Final Exam

Each listed stock option contract gives the holder the right to buy or sell __________ shares of stock. A) 100 B) 1 C) 1,000 D) 10

A) 100

Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio? A) 20 B) 2 C) 8 D) 6

A) 20

Another name for the dollar-weighted return is the _________. A) IRR B) difference between cash inflows and cash outflows C) arithmetic average return D) geometric average return

A) IRR

Because of convexity, when interest rates change, the actual bond price will ____________ the bond price predicted by duration. A) always be higher than B) always be lower than C) sometimes be lower than D) sometimes be higher than

A) always be higher than

An American call option gives the buyer the right to _________. A) buy the underlying asset at the exercise price on or before the expiration date B) sell the underlying asset at the exercise price on or before the expiration date C) buy the underlying asset at the exercise price only at the expiration date D) sell the underlying asset at the exercise price only on the expiration date

A) buy the underlying asset at the exercise price on or before the expiration date

If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________. A) expected returns to fall; risk premiums to fall B) expected returns to rise; risk premiums to rise C) expected returns to rise; risk premiums to fall D) expected returns to fall; risk premiums to rise

A) expected returns to fall; risk premiums to fall

A bank has an average duration of its liabilities equal to 2 years. The bank's average duration of its assets is 3.5 years. The bank's market value of equity is at risk if _____. A) interest rates rise B) credit spreads fall C) interest rates fall D) the price of all fixed-income securities rises

A) interest rates rise

In his famous critique of the CAPM, Roll argued that the CAPM ________. A) is not testable because the true market portfolio can never be observed B) is of limited use because systematic risk can never be entirely eliminated C) should be replaced by the APT D) should be replaced by the Fama-French three-factor model

A) is not testable because the true market portfolio can never be observed

You can be sure that a bond will sell at premium to par when _______. A) its coupon rate is greater than its yield to maturity B) its coupon rate is less than its conversion value C) its coupon rate is equal to its yield to maturity D) its coupon rate is less than its yield to maturity

A) its coupon rate is greater than its yield to maturity

Rational risk-averse investors will always prefer portfolios _____________. A) located on the capital market line to those located on the efficient frontier B) that are risk-free to all other asset choices C) located on the efficient frontier to those located on the capital market line D) at or near the minimum-variance point on the risky asset efficient frontier

A) located on the capital market line to those located on the efficient frontier

Everything else equal, the _______ maturity of a bond and the _______ coupon, the greater the sensitivity of the bonds prices to interest rate changes. A) longer; lower B) shorter; lower C) shorter; higher D) longer; higher

A) longer; lower

All other things equal, a bond's duration is _________. A) lower when the coupon rate is higher B) indeterminable when the coupon rate is higher C) higher with the coupon rate is higher D) the same with the coupon rate is higher

A) lower when the coupon rate is higher

According to the capital asset pricing model, a security with a _________. A) positive alpha is considered underpriced B) positive alpha is considered overpriced C) zero alpha is considered a good buy D) negative alpha is considered a good buy

A) positive alpha is considered underpriced

The market risk premium is best approximated by _________. A) the difference between the return on an index fund and the return on treasury bills B) the difference between the return on the risky asset with the lowest returns and the return on treasury bills C) the difference between the return on the highest yielding asset and the return on the lowest yielding asset D) the difference between the return on a small firm mutual fund and the return on the S&P 500 index

A) the difference between the return on an index fund and the return on treasury bills

The reward-to-volatility ratio is given by _________. A) the slope of the capital allocation line B) the second derivative of the capital allocation line C) the point at which the second derivative of the investor's indifference curve reaches zero D) the portfolio's excess return

A) the slope of the capital allocation line

The expected rate of return of a portfolio of risky securities is _____. A) the weighted sum of the individual securities' expected returns B) the weighted sum of the individual securities' variance C) the sum of the individual securities' variance D) the sum of the individual securities' covariance

A) the weighted sum of the individual securities' expected returns

The duration rule always _______ the value of a bond following a change in its yield. A) underestimates B) provides an unbiased estimate of C) the estimated price may be biased either upward or downward, depending on whether the bond is trading at a discount or a premium D) overestimates

A) underestimates

Which measure of downside risk predicts the worst loss that will be suffered with a given probability? A) value at risk B) Sharpe ratio C) variance D) standard deviation

A) value at risk

Assuming semiannual compounding, a 15-year zero coupon bond with a par value of $1,000 and a required return of 18.4% would be priced at

Answer: $71.34

1. Consider the following $1,000 par value zero-coupon bonds: Bond Years to Maturity Yield to Maturity A 1 6.10% B 2 7.60% C 3 8.10% D 4 9.60% E 5 10.50% What will be 1-year interest rate 3 years from now?

Answer: 14.23%

You buy a 10-year $1,000 par value 5.80% annual-payment coupon bond priced to yield 7.80%. You do not sell the bond at year-end. If you are in a 25% tax bracket, at year-end you will owe taxes on this investment equal to

Answer: 14.5

A coupon bond that pays interest of $75 annually has a par value of $1,000, matures in 5 years, and is selling today at a $104.00 discount from par value. The current yield on this bond is

Answer: 8.37%

Which of the following are assumptions of the simple CAPM model? 1. Individual trades of investors do not affect a stock's price 2. All investors plan for one identical holding period 3. All investors analyze securities in the same way, and share the same economic view of the world 4. All investors have the same level of risk aversion A) 1, 2, and 4 only B) 1, 2, and 4 only C) 2, 3, and 4 only D) 1, 2, 3, and 4

B) 1, 2, and 3 only

All other things equal (YTM= 10%), which of the following has the longest duration? A) A 10-year zero-coupon bond B) A 30-year bond with a 10% coupon C) A 20-year bond with a 9% coupon D) A 20-year bond with a 7% coupon

B) A 30-year bond with a 10% coupon

_______________ option can only be exercised on the expiration date. A) An Asian B) A European C) An American D) A Mexican

B) A European

Which one of the following stock return statistics fluctuates the most over time? A) Covariance of returns B) Average return C) correlation coefficient D) variance of returns

B) Average return

Which of the following would be considered a risk-free asset in real terms as opposed to nominal? A) US T bill B) US T bill whose return was indexed to inflation C) money market fund D) short term corporate bonds

B) US T bill whose return was indexed to inflation

Consider the liquidity preference theory of the term structure of interest rates. On average, one would expect investors to require _________. A) the same yield on both short term bonds and long-term bonds B) a higher yield on long-term bonds than on short term bonds C) a higher yield on short term bonds than on long-term bonds D) none ----the liquidity preference theory cannot be used to make any of the other statements

B) a higher yield on long-term bonds than on short term bonds

The writer of a put option _______________. A) agrees to sell shares at a set price if the option holder desires B) agrees to buy shares at a set price if the option holder desires C) has the right to buy shares at a set price D) has the right to sell shares at a set price

B) agrees to buy shares at a set price if the option holder desires

Which one of the following measures time-weighted returns and allows for compounding? A) dollar-weighted return B) geometric average return C) arithmetic average return D) historical average return

B) geometric average return

The ____ reward-to-variability ratio is found on the ____ capital market line. A) highest; flattest B) highest; steepest C) lowest; steepest D) lowest; flattest

B) highest; steepest

Yields on municipal bonds are typically ___________ yields on corporate bonds of similar risk and time to maturity. A) identical to B) lower than C) twice as high as D) slightly higher than

B) lower than

All else the same, an American-style option will be ______ valuable than a ______-style option. A) less; Canadian B) more; European C) more; Canadian D) less; European

B) more; European

Diversification is most effective when security returns are ____. A) positively correlated B) negatively correlated C) uncorrelated D) high

B) negatively correlated

Duration is a concept that is useful in assessing a bond's _________. A) credit risk B) price volatility C) liquidity risk D) convexity risk

B) price volatility

A ____ bond gives the bondholder the right to cash in the bond before maturity at a specific price after a specific date. A) Treasury B) puttable C) callable D) coupon

B) puttable

The excess return is the _______. A) index return B) rate of return an excess of the treasury bill rate C) rate of return that can be earned with certainty D) rate of return in excess of a predicted model like CAPM

B) rate of return an excess of the treasury bill rate

Both investors and gamblers take a risk on. The difference between an investor and a gambler is that an investor ________. A) is normally risk-neutral B) requires a risk premium to take on the risk C) knows he or she will not lose money D) knows the outcomes at the beginning of the holding period

B) requires a risk premium to take on the risk

An American put option gives its holder the right to _________. A) buy the underlying asset at the exercise price on or before the expiration date B) sell the underlying asset at the exercise price on or before the expiration date C) buy the underlying asset at the exercise price only at the expiration date D) sell the underlying asset at the exercise price only on the expiration date

B) sell the underlying asset at the exercise price on or before the expiration date

The invoice price of a bond is the ______. A) bid price B) stated or flat price in a quote sheet plus accrued interest C) stated or flat price in a quote sheet minus accrued interest D) average of the bid and ask price

B) stated or flat price in a quote sheet plus accrued interest

Market risk is also called __________ and _________. A) unique risk; non-diversifiable risk B) systematic risk; non-diversifiable risk C) systematic risk; diversifiable risk D) unique risk; diversifiable risk

B) systematic risk; non-diversifiable risk

An important characteristic of market equilibrium is __________. A) the lack of liquidity in the market B) the absence of arbitrage opportunities C) the presence of many opportunities for creating zero investment portfolios D) all investors exhibit the same degree of risk aversion

B) the absence of arbitrage opportunities

The rate of return on _____ is known at the beginning of the holding period, while the rate of return on ____ is not known until the end of the holding period. A) risky assets; treasury bills B) treasury bills; risky assets C) index assets; bonds D) Excess returns; risky assets

B) treasury bills; risky assets

In a well-diversified portfolio, __________ risk is negligible. A) systematic B) unsystematic C) market D) nondiversifiable

B) unsystematic

All other things equal (YTM= 10%), which of the following has the shortest duration? A) A 20-year bond with a 9% coupon B) A 10-year bond with a 9% coupon C) A 30-year bond with a 10% coupon D) A 20-year bond with a 7% coupon

C) A 30-year bond with a 10% coupon

Which of the following yield curves generally implies a normal healthy economy? A) Flat B) Negative slope C) Positive slope D) Hump-shaped curve

C) Positive slope

You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for the next year, the best forecast will be given by _______. A) index return B) dollar weighted return C) arithmetic average return D) geometric average return

C) arithmetic average return

Arbitrage is based on the idea that _________. A) securities with similar risk should sell at different prices B) the expected returns from equally risky assets are different C) assets with identical risk must have the same expected rate of return D) markets are perfectly efficient.

C) assets with identical risk must have the same expected rate of return

One method of forecasting the risk premium is to use the _______. A) coefficient of variation of analysts' earnings forecasts B) variations in the risk-free rate over time C) average historical excess returns for the asset under consideration D) average abnormal return on the index portfolio

C) average historical excess returns for the asset under consideration

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________. A) the standard deviation of returns B) the variance of returns C) beta D) unique risk

C) beta

The measure of risk used in the capital asset pricing model is ___________. A) the standard deviation of returns B) reinvestment risk C) beta D) specific risk

C) beta

A European call option gives the buyer the right to _________. A) buy the underlying asset at the exercise price on or before the expiration date B) sell the underlying asset at the exercise price on or before the expiration date C) buy the underlying asset at the exercise price only at the expiration date D) sell the underlying asset at the exercise price only on the expiration date

C) buy the underlying asset at the exercise price only at the expiration date

A ________ bond give the issuer an option to retire the bond before maturity at a specific price after a specific date. A) coupon B) puttable C) callable D) treasury

C) callable

If you are holding a premium bond, you must expect a _______ each year until maturity. If you are holding a discount bond, you must expect a _______ each year until maturity. (In each case assume that the yield to maturity remains stable over time.) A) capital gain; capital loss B) capital gain; capital gain C) capital loss; capital gain D) capital loss; capital loss

C) capital loss; capital gain

Floating-rate bonds have a __________ that is adjusted with current market interest rates. A) maturity date B) coupon payment date C) coupon rate D) dividend yield

C) coupon rate

You invest in the stock of Rayleigh corporation and write a call option on Rayleigh corporation. This strategy is called a _________. A) naked call B) money spread C) covered call D) long spread

C) covered call

Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________. A) equal to -1 B) greater than zero C) equal to zero D) equal to the sum of the securities' standard deviations

C) equal to the sum of the Securities' Standard deviations

The risk that can be diversified away is __________. A) beta B) market risk C) firm-specific risk D) systematic risk

C) firm-specific risk

Consider a 7-year bond with a 9% coupon and a yield to maturity of 12%. If interest rates remain constant, 1 year from now the price of this bond will be _________. A) lower B) the same C) higher D) indeterminate

C) higher

On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the _____________ the current investment opportunity set. A) left and below B) right and below C) left and above D) right and above

C) left and above

In a single-factor market model the beta of a stock __________. A) measures the stock's unsystematic risk B) changes with the variance of the residuals C) measures the stock's contribution to the standard deviation of the market portfolio D) measures the stock's contribution to the standard deviation of the stock

C) measures the stock's contribution to the standard deviation of the market portfolio

An investor's degree of risk aversion will determine their ______. A) optimal risky portfolio B) risk-free rate C) optimal mix of the risk-free asset and risky asset D) capital allocation line

C) optimal mix of the risk-free asset and risky asset

The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM ____________. A) recognizes multiple systematic risk factors B) places less emphasis on market risk C) recognizes only one systematic risk factor D) recognizes multiple on systematic risk factors

C) recognizes only one systematic risk factor

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. A) the returns on the stock and bond portfolios tend to move inversely B) the returns on the stock and bond portfolios tend to move together C) the returns on the stock and bond portfolios tend to vary independently of each other D) the covariance of the stock and bond portfolios will be positive

C) the returns on the stock and bond portfolios tend to vary independently of each other

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. A) down; left B) up; right C) up; left D) down; right

C) up; left

The market portfolio has a beta of _________. A) 0 B) - 1 C) 0.5 D) 1

D) 1

In a simple CAPM world which of the following statements is (are) correct? 1. All investors will choose to hold the market portfolio, which includes all risky assets in the world. 2. Investors' complete portfolio will vary depending on their risk aversion. 3. The return per unit of risk will be identical for all individual assets. 4. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio. A) 1, 3, and 4 only B) 1, 2, and 3 only C) 2, 3, and 4 only D) 1, 2, 3, and 4

D) 1, 2, 3, and 4

Risk that can be eliminated through diversification is called _____ risk. A) diversifiable B) unique C) firm-specific D) all of these options are correct

D) all of these options are correct

The __________ measure of returns ignores compounding. A) IRR B) geometric average C) dollar-weighted D) arithmetic average

D) arithmetic average

In the mean standard deviation graph, the line that connects the risk free rate and the optimal risky portfolio, P, is called the ________. A) indifference curve B) security market line C) investor's utility line D) capital allocation line

D) capital allocation line

The _____ of a bond is computed as the ratio of the annual coupon payment to the market price. A) yield to maturity B) yield to call C) nominal yield D) current yield

D) current yield

Consider the expectations theory of the term structure of interest rates. If the yield curve is downward sloping, this indicates that the investors expect short-term interest rates to _________ in the future. A) increase B) not change C) change in an unpredictable matter D) decrease

D) decrease

What type of risk is most significant for nearly all bonds? A) Maturity risk B) Reinvestment rate risk C) Interest rate risk D) default risk

D) default risk

When all investors analyze securities in the same way and share the same economic view of the world, we say they have ____________________. A) equal risk aversion B) heterogeneous expectations C) asymmetric information D) homogeneous expectations

D) homogeneous expectations

A call option on Brocklehurst Corporation has an exercise price of $30. The current stock price of Brocklehurst Corporation is $32. The call option is __________. A) knocked in B) out of the money C) at the money D) in the money

D) in the money

You buy a call option and a put option on General Electric. Both the call option and the put option have the same exercise price and expiration date. This strategy is called a _________. A) time spread B) short straddle C) money spread D) long straddle

D) long straddle

All else equal, bond price volatility is greater for ________. A) higher coupon rates B) shorter maturity C) lower default risk D) lower coupon rates

D) lower coupon rates

All other things equal, a bond's duration is _________. A) indeterminable, when the yield to maturity is high B) the same at all yield rates C) higher when the yield to maturity is higher D) lower when the yield to maturity is higher

D) lower when the yield to maturity is higher

The normal distribution is completely described by its ________. A) median and variance B) mean C) mode and standard deviation D) mean and standard deviation

D) mean and standard deviation

The probability of arbitrage arises when _________. A) investors do not diversify B) two identically risky securities carry the same expected risks C) there's no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily D) mispricing among securities creates an opportunities for riskless profits

D) mispricing among securities creates an opportunities for riskless profits

Bond prices are _______ sensitive to changes in yield when the bond is selling at a _______ initial yield to maturity. A) less; lower B) more; higher C) equally; higher or lower D) more; lower

D) more; lower

The holding period return on a stock is equal to ________. A) the capital gain yield over the period plus the inflation rate B) the dividend yield plus the risk premium C) the current yield plus the dividend yield D) the capital gain yield over the period plus the dividend yield

D) the capital gain yield over the period plus the dividend yield

The complete portfolio refers to the investment in _______. A) the risky portfolio B) the risky portfolio and the index C) the risk-free asset D) the risk free asset and the risky portfolio combined

D) the risk free asset and the risky portfolio combined

The complete portfolio refers to a portfolio consisting of _____. A) Securities from domestic markets combined with securities from foreign markets B) the market portfolio combined with the minimum-variance portfolio C) common stocks combined with bonds D) the risk-free asset combined with at least one risky asset

D) the risk-free asset combined with at least one risky asset

Firm-specific risk is also called __________ and __________. A) systematic risk; diversifiable risk B) unique risk; nondiversifiable risk C) systematic risk; nondiversifiable risk D) unique risk; diversifiable risk

D) unique risk; diversifiable risk