. B and C.
67. The maximum loss a buyer of a stock call option can suffer is equal to
A. The striking price minus the stock price
B. The stock price minus the value of the call.
C. The stock price.
D. The call premium.
E. None of the above
68. The intrinsic value of an out-of-the-money call option is equal to
A. The call premium.
B. The stock price minus the exercise price.
C. Zero.
D. The striking price.
E. None of the above
69. The maximum loss the writer of a stock put option can suffer is equal to
A. The striking price minus the put premium.
B. The striking price.
C. The stock price minus the put premium.
D. The put premium.
E. None of the above
70. Before expiration, the time value of a call option is equal to
A. Zero.
B. The actual call price plus the intrinsic value of the call.
C. The intrinsic value of the call.
D. The actual call price minus the intrinsic value of the call.
E. None of the above
71. The value of a stock put option is positively related to the following factors except
A. The time to expiration.
B. The stock price.
C. The striking price.
D. All of the above
E. None of the above
72. The expectations hypothesis of futures pricing
A. Is not a zero sum game.
B. States that the futures price equals the expected value of the future spot price of the asset
C. Is the simplest theory of futures pricing.
D. A and B
E. B and C
73. If a stock index futures contract is overpriced, you would exploit this situation by
A. Selling both the stock index futures and the stocks in the index.
B. Buying the stock index futures and selling the stocks in the index.
C. Buying both the stock index futures and the stocks in the index.
D. Selling the stock index futures and simultaneously buying the stocks in the index.
E. None of the above
74. Credit risk in the swap market
A. Is extensive.
B. Is equal to the total value of the payments that the floating rate payer was obligated to make.
C. Is limited to the difference between the values of the fixed rate and floating rate obligations.
D. A and C
E. None of the above
75. Commodity futures pricing
A. Converges to spot prices at maturity.
B. Includes cost of carry.
C. Must be related to spot prices.
D. All of the above are true.
E. None of the above
76. Suppose two portfolios have the same average return, the same standard deviation of returns, but portfolio X has a higher beta than
portfolio Y. According to the Sharpe measure, the performance of portfolio X
A. Is the same as the performance of portfolio Y.
B. Is better than the performance of portfolio Y.
C. Is poorer than the performance of portfolio Y
D. Cannot be measured as there is no data on the alpha of the portfolio.
E. None of the above
77. The __________ measures the reward to volatility trade-off by dividing the average portfolio excess return by the standard deviation
of returns.
A. Jensen measure
B. Treynor measure
C. Sharpe measure
D. Information ratio
E. None of the above
78. The M-squared measure
A. Considers only the return when evaluating mutual funds.
B. Considers only the market risk when evaluating mutual funds.
C. Considers only the total risk when evaluating mutual funds.
D. Considers the risk-adjusted return when evaluating mutual funds.
E. None of the above
79. If you were confident that the price of stock X would drop dramatically within two months, which of the following investment
transactions would yield the highest return on your investment?
A. Purchase stock X
B. Sell stock X short
C. Purchase a call on stock X
D. Purchase a put on stock X
80. What is the price of a stock estimated to pay a dividend of $.60 next year, if the dividend growth rate is 5% and the appropriate
discount rate is 8%?
A. $18
B. $19
C. $20
D. $21