finance test bank

Chapter Two Test Bank

Chapter Two Valuation, Risk, Return, and Uncertainty

A

1. An ordinary annuity is a _____ series of _____ cash. a. finite, constant b. finite, growing c. infinite, constant d. infinite, growing

B

2. The winner of a state lottery usually receives a(n) a. ordinary annuity b. annuity due c. growing annuity d. perpetuity

B

3. Using a discount rate of 8% per year, what is the present value of an ordinary annuity of $100 per year for 10 years? a. $1,000 b. $671 c. $887 d. $557

A

4. Using a discount rate of 8% per year, what is the present value of an annuity due of $100 per year with 10 payments? a. $725 b. $559 c. $793 d. $772

D

5. Using a discount rate of 8% per year (compounded quarterly), what is the present value of an ordinary annuity of $100 per year for 10 years? a. $726 b. $662 c. $811 d. $684

142


C

6. A perpetual cash flow stream makes its first payment of $500 in one year. Using a 7% annual discount rate and a 3% growth rate in the value of subsequent payments, what is the present value of this growing perpetuity? a. $2,000 b. $20,000 c. $12,500 d. $125,000

B

7. A perpetuity makes annual payments of $250. The perpetuity is valued using a 10% discount rate. What is the value of the perpetuity if the first payment is made immediately? a. $2,500 b. $2,750 c. $25,000 d. $2,525

A

8. The fact that most investors are risk averse means they will a. only take risks for which they are properly rewarded b. not take a risk c. not voluntarily take a risk d. not take a risk unless they know the outcome in advance

B

9. Which of the following statements is true? a. Some people are risk averse and others are not b. Some people are more risk averse than others c. Risk averse people will not take a risk d. Risk averse people are willing to settle for less return than risk neutral people

A

10. Risk must involve a. a chance of loss b. an unknown probability distribution c. actual dollars d. negative expected returns

C

11. Overall variability of returns is called a. systematic risk b. unsystematic risk c. total risk d. undiversifiable risk

143


B

12. Risk is often measured as a. central tendency of returns b. dispersion of returns c. expected value of returns d. possibility of negative returns

A

13. Riskier securities have _____ returns. a. higher expected b. lower realized c. higher instantaneous d. lower long-term

B

14. The market rewards investors for bearing _____risk. a. diversifiable b. undiversifiable c. unsystematic d. total

B

15. The diminishing marginal utility of money explains why a. some stocks sell for more than others b. most people will not take a fair bet c. people view the stock market as risky d. people tend to pay too much

C

16. The text described an example of the diminishing marginal utility of money with a statement made by a _____ player. a. hockey b. football c. tennis d. basketball

C

17. Individual investment behavior is more a function of _____ than _____. a. risk, expected return b. expected return, utility c. utility, expected return d. expected return, risk

B

18. The St. Petersburg paradox explains why a. some stocks sell for more than others b. most people will not take a fair bet c. people view the stock market as risky d. people tend to pay too much

144


A

19. In economic theory, if money is not saved, it is a. consumed b. invested c. unrealized d. deferred

D

20. Wearing a Rolex watch is an example of someone getting a. psychic return b. utility c. satisfaction d. all of the above

B

21. Two large classes of risk are a. systematic and undiversifiable b. price and convenience c. realized and psychic d. market and intermarket

C

22. Individual consumption decisions are a major factor in determining a. credit ratings of corporations b. dividend rates c. market interest rates d. levels of perceived risk

B

23. If a stock has a higher than average expected return, you would logically expect it is a. widely held by investors b. riskier than average c. in an industry with good prospects d. a well-managed company

D

24. What is the present value of a growing perpetuity with an initial cash flow of 1000 (C0), a growth rate of 3% per year (g), and a required rate of return of 8% (R)? a. $7777.64 b. $12,500 c. $20,000 d. $20,600

145


C

25. Most investors would not be interested in a fair bet because a. they would be concerned whether it is really fair b. investors do not willingly take a risk when it is possible to lose money c. losing a given amount of money would reduce utility more than winning the same amount would increase utility d. they accept only bets with a sure outcome

B

26. The holding period return is calculated as P1  P0 P0 P  P  income b. 1 0 P0 P  P  income c. 0 1 P0 P  P  income d. 1 0 P0

a.

C

27. You bought 100 shares of stock at $35, received $3 per share in dividends, and sold the shares for $50. Your holding period return is a. 36% b. $1,503 c. 51.4% d. $5,300

B

28. Which of the following is true of the holding period return? a. It considers the time value of money b. It is independent of the passage of time c. It explicitly considers risk d. It only considers capital gains or losses

C

29. A holding period return should only be compared with returns calculated a. over shorter periods b. over longer periods c. over periods of the same length d. over periods of the same length or less

D

30. A stock's return is 15.5%. The return relative is a. 0.845 b. -0.845 c. 0.155 d. 1.155

146


D

31. Return relatives are calculated primarily to deal with the potential problem of a. changing returns b. large returns c. zero returns d. negative returns

A

32. A stock has monthly returns of 4%, 5%, 2%, and -3%. Its arithmetic average return is a. 2% b. 3% c. 4% d. 5%

A

33. A stock has monthly returns of 4%, 5%, 2%, and -3%. Its geometric average return is a. 1.9% b. 2.1% c. 3.3% d. cannot be determined

B

34. You buy a stock for $50 per share. Over the next four months, it has monthly returns of 4%, 5%, 2%, and -3%. The value of a share at the end of the fourth month is a. $51.20 b. $54.02 c. $54.12 d. $56.45

A

35. Suppose a stock pays no dividends. Another method of calculating the return relative is a. b. c. d.

P1 P0 P0 P1 P1  P0 P0

P0  P1 P1

147


A

36. The arithmetic mean is always _______ the geometric mean. a. greater than or equal to b. greater than c. less than or equal to d. less than

A

37. The _____ the dispersion in a series of numbers, the ____ the gap between the arithmetic and geometric mean. a. greater, greater b. greater, smaller c. smaller, greater d. more predictable, less predictable

A

38. Technically, _____ refers to the past; _____ refers to the future. a. return, expected return b. realized return, return c. return relative, return d. return, return relative

C

39. According to the book, which of the following terms can mean different things to different people? a. Return on assets b. Return on equity c. Return on investment d. Return of principal

B

40. The use of _____ can dramatically affect an investor's return. a. historical data b. leverage c. arithmetic averages d. variance calculations

D

41. Total risk can be measured by all of the following EXCEPT a. variance b. standard deviation c. semi-variance d. arithmetic mean 42. The variance of x is 25. What is the variance of 2x? a. 25 b. 50 c. 75 d. 100

D

148


B

43. Semi-variance only considers a. extreme variation b. adverse variation c. unexpected variation d. anticipated variation

C

44. Discrete random variables are _____; continuous random variables are ______. a. quantifiable, unquantifiable b. objective, subjective c. counted, measured d. dependent, independent

B

45. A variable whose value is based on the value of other variables is a(n) a. independent variable b. dependent variable c. stochastic variable d. estimated variable

A

46. Random variables reside in a population a. sample b. continuous set c. discrete set

A

47. A jar contains a mixture of coins; you need a quarter. From your perspective, the distribution of coins in the jar is univariate a. bivariate b. trivariate c. multivariate 48. If a distribution shows more possible outcomes on one side of the mean than the other, the distribution shows a. uniformity b. normal characteristics c. random characteristics d. skewness

D

149


D

49. A coin-flipping experiment in which you measure heads or tails takes observations from a _____ distribution. a. chi-square b. exponential c. Poisson d. binomial

D

50. Which of the following is a measure of central tendency? a. Skewness b. Variance c. Kurtosis d. Mean

D

51. The expected value of a random variable is also called the a. skewness b. variance c. kurtosis d. mean

D

52. A jar contains 100 quarters, 50 dimes, and 50 nickels. What is the expected value of a single observation from this coin population? a. $0.375 b. $0.200 c. $0.133 d. $0.163

D

53. Which of the following can help reduce the effect of outliers? a. Rounding b. Regression c. Interpolation d. Logarithms

C

54. The expected value of x is 5%. What is E(6x)? a. 0.833% b. 5% c. 30% d. Cannot be determined

150


A

55. The correlation coefficient is equal to a.

~ cov(a~, b )

 a b ~ b. cov(a~, b ) a b

c.

~ cov(a~, b ) a

d. 1  [

b

~ cov(a~, b )

 a b

]

A

56. The minimum value of the correlation coefficient is a. -1 b. 0 c. +1 d. there is no minimum value

D

57. The minimum value of covariance is a. -1 b. 0 c. +1 d. there is no minimum value

A

58. R squared is a measure of a. goodness of fit b. partial dispersion c. central tendency d. skewness

B

59. A sample of 100 observations has a standard deviation of 25. What is the standard error? a. 5 b. 2.5 c. .25 d. Cannot be determined

C

60. A sample of 100 observations has a standard deviation of 25 and a mean of 75. What is the 95% confidence interval? a. 50  x  75 b. 73  x  77 c. 70  x  80 d. 74.5  x  75.5

151


B

61. The expected return on A is 12%; the expected return on B is 15%. What is the expected return of a portfolio that contains one-third A and the remainder B? a. 12% b. 14% c. 15% d. 13.5%

A

62. A tilde (~) over a symbol indicates it is a a. random variable b. constant c. continuous random variable d. discrete random variable

B

63. If two securities are negatively correlated, their covariance is a. positive b. negative c. zero d. cannot be determined

C

64. The covariance between a random variable and a constant is a. negative b. positive c. zero d. non-negative

A

65. Return is the a. benefit associated with an investment b. realized gain from an investment c. realized and unrealized gain from an investment d. measurable gain from an investment

C

66. Assume the risk-free rate is constant over time. The correlation between the return on security x and the return on the risk-free asset is a. negative b. positive c. zero d. cannot be determined without further information

152


A

67. The correct method for measuring the average return over several periods in the past is with a(n) a. geometric mean b. arithmetic mean c. statistical mean d. multiple variation mean

B

68. Using semivariance to measure risk is appropriate if the return distribution is a. symmetrical b. not symmetrical c. normally distributed d. uniformly distributed

C

69. The median of a distribution is the a. arithmetic average b. geometric average c. point where half of the observations lie on either side d. value that occurs most frequently

D

70. If the variance of x is 0.10, what is the variance of 2x? a. 0.05 b. 0.10 c. 0.20 d. 0.40

B

71. If the standard deviations of Stock A and B are 0.20 and 0.30 respectively and the COV(A,B) equals 0.012, what is the correlation coefficient? a. 0.00072 b. 0.20 c. 0.30 d. 2 Chapter Three Setting Portfolio Objectives

A

1. Two dominant factors contributing to a successful investment program are a. suitable investment objectives and policy, and successful managers b. suitable investment objectives and risk assessment c. successful managers and successful income generation d. accurate risk assessment and measurement of historical return

B

2. To an investment professional, which of the following provides no growth? 153


a. b. c. d.

Real estate Savings accounts Common stock Corporate bonds

B

3. With bequests, a semantic problem sometimes develops with regard to the meaning of the terms a. growth and income b. principal and interest c. risk and return d. present value and future value

D

4. A good example of the issue of multiple portfolio beneficiaries is found in people a. who want income and those who want growth b. who are risk averse and those who are not c. who pay taxes and those who do not d. today and people tomorrow

A

5. Which of the following deals with decisions that have been made about longterm investment activities, eligible investment categories, and the allocation of funds among the eligible investment categories? a. Investment policy b. Investment strategy c. Investment tactics d. Investment standards

C

6. All of the following are principal portfolio objectives EXCEPT a. stability of principal b. capital appreciation c. growth and income d. income

A

7. If someone wants no chance of a loss of principal value, the appropriate primary objective is a. stability of principal b. income c. growth of income d. capital appreciation 154


C

8. If someone is concerned about inflation eroding purchasing power of regular income, the appropriate primary objective is a. stability of principal b. income c. growth of income d. capital appreciation

D

9. A young, well-paid professional is best suited, on average, to which primary objective? a. Stability of principal b. Income c. Growth of income d. Capital appreciation

D

10. In the early years, which primary objective generally results in the least income? a. Stability of principal b. Income c. Growth of income d. Capital appreciation

A

11. A growth-of-income objective a. sacrifices some current return for some purchasing power protection b. generates maximum income as soon as possible c. makes only sparing use of equity securities d. generates income that declines over time

B

12. Tax-free income can be earned by investing in a. corporate bonds b. municipal bonds c. treasury bonds d. common stock

C

13. All investors seek to a. maximize their expected return b. minimize their risk exposure c. maximize their expected utility d. minimize the number of their capital losses

155


B

14. Some people do not like mutual funds because they a. have no tax advantages b. are not exciting c. offer less potential return than that available in securities d. are too risky

D

15. Establishing a secondary objective helps the portfolio manager a. learn more about the client's tax situation b. learn more about the client's expected utility of investment c. determine the appropriate level of risk for the customer d. determine the necessary level of equity investment

C

16. Which of the following primary/secondary objective combinations is infeasible? a. Stability of principal, income b. Income, stability of principal c. Growth of income, stability of principal d. Capital appreciation, growth of income

A

17. Which of the following primary/secondary objective combinations is infeasible? a. Stability of principal, growth of income b. Income, growth of income c. Growth of income, capital appreciation d. Income, capital appreciation

B

18. Which of the following primary/secondary objective combinations is infrequent? a. Stability of principal, growth of income b. Income, capital appreciation c. Growth of income, capital appreciation d. Growth of income, stability of principal

A

19. A disadvantage of portfolio splitting is that it a. enables overseers to avoid making tough decisions b. reduces current income c. reduces the potential for capital appreciation d. sacrifices liquidity

A

20. A common third category of investment (in addition to bonds and stock) is a. cash equivalents b. municipal securities 156


c. American depository receipts d. repurchase agreements A

21. Another name for portfolio dedication is a. liability funding b. technical analysis c. fundamental analysis d. strategic investment

B

22. Cash matching involves assembling a portfolio such that it a. has the duration desired b. has a cash flow stream that matches the requirements of a liability stream c. optimizes the risk/return combination d. is informationally efficient

A

23. Principal concerns in duration matching are the a. present value of the outflows and their duration b. future value of the outflows and their duration c. annuity value of the outflows d. certainty equivalent of the outflows and the present value of its duration

D

24. To reduce the duration of a bond portfolio, managers often use a. shares of common stock b. hard asset investments c. preferred stock shares d. treasury bills

C

25. The first mutual fund was founded in a. 1776 b. 1815 c. 1924 d. 1957

C

26. The approximate number of mutual funds in the United States is a. 100 b. 1,000 c. 10,000 d. 30,000

A

27. Which of the following trades on a stock exchange? a. A closed-end fund b. An open-end fund 157


c. Any mutual fund d. Any investment company C

28. For an open-end mutual fund a. net asset value < market value b. net asset value > market value c. net asset value = market value d. net asset value is greater than or equal to market value

C

29. If you buy shares in a load fund, you will pay a. net asset value b. less than net asset value c. more than net asset value d. cannot be determined

A

30. Before buying mutual fund shares, prospective investors must receive a a. prospectus b. indenture c. debenture d. hypothecation agreement

B

31. The portfolio objective with the highest risk is a. stability of principal b. capital appreciation c. income d. growth of income

D

32. A client’s need for liquidity might best be addressed by a. investing in growth industry stocks b. investing in real estate c. increasing the proportion of bonds in the portfolio d. investing a portion of the portfolio in assets with checkwriting privileges

158


A

33. Money market mutual funds are sometimes added in a portfolio to a. reduce the duration b. increase the duration c. move from an income objective to a growth in income objective d. decrease the short-term tax consequences

D

34. An objective to lower the short-term taxes for a client might be addressed by including a. stocks in the utilities industry b. short-term U.S. Treasury securities c. long-term U.S. Treasury securities d. municipal bonds

C

35. A no-load mutual fund means there are no a. management fees b. 12 b-1 fees c. selling fees d. stocks that pay dividends in this mutual fund

B

36. A redemption fee is a cost to the a. manager of a mutual fund to pay for poor investment decisions b. manager of a mutual fund when he resigns c. investor of a mutual fund on the sale of shares d. investor of a mutual fund when performance is poor

D

37. A mutual fund prospectus provides a. a forecast of future fund performance b. a forecast of the macroeconomy over the next year c. a forecast of the expected tax consequences over the next year d. provides the fund’s purpose and intended investment activity

A

38. The majority of mutual funds can be classified as a. stock funds b. taxable bond funds c. municipal bond funds d. money market funds

D

39. Which of the following deal with decisions that have been made about longterm decisions? a. Investment constraints b. Fiduciary interest c. Investment strategy d. Investment policy 159


Chapter Four Investment Policy

C

1. Retirement plans in the United States are subject to a. FDRC b. FERC c. ERISA d. ESSES

A

2. All of the following are purposes of an investment policy statement EXCEPT a. identify portfolio manager b. identify target return c. identify investment constraints d. provide a mechanism for evaluation

B

3. Clients are responsible for all of the following EXCEPT a. defining long-range objectives b. asset allocation c. ensuring managers follow the investment policy d. establishing investment policy

D

4. The investment manager is responsible for all of the following EXCEPT a. educating the client regarding infeasible objectives b. monitoring the portfolio c. revising the portfolio as necessary d. establishing investment policy

B

5. In the Bailard, Biehl, and Kaiser classification system what kind of person is impetuous and anxious? a. Individualist b. Celebrity c. Adventurer d. Guardian

A

6. In the Bailard, Biehl, and Kaiser classification system what kind of person is confident and careful? a. Individualist b. Celebrity c. Adventurer d. Guardian

160


C

7. In the Bailard, Biehl, and Kaiser classification system what kind of person is impetuous and confident? a. Individualist b. Celebrity c. Adventurer d. Guardian

D

8. All of the following are true regarding an endowment fund EXCEPT a. it is not-for-profit b. churches and universities often have one c. it has a board of trustees or directors d. is has a maximum life of 75 years

B

9. An endowment is most similar to a a. defined contribution pension plan b. foundation c. property and casualty insurance company d. mutual fund

C

10. The legal literature speaks of the ______ between the needs of current beneficiaries and future beneficiaries. a. parsimony b. symbiosis c. creative tension d. rational expectations

A

11. An investor’s tendency to look at their investment portfolio too often is partially explained by a phenomenon known as a. myopic loss aversion b. absolute risk aversion c. time and state preference d. mental accounting

D

12. Surplus management is most associated with a. mutual funds b. endowment funds c. foundations d. insurance companies

161


C

13. The single most important investment decision is a. time horizon b. investment strategy c. asset allocation d. risk assessment

B

14. A good performance benchmark should be a. published in a national financial newspaper like the Wall Street Journal b. investable c. composed equally of stocks and bonds d. revised as market conditions change

B

15. All of the following are infeasible return objectives EXCEPT a. maintain purchasing power with 100% probability b. average a 9% rate of return over a five year average c. earn a 10% rate of return each calendar year d. ensure the value of the fund never falls below the initial principal and that it produces an annual yield of 7%

A

16. Most states have adopted the a. Uniform Management of Institutional Funds Act b. Foundation Policy Act c. Uniform Statement of Investment Policy d. Safe Harbor Institutional Security Statement

D

17. Major categories of constraints in the investment policy statement include all of the following EXCEPT a. tax situation b. liquidity needs c. legal considerations d. benchmarking

A

18. Purposes of an endowment fund include all of the following EXCEPT a. raise the visibility of the institution b. help maintain operating independence c. provide operational stability d. provide a margin of excellence

B

19. The two main types of pension funds are a. defined contribution and variable contribution b. defined contribution and defined benefit c. fixed annuity and variable annuity d. equity based and fixed income based 162


D

20. The investment policy of which of the following is mostly liability driven? a. Mutual fund b. Property and casualty insurance company c. Foundation d. Life insurance company

A

21. Characteristics of a good investment policy statement include all of the following EXCEPT a. revised quarterly b. realistic c. unambiguous to an outsider d. sustainable over prior periods

B

22. The investment policy is the responsibility of the a. investment manager b. client c. ERISA administrators d. SEC

C

23. Enforcing the ERISA regulations is the responsibility of a. investment managers b. the Federal Reserve c. the Department of Labor d. the SEC

D

24. The investment policy statement should be changed if there is a material change in a. economic conditions b. the performance of the portfolio c. the allocation of assets in the portfolio d. the clients financial condition

C

25. A foundation is a. the section of an investment policy statement that specifies the primary goals and objectives of an investor b. the first section of an investment policy statement c. an organization designed to aid the arts, education, research or general welfare d. a legal document outlining the portfolio management principles to be followed

163


D

26. A fiduciary is a. an investor with experience managing investments b. an investor with little experience managing investments c. an investment advisor to those managing investments d. someone responsible for the management of someone else’s money

A

27. Socially responsible investing based on religious beliefs is known as a. faith-based investing b. denominational investing c. religious fund management d. life ethics investing Chapter Five The Mathematics of Diversification

A

1. The work of Harry Markowitz is based on the search for a. efficient portfolios b. undervalued securities c. the highest long-term growth rates d. minimum risk portfolios

B

2. Securities A and B have expected returns of 12% and 15%, respectively. If you put 30% of your money in Security A and the remainder in B, what is the portfolio expected return? a. 13.4% b. 14.1% c. 14.6% d. 15.3%

B

3. Securities A and B have expected returns of 12% and 15%, respectively. If you put 40% of your money in Security A and the remainder in B, what is the portfolio expected return? a. 13.4% b. 13.8% c. 14.6% d. 15.3%

B

4. The variance of a two-security portfolio decreases as the return correlation of the two securities a. increases b. decreases 164


c. changes in either direction d. cannot be determined D

5. A security has a return variance of 25%. The standard deviation of returns is a. 5% b. 15% c. 25% d. 50%

C

6. A security has a return variance of 16%. The standard deviation of returns is a. 4% b. 16% c. 40% d. 50%

A

7. Covariance is the product of two securities' a. expected deviations from their means b. standard deviations c. betas d. standard deviations divided by their correlation

C

8. The covariance of a random variable with itself is a. its correlation with itself b. its standard deviation c. its variance d. equal to 1.0

D

9. Covariance is _____ correlation is ______. a. positive, positive or negative b. negative, positive or negative c. positive or negative, positive or zero d. positive or negative, positive or negative

C

10. For a six-security portfolio, it is necessary to calculate ___ covariances plus ___ variances. a. 36, 6 b. 30, 6 c. 15, 6 d. 30, 12

165


B

11. COV (A,B) = .335. What is COV (B,A)? a. - 0.335 b. 0.335 c. (0.335 x 0.335) d. Cannot be determined

A

12. One of the first proponents of the single index model was a. William Sharpe b. Robert Merton c. Eugene Fama d. Merton Miller

B

13. Without knowing beta, determining portfolio variance with a sixty-security portfolio requires ___ statistics per security. a. 1 b. 60 c. 3600/2 d. 3600

B

14. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of an equally weighted portfolio of all three? a. 1.15 b. 1.40 c. 1.55 d. 1.60

B

15. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of a portfolio composed of 1/2 A and 1/4 each of B and C? a. 1.15 b. 1.35 c. 1.55 d. 1.60

B

16. A diversified portfolio has a beta of 1.2; the market variance is 0.25. What is the diversified portfolio’s variance? a. 0.33 b. 0.36 c. 0.41 d. 0.44

B

17. Security A has a beta of 1.2; security B has a beta of 0.8. If the market variance is 0.30, what is COV (A,B)? a. .255 166


b. .288 c. .314 d. .355 B

18. As portfolio size increases, the variance of the error term generally a. increases b. decreases c. approaches 1.0 d. becomes erratic

C

19. The least risk portfolio is called the a. optimum portfolio b. efficient portfolio c. minimum variance portfolio d. market portfolio

B

20. Industry effects are associated with a. the single index model b. the multi-index model c. the Markowitz model d. the covariance matrix

A

21. COV (A,B) is equal to a. the product of their standard deviations and their correlation b. the product of their variances and their correlation c. the product of their standard deviations and their covariances d. the product of their variances and their covariances

A

22. The covariance between a constant and a random variable is a. zero b. 1.0 c. their correlation d. the product of their betas

D

23. The covariance between a security's returns and those of the market index is 0.03. If the security beta is 1.15, what is the market variance? a. 0.005 b. 0.010 c. 0.021 d. 0.026

167


D

24. COV(A,B) = 0.50; the variance of the market is 0.25, and the beta of Security A is 1.00. What is the beta of security B? a. 1.00 b. 1.25 c. 1.50 d. 2.00

D

25. There are 1,700 stocks in the Value Line index. How many covariances would have to be calculated in order to use the Markowitz full covariance model? a. 1,700 b. 5,650 c. 12,350 d. 1,444,150

A

26. There are 1,700 stocks in the Value Line index. How many betas would have to be calculated in order to find the portfolio variance? a. 1,700 b. 5,650 c. 12,350 d. 1,444,150

A

27. Knowing beta, determining the portfolio with a sixty-security fully diversified portfolio requires ______ statistic(s) per security. a. 1 b. 60 c. 3600/2 d. 3600

A

28. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the expected return for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 17% b. 19% c. 21% d. 23%

168


B

29. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 15.8% b. 18.4% c. 22.0% d. 28.0%

A

30. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 0.57 b. 0.77 c. 0.97 d. 1.17

A

31. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the covariance between Stock A and Stock B? a. 0.015 b. 0.025 c. 0.035 d. 0.045

C

32. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the percent invested in Stock A to yield the minimum standard deviation portfolio containing Stock A and Stock B? a. 25% b. 50% c. 75% d. 90%

C

33. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 169


0.25. What is the expected return for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 18% b. 19% c. 20% d. 21%

B

34. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 15% b. 20% c. 23% d. 25%

C

35. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 0.425 b. 0.625 c. 0.825 d. 1.125

B

36. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 70% invested in Stock M and 30% invested in Stock N? a. 11% b. 13% c. 15% d. 17%

C

37. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 170


0.50. What is the standard deviation for a portfolio with 70% invested in Stock M and 30% invested in Stock N? a. 12.5% b. 13.6% c. 15.7% d. 18.0%

B

38. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the covariance between Stock M and Stock N? a. 0.01052 b. 0.01875 c. 0.03425 d. 0.04775

D

39. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the percent invested in Stock M to yield the minimum standard deviation portfolio containing Stock M and Stock N? a. 34% b. 55% c. 73% d. 92%

A

40. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 80% invested in Stock M and 20% invested in Stock N? a. 12% b. 14% c. 16% d. 18%

B

41. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the standard deviation for a portfolio with 80% invested in Stock M and 20% invested in Stock N? 171


a. b. c. d.

A

13.2% 15.1% 17.3% 21.5%

42. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the beta for a portfolio with 80% invested in Stock M and 20% invested in Stock N? a. 0.688 b. 0.738 c. 0.878 d. 0.968

The next 8 questions relate to the following table of information: Stock X Expected Return 14% Standard Deviation 40% Beta 1.20 Correlation (X,Y) = 0.25

Stock Y 18% 54% 1.50

C

43. What is the expected return for a portfolio with 60% invested in X and 40% invested in Y? a. 14.4% b. 14.9% c. 15.6% d. 16.1%

B

44. What is the standard deviation for a portfolio with 60% invested in X and 40% invested in Y? a. 32.4% b. 36.1% c. 41.2% d. 45.6%

C

45. What is the beta for a portfolio with 60% invested in X and 40% invested in Y? 172


a. b. c. d.

1.12 1.22 1.32 1.42

D

46. What is the covariance between Stock X and Stock Y? a. 0.025 b. 0.033 c. 0.047 d. 0.054

D

47. What is the percent invested in Stock X to yield the minimum variance portfolio with Stock X and Stock Y? a. 0.21 b. 0.38 c. 0.51 d. 0.69

D

48. What is the expected return for a portfolio with 20% invested in X and 80% invested in Y? a. 14.9% b. 15.6% c. 16.5% d. 17.2%

B

49. What is the standard deviation for a portfolio with 20% invested in X and 80% invested in Y? a. 41.2% b. 45.8% c. 47.1% d. 49.6%

D

50. What is the beta for a portfolio with 20% invested in X and 80% invested in Y? a. 1.14 b. 1.24 c. 1.34 d. 1.44 Chapter Six 173


Why Diversification is a Good Idea

A

1. Risk averse people only take risks when a. they believe they will be rewarded for doing so b. they have to c. it is necessary to guarantee an additional realized return d. actual returns are below expected return

C

2. The collection of eligible investments is called the a. eligible set b. efficient set c. security universe d. principal components

C

3. A security dominates another if a. it offers the same expected return with less risk b. it offers higher expected return for the same risk c. both a and b d. none of the above

B

4. In the absence of a riskfree rate, the minimum variance portfolio a. is usually efficient b. is always efficient c. is never efficient d. is usually the optimal portfolio

A

5. Portfolios that are not dominated a. lie on the efficient frontier b. are minimum risk portfolios c. have maximum expected returns d. have low correlations

A

6. With the availability of a riskfree rate, the efficient frontier becomes a. linear b. curved c. shaped like a letter S d. less attractive by moving down and to the right

C

7. Portfolios _____ do not exist. 174


a. b. c. d.

at the far right of the efficient frontier at the far left of the efficient frontier above the efficient frontier below the efficient frontier

A

8. The line passing through the risk free rate and the market portfolio is called the a. market line b. optimum combination line c. dominant line d. unlevered investment line

C

9. According to the separation theorem, all investors should hold a. as many securities as possible b. as many uncorrelated securities as possible c. only the risk-free rate and the market portfolio d. only two risky portfolios on the efficient frontier

D

10. Efficient portfolios to the left of the market portfolio are called a. borrowing portfolios b. fully invested portfolios c. dominant portfolios d. lending portfolios

A

11. Most computer output of efficient portfolios lists only the a. corner portfolios b. odd-numbered portfolios c. low variance portfolios d. maximum return portfolios

D

12. The Markowitz algorithm is an application of a. linear programming b. goal programming c. integer programming d. quadratic programming

C

13. What is the beta of the risk-free asset? a. –1.0 b. –0.5 c. 0 d. 1.0

B

14. The value of a negative beta asset is 175


a. b. c. d.

the higher expected return of this asset the risk reducing properties when added to a portfolio that it is a necessary component to have a fully diversified portfolio non-existent because negative beta assets are theoretically impossible

C

15. The Security Market Line relates expected return to a. standard deviation b. variance c. beta d. there is no relationship of the SML with expected returns

B

16. The Security Market Line is a a. curved line which passes through the risk-free rate and the Market portfolio b. straight line which passes through the risk-free rate and the Market portfolio c. line which dominates all assets except those on the efficient frontier d. line tangent to the efficient frontier

A

17. Beta is usually calculated using the a. market model b. SML c. CML d. security variances Chapter Seven International Investment and Diversification

C

1. In the U.S., a typical allocation to international stocks would be a. 1-2% b. 5-7% c. 10-20% d. 30-50%

C

2. U.S. equities represent about _________ of the world’s equity capitalization. a. 8% b. 17% c. 51% d. 83%

176


B

3. When the Evans and Archer study is repeated with a security universe that includes international securities, the level of systematic risk a. increases b. decreases c. remains unchanged d. there is no relation between systematic risk and the Evans and Archer study

C

4. For a portfolio with only U. S. securities, market risk accounts for about ___ of a security's total risk. a. 5% b. 17% c. 27% d. 54%

B

5. A study by Solnik indicates that systematic risk could be reduced to about ______ for a portfolio including both U.S. and international stocks. a. 6.2% b. 11.7% c. 19.6% d. 27.1%

B

6. The correlation among securities on European exchanges is generally a. decreasing b. increasing c. remaining unchanged d. cannot be determined

D

7. According to a study by Bruno Solnik, what percentage of total risk can be diversified away by holding international securities? a. One half b. Five eighths c. Three fourths d. Seven eighths

C

8. Globally, the number of equity securities is about a. 100,000 b. 250,000 c. 1 million 177


d. 100 million A

9. The changing relationships among currencies of interest to you constitute ______ risk. a. foreign exchange b. political c. social d. international

B

10. If something costs NZ$110 and the exchange rate between the New Zealand dollar and the U. S. dollar is $0.5855/NZ$, what is the cost in U. S. dollars? a. $58.55 b. $64.41 c. $110.00 d. $187.88

B

11. Suppose someone holds a security denominated in Australian dollars. If the Australian value of the security does not change but the U. S. dollar depreciates relative to the Australian dollar, the security holder has a a. paper loss b. paper gain c. realized gain d. realized loss

D

12. An investor purchased a security for ¥10,000 when the exchange rate was ¥750/$. He later sold the security for ¥12,000 and the exchange rate had changed to ¥850/$. What was the holding period return from a US investor's perspective? a. -5.9% b. -2.3% c. 2.3% d. 5.9%

A

13. An investor's exchange rate “frame of reference” is called the a. currency of account b. exchange rate c. nominal rate d. international standard

D

14. The nominal rate of interest is a function of all of the following EXCEPT a. real rate b. inflation rate c. risk premium d. prime rate 178


C

15. The current price of a foreign currency is the ___ rate. a. forward b. futures c. spot d. delivery

A

16. The contractual rate between a bank and a client for the future delivery of foreign exchange is the ___ rate. a. forward b. futures c. spot d. delivery

A

17. A U. S. storekeeper who entered into an obligation to pay Swiss francs for a delivery of goods could hedge the foreign exchange risk by a. entering into a forward contract to buy Swiss francs b. entering into a forward contract to deliver Swiss francs c. buying a foreign currency which is negatively correlated with the Swiss franc d. buying a foreign currency which is positively correlated with the Swiss franc

A

18. Forward rates reflect differences in a. national interest rates b. risk premiums c. the time value of money d. tax treatment

B

19. Inflation in the home country causes the value of the home currency to ____ in the global market. a. appreciate b. depreciate c. fluctuate d. change

D

20. The text described an example of purchasing power parity using a. automobiles b. bottles of wine c. airline tickets d. Big Mac hamburgers

179


B

21. The extent to which you face foreign exchange risk is a. nominal risk b. exposure c. political risk d. arbitrage risk

B

22. A foreign currency exchange forward contract priced at a discount means the a. forward rate is larger than the spot rate b. spot rate is larger than the forward rate c. forward rate minus the risk premium is negative d. spot rate minus the risk premium is negative

A

23. The type of foreign exchange risk exposure that a portfolio manager is most concerned with is a. economic exposure b. translation exposure c. transaction exposure d. accounting exposure Chapter Eight The Capital Markets and Market Efficiency

B

1. Capital markets trade securities with a life of a. less than one year b. more than one year c. more than ten years d. more than fifteen years

A

2. The most important function of the capital markets is the ___ function. a. economic b. continuous pricing c. fair price d. taxation

A

3. Which function of the capital markets facilitates the flow of capital from savers to borrowers? a. Economic b. Continuous pricing c. Fair price d. Taxation

180


B

4. Which function of the capital markets enables market participants to get accurate, up-to-date price information? a. Economic b. Continuous pricing c. Fair price d. Taxation

C

5. The ______ function of the capital markets removes the fear of buying or selling at an unreasonable price. a. economic b. continuous pricing c. fair price d. taxation

D

6. Fair pricing of securities is associated with the a. fair pricing theory b. separation theorem c. central limit theorem d. efficient market hypothesis

A

7. The “efficiency” referred to in the efficient market hypothesis is ______ efficiency. a. informational b. operational c. taxation d. inflation adjusted

C

8. The weak form of the efficient market hypothesis states that _____ are of no use in predicting future stock prices. a. balance sheets b. earnings reports c. charts d. annual reports

D

9. People who employ charting techniques in the analysis of securities are called a. operational security analysts b. fundamental security analysts c. informational security analysts d. technical security analysts

D

10. To an investment professional, which of the following is most important? a. Past prices b. Past and present prices 181


c. Future prices d. Present and future prices A

11. A means of investigating the weak form of market efficiency is via a _____ test. a. runs b. charting c. subjective d. psychological

D

12. How many runs are in the following sequence? HHHTTTHTHTHHHTTH a. 6 b. 7 c. 8 d. 9

B

13. The _____ form of the efficient market hypothesis states that security prices fully reflect all relevant publicly available information. a. weak b. semi-strong c. strong d. semi-efficient

B

14. Tests regarding stock splits or dividends are usually tests of the _____ form of market efficiency. a. weak b. semi-strong c. strong d. semi-efficient

C

15. Inside information is associated with the ____ form of market efficiency. a. weak b. semi-strong c. strong d. semi-efficient

D

16. The notion that some stocks are priced more efficiently than others is associated with the a. weak form of the EMH b. semi-strong form of the EMH c. strong form of the EMH 182


d. semi-efficient market hypothesis D

17. The random walk idea says that a. stock prices move randomly b. interest rates change randomly c. the stock market averages change randomly d. the news arrives randomly

A

18. In finance, the term _____ is associated with an unexplained result that deviates from that expected by finance theory. a. anomaly b. paradigm c. inefficiency d. abnormal profit

B

19. There is some evidence that ___ PE stocks outperform stocks with ____ PEs. a. high, lower b. low, higher c. extreme, more normal d. median, more unusual

A

20. The small firm effect states that a. firms with low capitalizations outperform larger firms b. firms with high capitalizations outperform smaller firms c. firms with average capitalizations outperform average size firms d. firms with large or small capitalizations outperform average size firms

A

21. Stock returns are inexplicably high in a. January b. May c. September d. November

B

22. A subfield of physics that is being applied to finance is a. quantum mechanics b. chaos theory c. angular momentum d. harmonic motion

B

23. Which of the following is a Fibonacci number? 183


a. b. c. d.

12 13 14 15

A

24. An odd thing about Fibonacci numbers is a. the frequency with which they appear in nature b. their predictive ability c. the fact that they are all even d. the fact that they are all odd

B

25. The first five Fibonacci numbers are 1, 1, 2, 3, and 5. What is the sixth? a. 6 b. 8 c. 12 d. Cannot be determined

D

26. Leonardo Fibonacci discovered the sequence of numbers that bears his name while exploring a. the stars b. the behavior of ants c. scores of dart contests d. the reproduction rates of rabbits

C

27. Which of the following is NOT one of the three primary functions of capital markets? a. Economic function b. Continuous pricing function c. Social welfare function d. Fair price function

C

28. The small firm effect means that a. small firms affect the market more than large firms b. small firms affect the market less than large firms c. low capitalization stocks tend to have a higher risk-adjusted return d. low capitalization stocks tend to have a lower risk-adjusted return

A

29. The neglected firm effect means a. stocks with a small security analyst following have a higher return b. stocks with a large security analyst following have a higher return c. stocks that investment managers monitor frequently have a higher return

184


d. stocks that investment managers monitor infrequently have a higher return B

30. The overreaction effect states that for stocks that experience extreme longterm gains or losses a. past winners significantly outperform past losers b. past losers significantly outperform past winners c. security analysts tend to exaggerate the impact of new information d. security analysts tend to dampen the impact of new information

C

31. The day of the week effect states that the returns on a. Tuesday and Thursday are higher than Monday, Wednesday, and Friday b. Monday, Wednesday, and Friday are higher than Tuesday and Thursday c. Monday are lower than returns on Wednesday and Friday d. Monday are higher than returns on Wednesday and Friday Chapter Nine Picking the Equity Players

A

1. The three kinds of dividends firms pay are a. stock, cash, and property b. stock, special, and regular c. cash, special, and regular d. monthly, quarterly, and year-end

B

2. Securities held on your behalf by a broker are a. held in a margin account b. held in a street name c. registered in your name with the issuing company d. ineligible for corporate dividends

D

3. Which of the following is an odd lot? a. 100 shares b. 500 shares c. 11,000 shares d. 11,300 shares

C

4. A spin-off is similar to a a. stock split b. stock dividend c. property dividend 185


d. cash dividend A

5. Rights are associated with a. new stock issues b. new bond issues c. any new security issue d. newly incorporated firms

C

6. The third date in the dividend payment chronology is the a. date of declaration b. ex-dividend date c. date of record d. date of payment

B

7. Stock prices tend to fall on the a. date of declaration b. ex-dividend date c. date of record d. date of payment

B

8. A company's date of record for a dividend is September 15. Which of the following is most likely to be the ex-dividend date? a. September 1 b. September 12 c. September 19 d. October 1

A

9. Dividend growth rates are of primary importance to a. fundamental analysts b. technical analysts c. original analysts d. chartists

B

10. A stock's current dividend is $4.56; ten years ago it was $2.88. What has been the average annual dividend growth rate? a. 4.0% b. 4.7% c. 5.6% d. 6.6%

186


C

11. A stock sells for $28; its current dividend is $1.00, and its dividend growth rate is 4.4%. What is the shareholder's required rate of return? a. 6.6% b. 7.7% c. 8.1% d. 8.8%

A

12. The dividend growth rate should be calculated via the _____ mean. a. geometric b. arithmetic c. harmonic d. standardized

D

13. To illustrate why dividends do not matter, the text used a _____ example. a. used car b. new car c. paint can d. shoebox

A

14. Dividend policy is associated with which of the following subfields within finance? a. Signaling b. Optimum capital structure c. Market anomalies d. Technical analysis

D

15. A stock split in which shareholders hold fewer shares after the split is a a. forward split b. direct split c. indirect split d. reverse split

A

16. The primary motivation for a stock split is usually a desire to a. reduce the stock price b. reduce the dividend requirement c. reduce the number of shares outstanding d. reduce earnings per share

D

17. A 25% stock dividend is equivalent to a 187


a. b. c. d.

2 for 1 stock split 1 for 2 stock split 4 for 5 stock split 5 for 4 stock split

A

18. Blue chip stocks generally a. have a long uninterrupted history of dividend payments b. are not growth stocks c. have high dividend payout ratios d. have high price-earnings ratios

D

19. A steel company is probably a _____ stock. a. blue chip b. income c. defensive d. cyclical

C

20. A retail food company is a good example of a _____ stock. a. blue chip b. income c. defensive d. cyclical

D

21. Which of the following pairs of stock categories are mutually exclusive? a. Income, blue chip b. Growth, penny c. Income, defensive d. Cyclical, defensive

B

22. If a stock symbol contains a period, this means a. it trades over the counter b. there is more than one class of stock c. it is a preferred stock d. it trades on the American Stock Exchange

D

23. The correct sequence in the dividend payment chronology is the a. date of record, date of declaration, ex-dividend date, date of payment b. date of declaration, date of record, ex-dividend date, date of payment c. date of declaration, date of record, date of payment, ex-dividend date d. date of declaration, ex-dividend date, date of record, date of payment

188


C

24. A company just paid a dividend of $2.00 per share. Five years ago, the company paid a dividend of $1.00 per share. What is the average growth rate in dividends? a. 8% b. 10% c. 15% d. 20%

D

25. A company just paid a dividend of $3.00 per share. Four years ago, the company paid a dividend of $2.00 per share. You expect the dividend payment to continue growing at this same rate indefinitely into the future. If the required rate of return on equity is 14% per year, what would be a fair price for this stock today? a. 27.09 b. 48.70 c. 90.09 d. 99.65

B

26. A company plans to pay a dividend of $2.00 next year and expects the dividend will grow 6% per year indefinitely into the future. If the required rate of return on equity is 12%, what would be a fair price for this stock today? a. 27.33 b. 33.33 c. 35.33 d. 43.33

B

27. A company just paid a dividend of $1.50 and expects the dividend will grow 7% per year indefinitely into the future. If the required rate of return on equity is 13%, what would be a fair price for this stock today? a. 25.00 b. 26.75 c. 30.25 d. 35.75

B

28. A company plans to pay a dividend of $1.40 next year, $1.60 the following year, and $1.80 three years from now. Thereafter, it is expected that the dividend will grow 5% per year indefinitely into the future. If the required rate of return is 14%, what would be a fair price for this stock today? a. 15.39 b. 17.85 c. 21.00 d. 22.80

189


Chapter Ten Equity Valuation Tools

B

1. Which of the following is most accurate? a. The present value of a stock is usually less than the current stock price. b. The present value of a stock equals the current stock price. c. The future value of a stock is greater than the current stock price. d. The future value of a stock is less than the current stock price.

A

2. In valuing a stock, in the long run ____ are (is) most important. a. earnings b. dividends c. psychology d. risk assessment

B

3. A stock sells for $30, has a required rate of return of 12%, and current earnings of $2.50. Its present value of growth opportunities (PVGO) is a. $20.83 b. $9.17 c. $30.00 d. $250.00

D

4. An investor assigns a required rate of return of 13% to a stock selling for $45 with a P/E ratio of 22. What percentage of the firm’s current value comes from growth opportunities? a. 25% b. 45% c. 55% d. 65%

A

5. A stock sells for $45. An analyst assigns a required rate of return of 12% to the stock. If the analyst subsequently raises the required rate of return, the present value of growth opportunities will a. decrease b. be unaffected c. increase d. initially decrease but return to the original value

190


D

6. EBITDA is also called a. cash flow from operations b. net income c. operating income d. operating cash flow

B

7. Free cash flow differs from cash flow from operations in that it accounts for a. interest expense b. capital expenditures c. dividends d. loan proceeds

B

8. An advocate of the PEG ratio usually looks for a ratio less than a. 0 b. 1.0 c. 10.0 d. 100.0

A

9. GARP stands for a. growth at a reasonable price b. generalized auto regressive program c. guaranteed account review procedure d. gross accounting residual process

B

10. A firm has a return on equity of 12% and a dividend payout rate of 45%. Its sustainable growth rate is a. 5.4% b. 6.6% c. 21.8% d. 26.7%

A

11. You calculate that a stock has an implied required rate of return of 15%, a $2.00 current dividend (D0), and a 5% dividend growth rate. If the required rate of return increases to 16%, the stock price will a. fall by $1.91 b. fall by $2.33 c. rise by $1.91 d. rise by $2.33

191


B

12. Which of the following is the correct formulation of the Greenspan model? a. S&P 500 P/E minus the 10-year bond yield b. 10-year bond yield minus the S&P 500 earnings yield c. 10-year bond yield minus the S&P 500 P/E d. S&P 500 earnings yield minus the 10-year bond yield

B

13. Which of the following is associated with a Greenspan model value of zero? a. Market undervaluation b. Fair market valuation c. Market overvaluation d. The Greenspan model cannot equal zero.

D

14. Which of the following is true regarding a company’s trailing versus forwardlooking Price/Earnings ratio? a. The trailing P/E will normally exceed the forward P/E b. The trailing P/E will normally be less than the forward P/E. c. The trailing and forward looking P/E will normally be equal. d. There is no necessary relationship between the trailing and the forward P/E.

D

15. A stock sells for $23.67 and currently pays a $0.44 annual dividend. If the market expects a 14% rate of return on this stock, what dividend growth rate do these figures imply? a. 7.2% b. 8.7% c. 10.2% d. 11.9% Chapter Eleven Security Screening

B

1. The primary motivation for stock screening is e. f. g. h.

C

the efficient market hypothesis lack of time lack of research material the implications of the efficient frontier

2. Common screens described in the text include all of the following EXCEPT

192


e. f. g. h. D

3. All of the following are characteristics of a good screen EXCEPT e. f. g. h.

A

ease of administration relevance and appropriateness acceptance to the user historical precedent

4. An investment service that ranks securities on both timeliness and safety is e. f. g. h.

A

SAT scores speed in the 40-yard dash hobbies bench press ability

Value Line Moody's Weissenberger's Standard and Poor's

5. Which of the following timeliness and safety rankings is preferred? e. f. g. h.

1,1 1,5 3,3 5,1

193


A

6. Which of the following publications is published each month with the entire publication conveniently fitting in a briefcase? e. f. g. h.

D

7. A set of screening criteria dealing with South Africa is the _______ principles. e. f. g. h.

A

The PE ratio The current ratio Return on assets Times interest earned

10. The primary objective of a security screen is to e. f. g. h.

B

MacBride Sutherland England Sullivan

9. Which of the following is a common screening criterion available from a local newspaper? e. f. g. h.

A

MacBride Sutherland England Sullivan

8. A set of screening criteria dealing with Ireland is the _____ principles. e. f. g. h.

A

S&P Stock Guide S&P Stock Report Value Line Investment Survey Moody's Manual of Investments

reduce the security universe in size find the best potential investment reduce portfolio risk increase portfolio dividends

11. A quick risk assessment can be accomplished by a historical comparison of e. f. g. h.

current ratio and debt ratio ROA and ROE dividend yield and PE payout ratio and plowback ratio 194


A

12. Shadow stocks are identified by the e. f. g. h.

C

13. A popular computerized mutual fund screen is published by e. f. g. h.

B

Computer Systems, Inc. American Portfolios Limited Business Week Dynamic Funds

14. Which of the following would NOT be strictly associated with socially responsible investing? e. f. g. h.

D

American Association of Individual Investors Value Line Investment Survey Standard & Poor's Corporation Dun and Bradstreet Corporation

CERES AAIA Sullivan McBride

15. Which of the following has a one-page summary of information on 1700 companies including 15 years of key financial information, a 3-5 year forecast, an historical stock price and volume chart, and a brief write-up describing the primary lines of business with current and future prospects? a. b. c. d.

S&P Stock Guide Business Week quarterly review Wall Street Journal annual review Value Line Chapter One The Process of Portfolio Management

B

1. Classical security analysis is sometimes called a. ABC analysis b. EIC analysis c. GBY analysis d. CPI analysis

195


C

2. The modern trend in investments is to ______ security analysis and ______ portfolio management. a. emphasize, emphasize b. emphasize, de-emphasize c. de-emphasize, emphasize d. de-emphasize, de-emphasize

B

3. Portfolio management is primarily concerned with a. increasing return b. reducing risk c. predicting the future d. explaining the past

D

4. Most of the academic literature of the past two decades has supported the a. arbitrage pricing theory b. benefits of high PE stocks c. usefulness of stock charts d. efficient markets paradigm

A

5. “The lower the dispersion in returns, the greater the accumulated value of otherwise equal investments.” This statement is a. true b. false c. true for the short run, but not necessarily true for the long run d. true for the long run, but not necessarily true for the short run

D

6. ______ is cheap in the investment business. a. Risk b. Return c. Time d. Talk

A

7. Which of the following is a key concept in finance? a. A dollar today is worth more than a dollar tomorrow b. Regardless of anything else, the higher the stock price, the better c. Regardless of anything else, the lower the risk, the better d. Risk averse people will not take a risk

B

8. Understanding ______ is essential to bond portfolio management. a. convexity b. duration c. semi-variance d. bond betas 196


C

9. According to the book, the first step in portfolio management is a. setting portfolio objectives b. formulating an investment strategy c. learning the basic principles of finance d. having a game plan for portfolio revision

B

10. A portfolio should have both ______ and ______ objective. a. a short term, a long term b. a primary, a secondary c. an initial, a final d. an explicit, an implicit

A

11. One of the most consequential bits of academic research regarding portfolio construction is a paper by a. Evans and Archer b. Andrew and McLaughlin c. Lawrence and Philippatos d. Miles and Ezzell

B

12. ______ is a topic in this textbook that most others omit. a. Real estate b. Security screening c. Performance evaluation d. Principles of the futures market

C

13. Real assets discussed in this book include a. art b. rare coins c. timberland d. diamonds

D

14. Which of the following is a popular means of increasing income from a portfolio? a. Selling bonds b. Selling stock short c. Buying put options d. Option overwriting

A

15. Portfolio protection was called ______ until the stock market crash in 1987. a. portfolio insurance b. portfolio hedging c. dynamic hedging 197


d. arbitrage D

16. In this text, the chapter on contemporary issues includes all of the following EXCEPT a. tactical asset allocation b. stock lending c. program trading d. put-call parity

C

17. A stock is a good investment if the company is a. well-run b. in a growing industry c. poorly run but the stock is underpriced d. extremely popular among investors

B

18. As an introduction, the two key concepts in finance are a. buy low and sell high b. the time value of money and adjustment for risk c. be patient, but strike when the time is right d. manage earnings and save judiciously

A

19. According to Chapter 1, should investors invest in stocks today? a. Yes, because it can be a costly decision to try to time the market b. Yes, because the economy looks good now c. No, because the market is too high now d. No, because the market is too volatile now Chapter Twelve Bond Pricing and Selection

D

1. Bonds are identified by all of the following EXCEPT a. issuer b. maturity c. coupon d. rating

B

2. How much interest does an XYZ 7s09 bond pay each year? a. 9% of par b. 7% of par c. 7.09% of par d. Cannot be determined

198


B

3. The details of a bond issue are contained in the a. debenture b. indenture c. confirmation statement d. call agreement

A

4. U. S. treasury bonds are ______ issues. a. full faith and credit b. secured c. subordinated d. corporate

B

5. Which of the following is the correct order of increasing maturity? a. Bills, bonds, notes b. Bills, notes, bonds c. Notes, bills, bonds d. Notes, bonds, bills

C

6. Which of the following are most similar? a. Bills and notes b. Bills and bonds c. Notes and bonds d. They are all equally similar

B

7. A debenture is like a _____ loan. a. secured b. signature c. automobile d. mortgage

A

8. Which of the following is most likely to be financed by a revenue bond? a. Bridge b. Low-income housing complex c. Fleet of corporate automobiles d. Airplane

B

9. Treasury bonds have an initial life of more than ___ years. a. five b. ten c. fifteen d. twenty 199


C

10. Debt that uses land and buildings as collateral is a _____ loan. a. collateral trust b. equipment trust c. mortgage d. senior

C

11. A cash reserve for the ultimate repayment of bond principal is a a. reserve fund b. depreciation fund c. sinking fund d. interest-only fund

B

12. A fleet of trucks might logically be financed with a. collateral trust bonds b. equipment trust certificates c. mortgages d. treasury bonds

A

13. A loan with a large final payment is a _____ loan. a. balloon b. escrow c. inflated d. descending

B

14. A bond on which the interest is payable only if it is earned is a(n) ____ bond. a. sinking fund b. income c. subordinated d. full faith and credit

C

15. An income bond is most likely to be associated with financing which of the following? a. An apartment complex b. A public highway c. A toll bridge d. Capital improvements to a park

B

16. Typical bond cash flows include all of the following EXCEPT a. annuity plus lump sum b. growing annuity plus lump sum c. perpetuity 200


d. lump sum only C

17. An example of a variable rate security is a a. fixed rate mortgage b. consol c. U. S. savings bond d. zero coupon bond

B

18. A ____ company issued a famous commodity-backed convertible bond. a. soybean processing b. silver mining c. sugar refining d. savings and loan

C

19. New debt may no longer be issued in _____ form. a. book entry b. registered c. bearer d. convertible

B

20. If you hold a bond certificate with your name on it, it is a _____ bond. a. book entry b. registered c. bearer d. convertible

A

21. Newly issued bonds issued by the U. S. Treasury are in _____ form only. a. book entry b. registered c. bearer d. convertible

C

22. An individual who wishes to buy a U. S. Treasury bond must open an account through the a. Federal Reserve System b. Security Investor Protection Corporation c. Treasury Direct System d. Federal Deposit Insurance Corporation

C

23. The clipping of coupons is associated with _____ bonds. a. book entry b. registered c. bearer 201


d. convertible A

24. To solve for a bond's yield to maturity with semi-annual interest payments a. divide the discount rate by two and double the number of periods b. divide the discount rate by two and halve the number of periods c. multiply the discount rate by two and double the number of periods d. multiply the discount rate by two and halve the number of periods

C

25. You own $5,000 par of the XYZ 8s of 09. The bond paid interest six months ago, and pays again tomorrow. How much is the next interest check? a. $40 b. $80 c. $200 d. $400

C

26. You own $5,000 par of the XYZ 8s of 09; they sell for 94% of par. The bond paid interest six months ago, and pays again tomorrow. How much is the next interest check? a. $376 b. $188 c. $200 d. $400

C

27. A consol is valued as a a. level annuity b. annuity due c. perpetuity d. growing perpetuity

B

28. The quantity



t 1

a. b. c. d. C

C

 (1  R)

t

equals

CxR C÷R CR RC

29. What is the value of a consol that pays $100 per year if the required rate of return is 8%? a. $800 b. $1000 202


c. $1250 d. $1500 A

30. The yield to maturity calculation assumes that _____ are reinvested at the yield to maturity. a. coupon proceeds b. sinking fund payments c. the principal payments d. dollars equal to the purchase price

D

31. A specific yield to maturity can only be locked in with which of the following bonds? a. consol b. variable rate c. convertible d. zero coupon

C

32. The effective annual rate is also called the a. arithmetic mean return b. geometric mean return c. realized compound yield d. internal rate of return

C

33. If a bond sells for par a. current yield exceeds the yield to maturity b. current yield is less than the yield to maturity c. current yield equals yield to maturity d. none of the above

A

34. If a bond sells at a premium a. current yield exceeds the yield to maturity b. current yield is less than the yield to maturity c. current yield equals yield to maturity d. none of the above

B

35. If a bond sells at a discount a. current yield exceeds the yield to maturity b. current yield is less than the yield to maturity c. current yield equals yield to maturity d. none of the above 203


A

36. If a bond sells at a premium, its price a. must decline over time b. must rise over time c. will remain relatively constant over time d. will be very volatile over time

D

37. Someone who relies on investment income for living expenses is most concerned with a. internal rate of return b. yield to maturity c. realized compound yield d. current yield

C

38. The yield curve is normally a. flat b. descending c. upward sloping d. none of the above

B

39. The yield curve normally has a ____ first derivative and a _____ second derivative. a. positive, positive b. positive, negative c. negative, positive d. negative, negative 40. If all interest rates rise by a similar amount, this is a _____ in the yield curve. a. parallel shift b. stochastic aberration c. non-parallel shift d. non-stochastic aberration

A

B

41. Corporate bonds rated BBB will show a _____ of yield curve than U. S. Treasury bonds. a. lower level b. higher level c. flatter plot d. steeper plot

B

42. Forward interest rates are mostly associated with the _____ theory of interest rate structure. a. liquidity premium b. expectations 204


c. inflation premium d. normal backwardation B

43. Two-year certificates of deposit yield 5.00%; a one-year CD has a 4.66% rate. What is the one-year forward rate? a. 4.66% b. 5.34% c. 5.66% d. 5.77%

B

44. If the expectations theory of interest rates is accurate, the only explanation for an upward sloping yield curve is a. fear of inflation b. an expectation that interest rates will continually increase c. demand for liquidity d. risk aversion

A

45. According to the liquidity premium theory of interest rates a. forward rates are actually higher than the expected interest rate b. forward rates are actually lower than the expected interest rate c. forward rates are equal to the expected interest rate d. none of the above

B

46. A $1000 par bond has a conversion price of $33.50. Its conversion ratio is a. $29.85 b. 29.85 shares c. $33,500 d. 33,500 shares

C

47. A $1000 par bond sells for $900 and has a conversion ratio of 25 shares. If the underlying stock price is $35, the conversion value is a. $25 b. $100 c. $875 d. $935

B

48. A convertible bond's ____ should never be _____ than its _____. a. conversion value, less, market value b. conversion value, more, market value c. conversion ratio, less, conversion price 205


d. conversion price, less, conversion ratio C

49.

For a convertible bond, an arbitrage profit would be available if the conversion value is a. positive b. negative c. greater than the market value d. less than the market value

D

50. For a convertible bond, the difference between the bond price and the conversion value is know as the a. intrinsic value b. residual value c. discount under conversion value d. premium over conversion value

A

51. The maximum level of accrued interest with most bonds occurs _____ times a year. a. two b. four c. six d. twelve

A

52. The amount a bond buyer pays is a. bond price + accrued interest + brokerage fees b. bond price – accrued interest + brokerage fees c. accrued interest – bond price + brokerage fees d. accrued interest – bond price – brokerage fees

C

53. How much interest has accrued on an 8%, $1000 par bond seven days after the last interest payment date? a. None b. $1.00 c. $1.53 d. $40.00

C

54. Credit risk is also called a. interest rate risk b. purchasing power risk c. default risk 206


d. reinvestment rate risk C

55. Standard & Poor's bond ratings measure a. interest rate risk b. purchasing power risk c. default risk d. reinvestment rate risk

C

56. The demarcation between investment grade bonds and junk bonds is the S&P _____ rating. a. AAA b. AA c. BBB d. B

A

57. _____ is a leading bond rating service. a. Moody's Investors Service b. Weissenberger's Investment Service c. Value Line Investment Survey d. Morningstar

A

58. The fact that bond prices change as market interest rates change is a result of a. interest rate risk b. purchasing power risk c. default risk d. reinvestment rate risk

A

59. Which of the following has no interest rate risk? a. Non-negotiable certificate of deposit b. U. S. Treasury bond c. Corporate bond d. Mortgage

A

60. Call risk is a type of _____ risk. a. convenience b. market c. interest rate d. default

D

61. If a bond is called, the bondholder often receives a. less than the par value b. the par value minus the last coupon payment c. the par value minus the last year's coupon payment 207


d. the par value plus a call premium C

62. The _____ the _____ on a bond, the higher its reinvestment rate risk. a. higher, yield to maturity b. lower, yield to maturity c. higher, coupon d. lower, coupon

C

63. Marketability risk refers to a. the possibility of selling a bond for less than the price paid b. the possibility of having the bond called c. the difficulty in selling a bond d. the magnitude of the total bond risk

B

64. Bond prices move _____ with market yields. a. directly b. inversely c. exponentially d. logarithmically

D

65. A famous set of bond pricing relationships is a. Kondradiev's theorems b. the Dow theory c. Fibbonacci theorems d. Malkiel's theorems

B

66. _____ term bonds have more _____ risk. a. Longer, reinvestment rate b. Longer, interest rate c. Shorter, reinvestment rate d. Shorter, interest rate

A

67. _____ coupon bonds have more _____ risk. a. Higher, reinvestment rate b. Higher, interest rate c. Lower, reinvestment rate d. Lower, interest rate

D

68. If interest rates fall,  t is the price change in a bond with “t” years until maturity. Suppose there are four bonds:  2 ,  4 ,  22 ,  24 . If the bonds are identical in every respect except for their maturity, which of the following statements is true?

208


a. b. c. d.

( 2 ( 2 ( 2 ( 2

-

4 ) > 0 4 ) = 0  4 ) - (  22 -  24 ) > 0  4 ) - (  22 -  24 ) < 0

A

69. Malkiel's theorem five deals with a. bond capital gains and losses b. changing default risk levels c. declining interest rates d. call risk

B

70. The principal value of duration is the fact that a. it makes knowledge of default risk unnecessary b. it incorporates Malkiel's theorems in a single expression c. it incorporates default risk into interest rate risk d. it eliminates the reinvestment rate risk problem

D

71. A definition of duration is a. the weighted average life of a bond b. the weighted average value of a bond's cash flows c. the weighted average of the bond's marketability d. the weighted average time until cash flows occur

A

72. In calculating duration via the traditional method, the “weights” reflect the a. time value of money b. level of default risk c. level of interest rate risk d. cost of capital

A

73. If a $1,000 par value bond has a coupon rate of 6% with interest paid semiannually, a maturity of 12 years, and a yield-to-maturity of 7%, what is the current price of this bond? a. $919.71 b. $989.71 c. $1014.71 d. $1062.71

209


B

74. If a $1,000 face value bond has a coupon rate of 5.5% with interest paid semiannually, a maturity of 15 years, and a yield to maturity of 4.5%, what is the current price of this bond? a. $854.66 b. $1108.23 c. $1162.89 d. $1242.72

B

75. If a $1,000 face value bond has a coupon rate of 6.5% with interest paid semiannually, a maturity of 11 years, and a current price of 1090.34, what is the annual yield-to-maturity of this bond? a. 2.7% b. 5.4% c. 5.8% d. 6.8%

C

76. If a $1,000 par value bond has a coupon rate of 7% with interest paid semiannually, a maturity of 18 years, and a current price of $1,235, what is the annual yield-to-maturity of this bond? a. 2.5% b. 4.3% c. 5.0% d. 6.4%

A

77. If a $1,000 face value zero coupon bond has a maturity of 15 years and a yield-to-maturity of 6%, what is the current price of this bond? a. $417.27 b. $518.27 c. $635.51 d. $782.48

B

78. If a $1,000 face value zero coupon bond has a maturity of 22 years and is currently priced at $521.89, what is the annual yield-to-maturity? a. 2% b. 3% c. 4% d. 5%

210


B

79. What is the duration of a $1,000 par value bond with a coupon rate of 8%, a yield-to-maturity of 6%, and 4 years left to maturity? (Assume annual coupon payments) a. 3.25 years b. 3.59 years c. 3.72 years d. 3.86 years

B

80. What is the duration of a $1,000 par value bond with a coupon rate of 6%, a yield-to-maturity of 5%, and 2 years left to maturity? (Interest payments are made semi-annually.) a. 1.7 years b. 1.9 years c. 2.0 years d. 3.8 years Chapter Thirteen The Role of Real Assets

B

1. Classical characteristics of land include all of the following EXCEPT a. it is immobile b. it is fungible c. it is indestructible d. it is non-income producing

B

2. Which of the following is a financial asset? a. Gold bar b. Stock certificate c. Automobile d. Office building

D

3. Which of the following is a real asset? a. Corporate bond b. Government bond c. Twenty dollar bill d. Computer

D

4. ______ property is a legal interest in real estate. a. Personal b. Proprietary c. Financial d. Real 211


A

5. Which of the following is a characteristic of a financial asset? a. It has a corresponding liability b. It produces income c. It usually shows price appreciation d. It usually generates no income

D

6. The majority of institutional landowners are looking for a. annual cash flows b. long-term price appreciation c. short-term price appreciation d. a mix of annual cash flows and long-term price appreciation

B

7. Of their investments in real estate, pension funds have about ____ of their money in timberland. a. 2% b. 4% c. 8% d. 12%

A

8. Usual motivations for timberland investment include all of the following EXCEPT a. regulatory defense b. collateral c. pure investment d. strategic investment

A

9. State governments with large investments in timberland are a. California and New Hampshire b. Missouri and Maine c. Alabama and Texas d. Pennsylvania and New Jersey

B

10. Growing trees are called a. land stands b. stumpage c. wood on the hoof d. volume land

C

11. Conditions that make a section of land different than the surrounding terrain are called a. biological factors 212


b. fungibility factors c. microsite factors d. acquisition factors D

12. A trained forest appraiser knows to look for forests undergoing a. a species shift b. a micro site shift c. mutual canopy support d. a product class shift

A

13. Timberland losses due to fire, insects, and disease total less than _____ per year. a. 0.2% b. 2% c. 5% d. 10%

B

14. Clear-cutting may be appropriate if a forest depends on a. river drainage b. mutual canopy support c. wetland waterfowl d. animal grazing

A

15. A significant inhibition to timberland investment has historically been a. the lack of a standard timberland index b. adverse Internal Revenue Service rulings c. high commission costs d. inability to generate income

A

16. One study indicates that the correlation coefficient between timberland and the S&P500 index is about a. -.50 b. 0 c. .50 d. .95

C

17. A common motivation for the purchase of gold is a. income generation b. tax advantages c. the security it provides 213


d. a substitute for equity securities D

18. The price of gold is fixed daily in a. Budapest b. Washington, D. C. c. Amsterdam d. London

A

19. The largest percentage of privately held gold is in a. France b. United States c. India d. Saudi Arabia

C

20. Which of the following is generally not a driving force behind gold price movements? a. Inflation b. The strength of foreign currencies c. Supply d. Demand

A

21. The primary advantage of gold certificates is a. convenience b. tax reasons c. added income producing ability d. added security against corporate default

D

22. For a U. S. coin in circulation, which of the following is usually highest? a. Numismatic value b. Intrinsic value c. Popular value d. Fiat value

C

23. Which of the following is not an official gold coin issued by a government? a. South African Krugerrand b. Canadian Maple Leaf c. Congolese Harmonica d. Chinese Panda

B

24. Land is widely considered to be a a. mobile investment b. long-term investment c. fungible investment 214


d. financial asset B

25. Which of the following is not a way to invest in gold? a. Bullion b. Gold ADRs c. Gold certificates d. Shares in gold mining companies Chapter Fourteen Alternative Assets

D

1. A new infrastructure project is a _____ project. a. blue field b. red field c. gold field d. greenfield

B

2. In the context of infrastructure investing, “PPP” stands for a. per-person project b. public/private partnership c. progressive project program d. programmed premium project

A

3. Which of the following is a characteristic of most infrastructure projects? a. long life b. unstable cash flows c. little leverage d. liquid

C

4. A primary objective of most hedge funds is a. maximum capital appreciation b. income generation c. stable returns d. high correlation with the broad equity market.

D

5. All of the following are common hedge fund strategies except a. directional b. arbitrage/relative value c. long/short d. constant proportion

215


A

6. “Drawdown” is primarily a measure of a fund’s a. volatility b. profitability c. turnover d. management fee

B

7. A primary disadvantage of a hedge fund-of-funds is a. added risk b. higher expenses c. a tax disincentive d. high correlation

A

8. Institutional investors seeking exposure to commodities normally use a. futures contracts b. individual equity positions c. physical assets d. investment contracts

C

9. Venture capital is a type of a. hedge fund b. municipal bond c. private equity d. infrastructure project

A

10. The typical profitability pattern of private equity investments is called the a. J curve b. S curve c. U curve d. V curve

B

11. A strategy described as 130/30 involves a. equity and bonds b. long and short positions c. futures and options d. short and long-term investments

A

12. Mezzanine financing is analogous to a a. second mortgage b. margin loan c. unsecured signature loan d. zero coupon bond 216


Chapter Fifteen Revision of the Equity Portfolio

B

1. In an active management strategy, the composition of the portfolio is e. static f. dynamic g. determined in advance and not changed h. revised very seldom

B

2. A strategy of passive management is one in which, once established, the portfolio is e. readjusted on a regular basis f. largely left alone g. readjusted at the manager's discretion h. only readjusted if prices decline

B

3. Naive strategies e. should never be used f. are not necessarily bad ones g. are only appropriate with small portfolios of stock h. are seldom in the investor's best interest

D

4. Which of the following is a naive strategy? e. Constant beta f. Constant proportion g. Laddered portfolio h. Buy and hold

A

5. Common methods of stock portfolio rebalancing include all of the following EXCEPT e. maintaining a constant price earnings ratio f. maintaining a constant beta g. indexing h. maintaining a constant proportion

B

6. Many investors try to avoid e. blue chip stocks f. odd lots g. no-load mutual funds h. stocks with no beta 217


B

7. The purchase of odd lots sometimes involves e. added risk f. a slightly higher commission cost g. a tax disincentive h. slightly lower dividends

C

8. Round lots are especially important to the e. bond investor f. short-term investor g. option user h. speculator

B

9. A portfolio revision strategy that makes use of a “multiplier” is e. constant mix f. constant proportion portfolio insurance g. dollar cost averaging h. constant beta

C

10. A portfolio has a floor value of $4 million, a market value of $7 million, and a multiplier of 1.5. The investment in stock should be e. $2 million f. $2.5 million g. $4.5 million h. $6 million

A

11. A portfolio has a floor value of $4 million, a market value of $7 million, and a multiplier of 1.5. The portfolio will be 100% invested in stock when the portfolio value is e. $12 million f. $14 million g. $16 million h. $18 million

C

12. Which of the following statements is most accurate? e. A CPPI strategy sells stock as it rises f. A CPPI strategy fares best in a declining market g. Market volatility does not help a CPPI strategy h. A CPPI strategy also must maintain a constant mix

218


D

13. A portfolio has a floor value of $4 million, a market value of $7 million, and a multiplier of 1.5. The portfolio will be 100% invested in bonds when the portfolio value is a. $12 million b. $10 million c. $8 million d. $4 million

A

14. A constant mix strategy does best in a _____ market. a. volatile b. declining c. rising d. flat

B

15. When stocks outperform bonds, rebalancing a portfolio with a constant mix strategy containing stocks and bonds requires a. buying stocks and selling bonds b. buying bonds and selling stocks c. buying stocks and bonds d. selling stocks and bonds

C

16. Comparing a constant mix strategy and a CPPI strategy, in a rising market a. both the constant mix and CPPI strategy buy stocks b. both the constant mix and CPPI strategy sell stocks c. the constant mix strategy sells stock while the CPPI strategy buys stock d. the constant mix strategy buys stock while the CPPI strategy sells stock

C

17. A constant mix strategy for portfolio rebalancing means a. constantly changing the mix between stocks and bonds to time the market b. constantly changing the individual stocks contained in the equity asset allocation category c. maintaining the same relative weighting of asset categories d. increasing or decreasing the amount of funds in a portfolio depending on the expected return

A

18. Suppose you are managing a $1,000,000 portfolio of stocks and bonds with a constant mix strategy of 50% stocks and 50% bonds. If the stock market increases 20% and the bond market increases 10%, rebalancing would require a. selling $25,000 in stocks and buying $25,000 in bonds b. selling $25,000 in bonds and buying $25,000 in stocks c. selling $50,000 in stocks and buying $50,000 in bonds d. selling $50,000 in bonds and buying $50,000 in stocks 219


D

19. A CPPI portfolio has a floor value of $4 million in stocks, a market value of $7 million, and a multiplier of 1.5. If the value of the portfolio increases 20%, the investment in stocks should be a. $4.4 million b. $4.8 million c. $5.4 million d. $6.6 million

A

20. A CPPI portfolio has a floor value of $4 million in stocks, a market value of $7 million, and a multiplier of 1.5. If stocks increase by 20% and bonds increase by 12%, rebalancing requires buying $900,000 in stocks and selling $900,000 in bonds a. buying $900,000 in bonds and selling $900,000 in stocks b. buying $1,200,000 in stocks and selling $1,200,000 in bonds c. no action because a CPPI portfolio is passively managed

A

21. A stock portfolio designed to mimic a market index but with fewer stocks will likely have less tracking error if it has a a. beta of 1 and a high R2 b. beta of 1 and a low R2 c. beta of 0 and a high R2 d. beta of 0 and a low R2

B

22. Which of the following would increase the portfolio beta? a. Selling stocks with low unsystematic risk and buying stocks with high unsystematic risk b. Selling Treasury Bills in the portfolio and buying stocks with low systematic risk c. Selling stocks with high systematic risk and buying stocks with low systematic risk d. Shifting new funds to the portfolio and buying stocks with low systematic risk

D

23. Successful implementation of which of the following is inconsistent with the efficient market hypothesis? a. Short selling b. Stock lending c. Certificateless trading d. Tactical asset allocation

220


A

24. The hardest part of a tactical asset allocation strategy is a. asset class appraisal b. product class shifting c. determining covariances d. determining the swing component

D

25. Investment strategies are commonly grouped into all of the following categories EXCEPT a. anticipatory b. reactive c. static d. variable

A

26. The ideal investment strategy is a. anticipatory b. reactive c. static d. variable

B

27. The key element of tactical asset allocation is a. duration matching b. properly investing the swing component c. dollar cost averaging d. immunization

B

28. Dollar cost averaging involves _____ investments over time. a. declining b. constant c. rising d. proportional

D

29. Largely cosmetic changes that are made to a portfolio near the end of a reporting period are called a. churning the cheese b. Bait and Switch (B/S) reporting c. padding the scorecard d. window dressing Chapter Eighteen Option Overwriting

221


D

1. The most common motivation for option overwriting is a. risk management b. tax reduction c. leverage d. income generation

A

2. If someone writes a call while owning the underlying asset, the call is a. covered b. long b. naked c. cash-secured

B

3. A long position is a(n) a. long-term investment b. owned asset c. borrowed asset d. a position with a paper gain

B

4. If a person writes a covered call with a striking price of $45 and receives $3 in premium, exercise will occur if the stock price is above ____ on expiration day. a. $42 b. $45 c. $48 d. $50

C

5. If stock is purchased at $50 and a $55 call is written for a premium of $2, the maximum possible gain per share is a. $2 b. $5 c. $7 d. $10

A

6. If you buy a call option with a striking price of $50 for $3 1/2, your maximum loss is a. $3 ½ b. $46 ½ c. $50 d. unlimited

B

7. Which of the following strategies has the highest possible loss? a. Buying a call b. Writing a naked call c. Writing a covered call 222


d. Buying a put D

8. Which of the following terms is least common? a. Long call b. Short call c. Covered call d. Covered put

A

9. Writing a covered call results in a position similar to a a. fiduciary put b. long put c. long call d. long stock position

B

10. Fiduciary puts are also called a. regulatory puts b. cash-secured puts c. long puts d. uncovered puts

A

11. If someone writes a put, they usually want the underlying asset to a. go up b. go down c. stay unchanged d. fluctuate

B

12. If someone writes a naked call, they usually want the underlying asset to a. go up b. go down c. stay unchanged d. fluctuate

A

13. If someone writes an in-the-money put, they usually want the underlying asset to a. go up b. go down c. stay unchanged d. fluctuate

B

14. If someone writes an in-the-money naked call, they usually want the underlying asset to a. go up b. go down 223


c. stay unchanged d. fluctuate D

15. Which of the following has the greatest possible dollar loss? a. Writing a covered call b. Buying a call c. Writing a fiduciary put d. Put overwriting

A

16. Index options have little ______ risk. a. unsystematic b. systematic c. market d. total

B

17. Which of the following is true for writing index calls? a. It always increases portfolio market risk b. It need not involve borrowing any money c. It is inappropriate for a tax-exempt investor d. It lowers portfolio income

A

18. Which of the following “counts most” in the margin equivalents table? a. Cash b. U.S. treasury securities c. Corporate debt d. Stock

D

19. A person who sought to buy stock at a price below the current price might a. buy deep-in-the-money calls b. buy deep-in-the-money puts c. write deep-in-the-money calls d. write deep-in-the-money puts

C

20. A person who sought to sell stock at a price above the current price might a. buy deep-in-the-money calls b. buy deep-in-the-money puts c. write deep-in-the-money calls d. write deep-in-the-money puts

D

21. A covered call means the call was purchased a. with cash b. from a fully funded margin account c. while simultaneously holding a put on the same stock 224


d. while simultaneously holding a long position in the stock A

22. Assume the stock price is $50, a call option on that stock has a premium of $5 and a put option on that stock has a premium of $3, and you presently hold no position in the three. Ignoring commissions, a covered call on 100 shares would require an investment of a. $4,500 b. $4,700 c. $5,300 d. $5,700

C

23. Assume the premium on a call option is $5 per share. Writing this call option when you already own 100 shares a. requires an immediate investment of $500 b. generates no cash flow because you already own the stock c. initially generates a positive cash flow of $500 d. eventually will require an investment of $500 unless the stock price increases enough

A

24. Assume the stock price is $50, a call option on that stock has a premium of $5, a put option on that stock has a premium of $3, the strike price on both options is $50, and you presently hold no position in the three. Suppose you take one of the following positions and the stock price drops to $47 per share. Which position would have gained the most dollars? a. Writing a naked call b. Writing a covered call c. Writing a fiduciary put d. Selling the stock short

A

25. The systematic risk in a portfolio can be lowered by a. writing index call options b. writing index put options c. buying index call options d. none of the above because index options cannot be used to lower systematic risk

B

26. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.40 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a February 580 OEX 100 call option contract has a premium of 7.30, what is the maximum number of contracts you could write on a cash account basis using the stock portfolio as collateral? 225


a. b. c. d.

26 36 46 56

B

27. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.40 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a February 580 OEX 100 call option contract has a premium of 7.30, what is the maximum amount of funds you could generate by writing calls on a cash account basis using the stock portfolio as collateral? a. $18,980 b. $26,280 c. $33,580 d. $40,880

C

28. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.40 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a February 580 OEX 100 call option contract has a premium of 7.30, what is the maximum number of contracts you could write on a margin account basis using the stock portfolio as collateral? a. 99 b. 149 c. 198 d. 396

C

29. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.40 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a February 580 OEX 100 call option contract has a premium of 7.30, what is the maximum amount of funds you could generate by writing calls on a cash account basis using the stock portfolio as collateral? a. $72,270 b. $108,770 c. $144,540 d. $289,080

226


B

30. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.60 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a July 600 OEX 100 call option contract has a premium of 2.45, what is the maximum number of contracts you could write on a cash account basis using the stock portfolio as collateral? a. 26 b. 36 c. 46 d. 56

B

31. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.60 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a July 600 OEX 100 call option contract has a premium of 2.45, what is the maximum amount of funds you could generate by writing calls on a cash account basis using the stock portfolio as collateral? a. $6,370 b. $8,820 c. $11,270 d. $13,720

C

32. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.60 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a July 600 OEX 100 call option contract has a premium of 2.45, what is the maximum number of contracts you could write on a margin account basis using the stock portfolio as collateral? a. 195 b. 293 c. 390 d. 781

C

33. Suppose you are managing a stock portfolio currently valued at $2 million that has a portfolio beta of 1.60 and you are interested in call option overwriting to raise additional funds. If the S&P 100 index recently closed at 541.86 and a July 600 OEX 100 call option contract has a premium of 2.45, what is the maximum amount of funds you could generate by writing calls on a cash account basis using the stock portfolio as collateral? a. $47,775 b. $71,785 c. $95,550 d. $191,345 227


C

34. Suppose a stock is currently priced at $40 per share, a February 35 call has a premium of $8, and a February 45 put has a premium of $7. If you wanted to buy this stock below the current market price using options, at what effective price could you buy the stock if the option is exercised? (Ignore brokerage commissions.) a. 35 b. 37 c. 38 d. 39

C

35. Suppose a stock is currently priced at $40 per share, a February 35 call has a premium of $8, and a February 45 put has a premium of $7. If you wanted to buy this stock below the current market price using options, at what future stock price would a strategy of buying the stock using options just break even with simply buying the stock today? (Ignore brokerage commissions.) a. 32 b. 33 c. 47 d. 48

C

36. Suppose a stock is currently priced at $40 per share, a February 35 call has a premium of $8, and a February 45 put has a premium of $7. If you wanted to sell this stock above the current market price using options, at what effective price could you sell the stock if the option is exercised? (Ignore brokerage commissions.) a. 41 b. 42 c. 43 d. 45

A

37. Suppose a stock is currently priced at $40 per share, a February 35 call has a premium of $8, and a February 45 put has a premium of $7. If you wanted to sell this stock above the current market price using options, at what future stock price would a strategy of selling the stock using options just break even with simply selling the stock today? (Ignore brokerage commissions.) a. 32 b. 33 c. 47 d. 48

228


D

38. Suppose a stock is currently priced at $65 per share, a July 60 call has a premium of $8, and a July 70 put has a premium of $7. If you wanted to buy this stock below the current market price using options, at what effective price could you buy the stock if the option is exercised? (Ignore brokerage commissions.) a. 57 b. 58 c. 62 d. 63

C

39. Suppose a stock is currently priced at $65 per share, a July 60 call has a premium of $8, and a July 70 put has a premium of $7. If you wanted to buy this stock below the current market price using options, at what future stock price would a strategy of buying the stock using options just break even with simply buying the stock today? (Ignore brokerage commissions.) a. 57 b. 58 c. 72 d. 73

A

40. Suppose a stock is currently priced at $65 per share, a July 60 call has a premium of $8, and a July 70 put has a premium of $7. If you wanted to sell this stock above the current market price using options, at what effective price could you sell the stock if the option is exercised? (Ignore brokerage commissions.) a. 68 b. 72 c. 73 d. 77

A

41. Suppose a stock is currently priced at $65 per share, a July 60 call has a premium of $8, and a July 70 put has a premium of $7. If you wanted to sell this stock above the current market price using options, at what future stock price would a strategy of selling the stock using options just break even with simply selling the stock today? (Ignore brokerage commissions.) a. 57 b. 58 c. 72 d. 73 Chapter Nineteen Performance Evaluation

229


C

1. The essence of performance evaluation is a. measuring after-tax dollars b. associating a measure of risk with expected return c. associating a measure of risk with realized return d. using the geometric mean whenever possible

B

2. Expected utility is a ____ function of return and a ______ function of risk. a. positive, positive b. positive, negative c. negative, positive d. negative, negative

D

3. The two mutual funds used in the text example are a. Vanguard and Twentieth Century b. Fidelity and Strong c. Beacon Hill and Pennsylvania Mutual d. 44 Wall Street and Mutual Shares

A

4. _____ are more important than _____. a. Dollars, percentages b. Paper gains, paper losses c. Monthly returns, annual returns d. Dividends, capital gains

C

5. Which measure calculates excess return per unit of total risk? a. Jensen b. Treynor c. Sharpe d. Geometric mean

B

6. Which measure calculates excess return per unit of systematic risk? a. Jensen b. Treynor c. Sharpe d. Geometric mean

B

7. A single security should be evaluated using the _____ measure. a. Jensen b. Treynor c. Sharpe d. geometric mean 230


A

8. The best performance comes from a. highest return per unit of risk b. lowest risk c. lowest long-term volatility d. highest excess return

A

9. Which of the following performance measures has statistical problems? a. Jensen b. Treynor c. Sharpe d. Geometric mean

A

10. If a portfolio experiences cash withdrawals and deposits, the best performance measure is the a. internal rate of return b. payback period c. Treynor measure d. Sharpe measure

A

11. A common finance assumption that is violated when options are included in a stock portfolio is a. normality of returns b. constant interest rates c. constant beta d. no taxes

C

12. The incremental risk-adjusted return from options makes use of the _____ performance measure. a. Jensen b. Treynor c. Sharpe d. geometric mean

D

13. The residual option spread makes use of the _____ performance measure. a. Jensen b. Treynor c. Sharpe d. geometric mean 231


A

14. If a portfolio earned –10%, -20%, +40%, and +10% over the last four years, the arithmetic mean return per year is a. 5% b. 10% c. 20% d. 30%

B

15. If a portfolio earned –10%, -20%, +40%, and +10% over the last four years, the geometric mean return per year is a. –3.2% b. 2.6% c. 3.2% d. 5.0%

D

16. If a portfolio earned 5%, 45%, 20%, and 10% over the last four years, the arithmetic mean return per year is a. 17% b. 18% c. 19% d. 20%

C

17. If a portfolio earned 5%, 45%, 20%, and 10% over the last four years, the geometric mean return per year is a. 17% b. 18% c. 19% d. 20%

C

18. If the average realized return of a portfolio is 20% per year, the standard deviation of returns is 30%, the portfolio beta is 1.5, the average return of Treasury bills over the same period is 5% per year, and the average return on the market is 15% per year, the Sharpe measure is a. 0.10 b. 0.25 c. 0.50 d. 0.75

A

19. If the average realized return of a portfolio is 20% per year, the standard deviation of returns is 30%, the portfolio beta is 1.5, the average return of Treasury bills over the same period is 5% per year, and the average return on the market is 15% per year, the Treynor measure is a. 0.10 232


b. 0.25 c. 0.50 d. 0.75 B

20. If the average realized return of a portfolio is 20% per year, the standard deviation of returns is 30%, the portfolio beta is 1.5, the average return of Treasury bills over the same period is 5% per year, and the average return on the market is 15% per year, the Jensen measure is a. 0 b. 5% c. 10% d. 20%

C

21. If the average realized return of a portfolio is 27.5% per year, the standard deviation of returns is 50%, the portfolio beta is 1.25, the average return of Treasury bills over the same period is 2.5% per year, and the average return on the market is 12.5% per year, the Sharpe measure is a. 0.20 b. 0.25 c. 0.50 d. 1.00

A

22. If the average realized return of a portfolio is 27.5% per year, the standard deviation of returns is 50%, the portfolio beta is 1.25, the average return of Treasury bills over the same period is 2.5% per year, and the average return on the market is 12.5% per year, the Treynor measure is a. 0.20 b. 0.25 c. 0.50 d. 1.00

D

23. If the average realized return of a portfolio is 27.5% per year, the standard deviation of returns is 50%, the portfolio beta is 1.25, the average return of Treasury bills over the same period is 2.5% per year, and the average return on the market is 12.5% per year, the Jensen measure is a. 0 b. 5% 233


c. 10% d. 15% D

24. Suppose a portfolio has a beginning balance of $1 million and has a return of 10% the first period and 20% the second period. Then $500,000 is added to the account. The subsequent return is –9% in the third period and 25% return in the fourth period. Using the daily valuation method, what is the holding period return over the four periods? a. 38% b. 42% c. 46% d. 50%

C

25. Suppose a portfolio has a beginning balance of $200,000 and earns $25,000 in the first period and $15,000 in the second period. Then $60,000 in new funds are added to the account. After that, the portfolio earns $20,000 in the third period and $40,000 in the fourth period. Using the daily valuation method, what is the holding period return over the four periods? a. 30% b. 33% c. 44% d. 50% Chapter Twenty Fiduciary Duties and Responsibilities

D

1. Which of the following is probably least likely to serve as a fiduciary? a. Stockbroker b. Lawyer c. Bank trust officer d. Security analyst

A

2. The origin of modern fiduciary law is probably the a. Prudent Man Rule b. Prudent Expert Rule c. Spitzer case d. Uniform Prudent Expert Act

B

3. Which of the following came from the Spitzer v Bank of New York case? a. Portfolios do not necessarily have to be diversified

234


b. The fact that a portfolio went up in value is not evidence it was managed prudently c. A loss of value is evidence of imprudent management d. A reasonable person may occasionally speculate C

4. The Prudent Expert Rule came from a. Harvard College v Amory b. Spitzer case c. ERISA d. Uniform Management of Institutional Funds Act

A

5. Which of the followed is most recent? a. Uniform Prudent Investor Act b. Harvard College v Amory c. ERISA d. Uniform Management of Institutional Funds Act

C

6. Which of the following is not an element of the duty of care? a. Diversification rule b. Documents rule c. Statutory evidence rule d. Indicia of ownership rule

A

7. Which of the following is an element of the duty of loyalty? a. Sole interest of the beneficiary rule b. Prudent expert rule c. Diversification rule d. Reasonable basis rule

A

8. Under ERISA, all of the following are prohibited transactions EXCEPT a. foreign investment restrictions b. general transaction restrictions c. fiduciary conduct restrictions d. property restrictions

C

9. The legal status of social investing is a. it is clearly allowed b. it is clearly disallowed c. it is unclear d. not addressed

C

10. A fiduciary must 235


a. b. c. d.

vote proxies vote proxies if the client wishes him or her to do so always vote proxies in the best interest of the client always vote in accordance with management’s recommendations

B

11. Annual meetings frequently have a vote on a shareholder proposal regarding a. employee retirement plans b. cumulative voting c. acquisitions d. divestitures

D

12. A common shareholder proposal dealing with environmental issues is a. ACTNOW b. NOWAY c. CHIRP d. CERES

A

13. Soft dollar arrangements are legal in conjunction with a. research b. travel c. equipment d. salaries

C

14. A fiduciary is a. the person who owns an investment account b. the person who buys and sells the securities in the account under the direction of the investment manager c. the person who uses his discretion in managing the account d. generally not considered an “expert” in money management matters

D

15. The Prudent Man rule means an investment manager must a. be morally sound b. not lose money over the long run c. not invest the client’s funds in highly risky investments d. use good judgment and make decisions consistent with how reasonable people manage their own money

D

16. Which of the following is not one of the four elements of the duty of care? a. Prudent expert standard b. Diversification rule c. Documents rule d. Privacy rule 236


Chapter Twenty One Principles of the Futures Market

D

1. Options are _____; futures are _____. a. rights, promises b. securities, contracts c. paid for, margined d. all of the above

C

2. The cash price is also called the a. delivery price b. settlement price c. spot price d. bid price

A

3. The primary economic purpose of the futures market is a. risk transfer b. income generation c. time value of money adjustments d. speculation

A

4. The clearing corporation helps eliminate a. credit risk b. the risk of crop failure c. the risk of poor crop prices d. liquidity risk

C

5. Futures trades occur in an area called a(n) a. arena b. ring c. pit d. box

A

6. The money a futures buyer puts down is called all of the following EXCEPT a. premium b. good faith deposit c. margin d. performance bond

237


D

7. People who seek to reduce risk using futures contracts are a. speculators b. investors c. gamblers d. hedgers

C

8. In some respects, speculators sell a. time value b. risk c. insurance d. improved credit ratings

A

9. Someone who routinely maintains a futures position overnight is likely to be any of the following EXCEPT a. scalper b. position trader c. speculator d. hedger

B

10. A major function of the clearing process is a. risk reduction b. matching trades c. finding willing buyers d. finding willing sellers

D

11. The newspaper price for a particular futures contract is properly called the a. bid price b. ask price c. closing price d. settlement price

C

12. The prices of some futures contracts are constrained by a. initial margin requirements b. variation margin requirements c. daily price limits d. capital constraints

D

13. The three main paradigms in futures pricing include all of the following EXCEPT a. the expectations hypothesis b. normal backwardation c. a full carrying charge market d. supply and demand 238


B

14. According to John Maynard Keynes, futures prices are a. unbiased b. biased downward c. biased upward d. biased either upward or downward

A

15. The difference between a futures price and the cash price is known as the a. basis b. settlement price c. vigorish d. spread

B

16. A futures contract represents a promise of deliver or acceptance of a commodity in a future month. A characteristic of futures contracts is that a. this exchange occurs for 98% of all contracts b. fewer than 2% actually result in delivery c. they cannot be created or destroyed d. they have no effect on the risk of the parties to the contracts

B

17. The Clearing Corporation a. establishes the margin requirements for futures contracts b. ensures the integrity of each futures contract c. often takes an opposite position in a futures contract to make the market seem continuous d. is the primary market for futures contracts

B

18. Hedgers in the futures market a. often seek to leverage their position to get extra expected return b. primarily sell risk to speculators c. trim their holdings to the highest expected returns securities d. diversify their investments to maximize expected return while reducing risk

A

19. Futures contracts are marked to market, which means that a. the gains or losses are cash settled at the end of each day b. each contract is marked with an X when they are bought or sold c. all contracts are sent to the Clearing Corporation where they are settled d. all contracts have an official serial number issued by the Clearing Corporation Chapter Seventeen

239


Principles of Options and Option Pricing

B

1. A famous option-pricing model was developed by a. Fisher and Lorie b. Black and Scholes c. Ingersoll and Rand d. Sharpe and Lintner

A

2. A primary use of options in portfolio management is a. risk management b. meeting statutory requirements c. satisfying legal lists d. estate taxes

B

3. The most common use of options by individuals is a. tax avoidance b. income generation c. arbitrage d. diversification

C

4. Which of the following gives its owner the right to buy? a. Straddle b. Put option c. Call option d. Spread

C

5. The price of an option is called its a. time value b. intrinsic value c. premium d. expiration value

D

6. For most options, an individual investor views expiration day as the _____ of the month. a. first business day b. second Tuesday c. second Tuesday after the first Monday d. third Friday

A

7. Writing an option is a. selling an option as an opening transaction 240


b. selling an option as a closing transaction c. buying an option as an opening transaction d. buying an option as a closing transaction B

8. Who keeps the option premium no matter what? a. The Options Clearing Corporation b. The option writer c. The option buyer d. The option writer and the option buyer split it

D

9. A stock priced at $55 per share will most likely have option striking prices _____ apart. a. $1 b. $2 c. $4 d. $5

B

10. The Options Clearing Corporation is most concerned with a. market risk b. credit risk c. interest rate risk d. political risk

A

11. On which of the following exchanges are the fewest options traded? a. New York Stock Exchange b. Philadelphia Stock Exchange c. Chicago Board Options Exchange d. American Stock Exchange

B

12. The book used an example of call options and a. libraries b. hockey tickets c. automobile transmissions d. telephones

B

13. Which of the following is correct? a. Intrinsic value - time value = option premium b. Intrinsic value + time value = option premium c. Intrinsic value = time value - option premium d. Intrinsic value = time value + option premium

D

14. An option which can be exercised anytime is a(n) a. European option 241


b. wildcard option c. Asian option d. American option C

15. An option contract usually covers ____ shares. a. 10 b. 50 c. 100 d. 1000

B

16. Option exercise is at the prerogative of the a. option writer b. option buyer c. either the option writer or the option buyer d. Options Clearing Corporation

C

17. An increase in which of the following will cause a call option to decline in value? a. Volatility b. Underlying asset price c. Striking price d. Interest rates

B

18. A person holds 2 XYZ APR 60 calls. What is their holding after a 2 for 1 stock split? a. 2 XYZ APR 60 calls b. 4 XYZ APR 30 calls c. 2 XYZ APR 30 calls d. 4 XYZ APR 60 calls

D

19. All of the following are assumptions of the Black-Scholes option pricing model EXCEPT a. markets are efficient b. no dividends c. interest rates are constant d. investors are generally bullish

B

20. Delta is the a. theoretical value of an option 242


b. expected change in the option value as the underlying asset price changes c. intrinsic value of the option d. influence of dividends on the option value C

21. For at-the-money stock options, put/call parity requires that, for otherwise similar options a. puts sell for more than calls b. puts sell for the same price as calls c. puts sell for less than calls d. puts sell for at least as much as calls

A

22. The delta of a call option can be calculated as part of the Black-Scholes model since it is equal to a. N(d1) b. N(d2) c. Ke-rt d. d2

B

23. According to option pricing theory, a higher dividend payout would cause the call option premium to a. increase b. decrease c. remain the same d. any of the above can occur

A

24. According to option pricing theory, a higher dividend payout would cause the put option premium to a. increase b. decrease c. remain the same d. any of the above can occur

A

25. According to option pricing theory, a higher volatility would cause the call option premium to a. increase b. decrease c. remain the same d. any of the above can occur

A

26. According to option pricing theory, a higher volatility would cause the put option premium to a. increase 243


b. decrease c. remain the same d. any of the above can occur C

27. If the stock price is 54, the exercise price is 50, and the call premium is 7, what is the intrinsic value? a. 0 b. 3 c. 4 d. 7

B

28. If the stock price is 54, the exercise price is 50, and the call premium is 7, what is the time value? a. 0 b. 3 c. 4 d. 7

A

29. If the stock price is 54, the exercise price is 50, and the put premium is 1, what is the intrinsic value? a. 0 b. 1 c. 3 d. 4

B

30. If the stock price is 54, the exercise price is 50, and the put premium is 1, what is the time value? a. 0 b. 1 c. 3 d. 4

B

31. If the stock price is 27, the strike price is 30, and the call premium is 2, the intrinsic value is a. –2 b. 0 c. 2 d. 3

C

32. If the stock price is 27, the strike price is 30, and the call premium is 2, the time value is a. –2 b. 0 244


c. 2 d. 3 C

33. If the stock price is 27, the strike price is 30, and the put premium is 5, the intrinsic value is a. –3 b. 0 c. 3 d. 4

C

34. If the stock price is 27, the strike price is 30, and the put premium is 5, the time value is a. –2 b. 0 c. 2 d. 3

B

35. The delta for a call option will always satisfy which of the following conditions? a. –1 < deltac < 0 b. 0 < deltac < 1 c. –1 < deltac < 1 d. deltac > 0

A

36. The delta for a put option will always satisfy which of the following conditions? a. –1 < deltap < 0 b. 0 < deltap < 1 c. –1 < deltap < 1 d. deltap < 0 Chapter Sixteen Revision of the Fixed-Income Portfolio

A

1. Passive bond strategies include a. buy & hold, indexing b. constant beta, constant proportion c. constant duration, constant yield d. constant duration, constant convexity

245


A

2. Which of the following is usually least appropriate for a bond portfolio? a. Buy and hold b. Indexing c. Constant proportion d. Barbell strategy

D

3. The Handbook of Fixed Income Securities lists about _____ different bond indexes. a. 9 b. 29 c. 129 d. 229

C

4. A well-known bond index is one published by a. Jackson, Brookings b. Donaldson, Lufkin, Jenrette c. Lehman Kuhn Loeb d. Josephthals

D

5. Which of the following is the principal characteristic of a laddered bond portfolio? a. Constant annual income b. Constant portfolio value c. No interest rate risk d. Equal proportions across the yield curve

A

6. Annual revision of a laddered bond portfolio requires a. buying a long-term bond b. selling a short-term bond c. selling a long-term bond d. buying a short-term bond

B

7. The principal way in which a barbell portfolio differs from a laddered portfolio is the barbell has a. greater investment in the middle maturities b. less investment in the middle maturities c. greater investment in high coupon bonds d. greater investment in low coupon bonds

D

8. Which of the following is arbitrary in a barbell bond portfolio? a. Number of weights b. Size of the weights c. Thickness of the bar 246


d. All of the above B

9. If you pay commissions to buy or sell bonds, annual revision of a barbell portfolio requires the payment of ____ commissions. a. 2 b. 3 c. 4 d. 6

B

10. If you hold yield to maturity constant and plot bond duration as a function of years until maturity, the curve has a _____ first derivative and a _____ second derivative. a. positive, positive b. positive, negative c. negative, positive d. negative, negative

A

11. Yield curve inversion occurs when a. short-term rates are rising faster than long-term rates b. long-term rates are rising faster than short-term rates c. short-term rates equal long-term rates d. T-bill rates are less than government bond rates

A

12. Which of the following types of swaps is inconsistent with the efficient market hypothesis? a. Substitution b. Intermarket c. Bond rating d. Rate anticipation

A

13. Convexity is the difference between a. actual price change and duration-predicted price change b. actual price change and market average price change c. actual price change and government bond price change d. actual price change and yield to maturity change

D

14. The importance of convexity increases as a. time passes b. the level of interest rates rises c. the level of interest rates falls d. the magnitude of the rate change increases 247


B

15. Convexity is related to the ____ derivative of the bond pricing relationship. a. first b. second c. third d. fourth

C

16. Modified duration is ______ Macaulay duration. a. equal to b. greater than c. less than d. greater than or equal to

D

17. Which of the following is false? a. The higher the yield to maturity, the lower the convexity, everything else being equal b. The lower the coupon, the greater the convexity, everything else being equal c. The greater the convexity, the better, everything else being equal d. The higher the duration, the lower the convexity, everything else being equal

A

18. Everything else being equal, bond investors prefer a. high convexity b. low convexity c. convexity equal to the bond market average d. none of the above

B

19. An appropriate comparison between the performance of a managed bond portfolio and an index requires finding an index with the same a. reinvestment rate risk and interest rate risk b. default risk and duration c. level of annual turnover d. average coupon rate and maturity

A

20. Assuming average coupon rates and a normal yield curve, the ladder portfolio generally has ________ reinvestment rate risk and _______ interest rate risk than a barbell portfolio. a. less, more b. less, less 248


c. more, less d. more, more A

21. When comparing the performance of ladder and barbell portfolios, if interest rates decrease, _______ portfolios are favored in terms of reinvestment rate risk and _______ portfolios are favored in terms of interest rate risk. a. ladder, ladder b. ladder, barbell c. barbell, ladder d. barbell, barbell

B

22. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay duration of 11.23 years and a convexity of 170.26, and the yield to maturity increases 1%, an estimate of the percent price change in the bond due only to duration would be a. –11.23% b. –10.90% c. –9.23% d. –8.23%

C

23. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay duration of 11.23 years and a convexity of 170.26, and the yield to maturity increases 1%, an estimate of the percent price change in the bond due only to convexity would be a. –0.85% b. –1.77% c. +0.85% d. +1.77%

C

24. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay duration of 11.23 years and a convexity of 170.26, and the yield to maturity increases 1%, an estimate of the percent price change in the bond due to both duration and convexity would be a. –12.36% b. –11.44% c. –10.05% d. –8.82%

B

25. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay 249


duration of 11.23 years and a convexity of 170.26, and the yield to maturity decreases 1%, an estimate of the percent price change in the bond due only to duration would be a. 11.23% b. 10.90% c. 9.23% d. 8.23% C

26. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay duration of 11.23 years and a convexity of 170.26, and the yield to maturity decreases 1%, an estimate of the percent price change in the bond due only to convexity would be a. –0.85% b. –1.77% c. 0.85% d. 1.77%

B

27. Suppose a bond has 20 years left to maturity, an 8% coupon rate, pays interest semi-annually, and has a 6% yield to maturity. If this bond has a Macaulay duration of 11.23 years and a convexity of 170.26, and the yield to maturity decreases 1%, an estimate of the percent price change in the bond due to both duration and convexity would be a. 12.93% b. 11.75% c. 10.59% d. 9.23%

B

28. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity increases 1/2%, an estimate of the percent price change in the bond due only to duration would be a. –6.50% b. –6.28% c. –5.64% d. –5.21%

C

29. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity increases 250


C

1/2%, an estimate of the percent price change in the bond due only to convexity would be a. –0.60% b. –0.30% c. +0.30% d. +0.60% 30. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity increases 1/2%, an estimate of the percent price change in the bond due to both duration and convexity would be a. –6.37% b. –6.21% c. –5.98% d. –5.61%

C

31. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity decreases 1/2%, an estimate of the percent price change in the bond due only to duration would be a. 5.21% b. 5.64% c. 6.28% d. 6.50%

C

32. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity decreases 1/2%, an estimate of the percent price change in the bond due only to convexity would be a. –0.60% b. –0.30% c. +0.30% d. +0.60%

C

33. Suppose a bond has 25 years left to maturity, a 5% coupon rate, pays interest semi-annually, and has a 7% yield to maturity. If this bond has a Macaulay duration of 13 years and a convexity of 237.15, and the yield to maturity decreases

251


1/2%, an estimate of the percent price change in the bond due to both duration and convexity would be a. 5.77% b. 6.20% c. 6.58% d. 6.87% Chapter Twenty Two Benching the Equity Players

A

1. Delta enables the portfolio manager to determine the a. number of options necessary to mimic the returns of the underlying security b. number of options necessary to reduce the risk of the underlying portfolio by half c. number of options necessary to double the portfolio return per unit of risk d. standard deviation of portfolio returns

B

2. The simultaneous holding of a long stock position and a long put is called a a. fiduciary put b. protective put c. collateralized put d. cash-secured put

C

3. For a call option, delta is always a. greater than one b. less than one c. less than one and greater than zero d. less than or equal to zero

B

4. For a call option, delta _____ as the striking price _____. a. increases, increases b. decreases, increases c. increases, approaches the stock price d. decreases, approaches the stock price

A

5. For at-the-money puts and calls on the same stock a. the put delta is always less than the call delta b. the put delta is always equal to the call delta c. the put delta is always greater than the call delta 252


d. the put delta is always less than or equal to the call delta

B

6. When calculating a protective put hedge ratio, all of the following pieces of information are necessary EXCEPT a. delta b. option striking price c. stock beta d. number of shares of stock held

C

7. A characteristic of stock index futures is, they a. have limited risk b. pay dividends monthly c. are settled in cash d. have a beta of zero

B

8. If the S&P500 index is 400.00, how many S&P500 futures contracts must you sell to hedge a $10 million stock portfolio with a beta of 1.10? a. 100 b. 110 c. 120 d. 130

B

9. Which of the following statements is true regarding a stock index futures contract? a. The basis is usually negative b. The basis will converge on zero as time passes c. The basis will only decrease; it cannot increase d. The basis will only increase; it cannot decrease

A

10. Dynamic hedging strategies seek to a. replicate a put option b. replicate a call option c. replicate a covered call option d. replicate a short put

C

11. A portfolio contains 10,000 shares of XYZ stock; the portfolio manager writes 10 XYZ calls. If the call delta is 0.455, what is the position delta? a. 455 b. 545 253


c. 9,545 d. 10,455

B

12. A portfolio contains 10,000 shares of XYZ stock; the portfolio manager buys 100 XYZ puts. If the put delta is -0.220, what is the position delta? a. 220 b. 7,800 c. 10,220 d. Cannot be determined

C

13. An ABC JUN 45 call has a delta of 0.445; what is the delta of an ABC JUN 45 put? a. 0.445 b. 0.555 c. -0.555 d. -0.445

B

14. All of the following will lower position delta EXCEPT a. buying puts b. buying calls c. writing calls d. selling stock

C

15. When futures contracts are used in dynamic hedging, falling security prices will cause the manager to a. buy futures contracts b. buy more stock c. sell futures contracts d. sell stock

B

16. Assume the stock price is $50, a call option has a premium of $5, a put option on that stock has a premium of $3, and you presently hold no position in the three. Ignoring commissions, a protective put would require an investment of a. $47 per share b. $53 per share c. $55 per share d. $58 per share

C

17. Suppose you hold a protective put position when the stock price is $52 and the put option has a strike price of $50. If the put option has a delta of –0.500 and the

254


stock price falls to $44 at the expiration date, what would be the change in value of your protective put position from today to the expiration date? a. -$8 per share b. -$4 per share c. -$2 per share d. 0 B

18. Suppose the stock price is $48, a call option has a strike price of $50 and a premium of $5, and a put option has a strike price of $45 and a premium of $2. Assume you currently hold no position. If you create a protective put position, what is the maximum possible loss and maximum possible gain per share at the expiration date? a. Maximum Loss = $1, Maximum Gain = Unlimited b. Maximum Loss = $5, Maximum Gain = Unlimited c. Maximum Loss = $47, Maximum Gain = $1 d. Maximum Loss = $50, Maximum Gain = $5

C

19. Suppose the stock price is $48, a call option has a strike price of $50 and a premium of $5, and a put option has a strike price of $45 and a premium of $2. Assume you currently hold no position. If you create a covered call position, what is the maximum possible loss and maximum possible gain per share at the expiration date? a. Maximum Loss = $1, Maximum Gain = Unlimited b. Maximum Loss = $5, Maximum Gain = Unlimited c. Maximum Loss = $43, Maximum Gain = $7 d. Maximum Loss = $53, Maximum Gain = $3

A

20. Suppose the stock price is $50, the call delta is 0.600 and the put delta is – 0.400. A portfolio of 1,000 shares, writing calls on 500 shares, and buying puts on 500 shares has a position delta of a. 500 b. 1500 c. 4500 d. 5500

A

21. Suppose the stock price is $50, the call delta is 0.600 and the put delta is –0.400. A portfolio of 1,000 shares, writing calls on 700 shares, and buying puts on 300 shares has a position delta of a. 460 b. 700 c. 1200 d. 1300

255


B

22. Suppose the S&P 100 index closed at 541.86 and that a May 500 put has a premium of $2.50 and a delta of –0.444. You have a $1 million stock portfolio with a beta of 1.20. How many index put options contracts must you buy to fully hedge this portfolio? a. 22 b. 50 c. 125 d. 5000

B

23. Suppose the June S&P 500 index futures contract settled at 1091.80. You have a $2.730 million stock portfolio with a beta of 1.20. How many index futures contracts must you enter into in order to have a 100% hedge? a. Short 10 contracts b. Short 12 contracts c. Long 10 contracts d. Long 12 contracts Chapter Twenty-Three Removing Interest Rate Risk

C

1. The most important intermediate term interest rate futures contract is on a. treasury bills b. Eurodollars c. treasury notes d. treasury bonds

A

2. A Eurodollar is a dollar-denominated deposit a. outside the United States b. in Europe c. in Europe or Canada d. in Europe, Asia, or the Pacific Basin

B

3. A $10,000 6-month T-bill sells for $9,800. What is its annualized yield to maturity? a. 2.04% b. 4.08% 256


c. 6.12% d. 6.66% D

4. A T-bill futures contract calls for the delivery of a. $100,000 of 60 day T-bills b. $100,000 of 90 day T-bills c. $1 million of 60 day T-bills d. $1 million of 90 day T-bills

A

5. If someone had a need to lock in a short-term interest rate, they would be most likely to a. buy T-bill futures b. sell T-bill futures c. buy T-note futures d. sell T-note futures

C

6. Treasury bonds a. are not callable b. may be callable after 10 years c. may be callable after 15 years d. are always callable after 5 years

B

7. An adjustment factor is used to convert a T-bond to a bond yielding a. 5% b. 6%, a decline from the former 8% level c. 8%, an increase from the former 7% level d. 9%

B

8. Which is the correct formula for invoice price? a. (settlement price/conversion factor) – accrued interest b. (settlement price * conversion factor) + accrued interest c. (settlement price/conversion factor) + accrued interest d. (settlement price * conversion factor) – accrued interest

A

9. When long-term interest rates are above 6%, the cheapest to deliver bond has a. the highest duration b. the lowest duration c. duration equal to 15.0 d. the highest yield to maturity

D

10. Immunization strategies deal mostly with a. credit risk b. market risk 257


c. convenience risk d. interest rate risk A

11. In a bullet immunization application, the manager seeks to get ___________ to cancel out. a. interest rate risk and reinvestment rate risk b. interest rate risk and default risk c. convenience risk and price risk d. reinvestment rate risk and default risk

B

12. If interest rates are expected to rise, the portfolio manager might logically a. raise duration b. lower duration c. lower average yield d. lower average bond rating

D

13. A bank's funds gap equals a. the extent to which asset duration exceeds liability duration b. total assets minus total liabilities c. total assets minus current liabilities d. rate sensitive assets minus rate sensitive liabilities

A

14. Banks usually make duration adjustments by a. altering the left side of the balance sheet b. altering the right side of the balance sheet c. altering both sides of the balance sheet d. altering only the equity account

B

15. Disadvantages of immunization include all of the following EXCEPT a. cost of being wrong b. it only works for long-term investment horizons c. transactions costs d. it reduces the portfolio yield

C

16. Suppose a $10,000 Treasury Bill with 82 days left until maturity is quoted at an asking bank discount rate of 3.20%. What would be the price of this Treasury Bill? a. $9,727 b. $9,866 c. $9,927 d. $10,000

258


B

17. Suppose a $10,000 Treasury Bill with 85 days left until maturity has a selling price of $9933.89. What is the asking bank discount yield? a. 2.3% b. 2.8% c. 3.3% d. 3.8%

B

18. Suppose a $10,000 Treasury Bill with 85 days left until maturity has a selling price of $9933.89. What is the asking bond equivalent yield? a. 2.36% b. 2.86% c. 3.36% d. 3.86%

B

19. Suppose a $10,000 Treasury Bill with 85 days left until maturity has a selling price of $9933.89. What is the compounded effective annual rate? a. 2.39% b. 2.89% c. 3.39% d. 3.89%

B

20. Suppose a Treasury Bill futures contract is quoted at a settlement price of 96.45 percent of par. If two months from now the futures price is quoted at 95.45 percent of par, what would be the gain or loss for a long Treasury Bill futures position over this period? a. -$2,550 b. -$2,450 c. $2,450 d. $2,550

D

21. Suppose you are managing a bond portfolio with a current market value of $4.6 million. The bonds in this portfolio are priced at an average price of 98% of par and the duration of the portfolio is 12.62 years. If the cheapest to deliver bond for a Treasury Bond futures contract has a duration of 13.22 years, is priced at 97.5% of par, and has a conversion factor of 0.8315, what is the hedge ratio for using this Treasury Bond futures contract? a. 1.0773 b. 0.9373 c. 0.8664 d. 0.7978

259


C

22. Suppose you are managing a bond portfolio with a current market value of $4.6 million. The bonds in this portfolio are priced at an average price of 98% of par and the duration of the portfolio is 12.62 years. If the cheapest to deliver bond for a Treasury Bond futures contract has a duration of 13.22 years, is priced at 97.5% of par, and has a conversion factor of 0.8315, how many Treasury Bond futures contracts would represent a 100% hedge? a. Long 37 contracts b. Long 57 contracts c. Short 37 contracts d. Short 57 contracts

260

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