Investments HW/Exam Study

Asset allocation refers to ___.

The allocation of the investment portfolio across broad asset classes.

You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ___.

Correlation coefficient between ACE and the market has risen.

A bond issued by the state of Alabama is priced to yield 6.60%. If you are in the 20% tax bracket, this bond would provide you with an equivalent taxable yield of ___.

8.25% Explanation: 0.66 / (1 - 0.2) = .0825 or 8.25%

You find that the bid and ask prices for a stock are $11.75 and $12.50, respectively. If you purchase or sell the stock, you must pay a flat commission of $15. If you buy 200 shares of the stock and immediately sell them, what is your total implied and actual transaction cost in dollars?

$180 Explanation: [200 x (12.50 - 11.75)] + (2 x 15) = $180

The holding-period return on a stock was 25%. Its ending price was $18, and its beginning price was $16. Its cash dividend must have been ____.

$2.00 Explanation: HPR= (P1 + DIV - P0) / P0 HPR x P0 = P1 + DIV - P0 HPR x P0 - P1 + P0 = DIV (.25 x $16) - $18 + $16 = $2.00

__________ fund is defined as one in which the fund charges a sales commission to either buy into or exit from the fund.

A load

Which of the following is a FALSE statement regarding open-end mutual funds? A. They offer investors a guaranteed rate of return. B. They offer investors a well-diversified portfolio. C. They redeem shares at their net asset value. D. They offer low-cost diversification.

A.

Asset A has an expected return of 15% and a reward-to-variability ratio of 0.4. Asset B has an expected return of 20% and a reward-to-variability ratio of 0.3. A risk-averse investor would prefer a portfolio using the risk-free asset and ___.

Asset A

Which of the following is NOT a true statement regarding municipal bonds? A. A municipal bond is a debt obligation issued by state or local government. B. A municipal bond is a debt obligation issued by the federal government. C. The interest income from a municipal bond is exempt from federal income tax. D. The interest income from a municipal bond is exempt from state and local taxation in the issuing state.

B.

___ portfolio construction starts with selecting attractively priced securities.

Bottom-up

Mutual funds provide the following for their shareholders. A. Diversification B. Professional management C. Record keeping and administration D. All of these options

D

Advantages of investment companies to investors include all but which of the following? A. Record keeping and administration B. Low-cost diversification C. Professional management D. Guaranteed rates of return

D.

Financial markets allow for all but which of the following? A. Shift consumption through time from higher-income periods to lower. B. Price securities according to their riskiness. C. Channel funds from lenders of funds to borrowers of funds. D. Allow most participants to routinely earn high returns with low risk.

D.

Risk that can be eliminated through diversification is called ____ risk. A. Unique B. Firm-specific C. Diversifiable D. All of these options

D.

The ratio of trading activity of a portfolio to the assets of the portfolio is called the ____________.

Portfolio turnover

Transactions that do not involve the original issue of securities take place in ___.

Secondary markets

The bid price of a Treasury bill is ___.

The price at which the dealer in Treasury bills is willing to buy the bill.

Which of the following is a false statement regarding open-end mutual funds?

They offer investors a guaranteed rate of return

The most marketable money security is ___.

Treasury bills

In securities markets, there should be a risk-return trade-off with higher-risk assets having ___ expected returns than lower-risk assets.

Higher

A loan for a new car costs the borrower .8% per month. What is the EAR?

10.03% Explanation: (1.008^12) - 1 = 10.03%

The holding period return on a stock is equal to ___.

The capital gain yield over the period plus the dividend yield.

Suppose you short-sell 100 shares of IBX, now selling at $200 per share. a. What is your maximum possible loss? b. What happens to the maximum loss if you simultaneously place a stop-buy order at $210?

a. The maximum possible loss is UNLIMITED. Explanation: In principle, potential losses are unbounded, growing directly with increases in the price of IBX. b. The maximum possible loss is now $1,000. Explanation: If the price of IBX shares goes above $210, then the stop-buy order would be executed, limiting the losses from the short sale. If the stop-buy order can be filled at $200, the maximum possible loss per share is $10. The total loss is: $10 x 100 shares = $1,000.

Assume you purchased 300 shares of XYZ common stock on margin at $60 per share from your broker. If the initial margin is 60%, the amount you borrowed from the broker is ___.

$7,200 Explanation: $300 x $60 x (1 - 0.60) = $7,200

You put up $50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.50. Your HPR was ___.

11% Explanation: .04 + ($3.50 / $50) = 11%

If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?

11.24% Explanation: (1.08 x 1.03) - 1 = 11.24%

An order to buy or sell a security at the current price is a ___.

Market order

Investors expect the market rate of return this year to be 10%. The expected rate of return on a stock with a beta of 1.2 is currently 12%. If the market return this year turns out to be 8%, how would you revise your expectation of the rate of return on the stock?

Revised rate of return is 9.6% Explanation: The expected rate of return on the stock will change by beta times the unanticipated change in the market return: 1.2 x (.08 - .10) = -2.4% Therefore, the expected rate of return on the stock should be revised to: .12-.024 = 9.6%

Initial public offerings (IPOs) are usually ___ relative to the levels at which their prices stabilize after they begin trading in the secondary market.

Underpriced

Real assets in the economy include all but which of the following?

Common stock

Mutual funds provide the following for their shareholders.

Diversification, professional management, and record keeping and administration.

The ___ reward-to-variability ratio is found on the ___ capital market line.

Highest; Steepest

A market order has:

Price uncertainty but not execution uncertainty.

The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for this year?

-6.44% Explanation: Nominal return on stock (R): [(50 + 3) / 55] -1 = -3.64% Real return: (1 + R) = (1 + r)(1 + i) 1 + r = (1 - .0364)/(1.03) = .935 R= .935 - 1 = -.0644

Security selection refers to the ___.

Choice of specific securities within each asset class.

Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni's owners. Choose the correct answer in the following statements about financial and real assets. b. Lanni uses the cash from the bank plus $20,000 of its own funds to finance the development of new financial planning software. The cash paid by Lanni is the transfer off a ___ to the software developer. In return, Lanni gets a ____, the completed software.

Financial asset; Real Asset

You are considering investing in one of several mutual funds. All the funds under consideration have various combinations of front-end and back-end loads and/or 12b-1 fees. The longer you plan on remaining in the fund you choose, the more likely you will prefer a fund with a __________ rather than a __________, everything else equal.

Front-end load; 12b-1 fee

You purchased a bond 90 days ago for $881.03. You received an interest payment of $20.00 50 days ago. Today the bond's price is $830.64. What is the holding period return (HPR) on the bond as of today?

HPR is -3.45% Explanation: (830.64 - 881.03 + 20.00) / 881.03 = -3.45% The HPR reflects the capital gain (loss) and any income received from the investment.

The yield on tax-exempt bonds is ___.

Less than the yield on taxable bonds.

The primary measurement unit used for assessing the value of one's stake in an investment company is ___________________.

Net asset value

___ portfolio management calls for holding diversified portfolios without spending effort or resources attempting to improve investment performance through security analysis.

Passive

Suppose an investor is considering one of two investments that are identical in all respects except for risk. If the investor anticipates fair return for the risk of the security he invests in, he can expect to ___.

Pay less for the security that has higher risk.

Corporate Fund started the year with a net asset value of $13.50. By year-end, its NAV equaled $12.60. The fund paid year-end distributions of income and capital gains of $2.00. What was the rate of return to an investor in the fund?

Rate of return is 8.15%. Explanation: 12.60 - 13.50 = -0.90 (-0.90 + 2.00) / 13.50 = 8.15%

___ assets generate net income to the economy, and ___ assets define allocation of income among investors.

Real; Financial

The plot of a security's excess return relative to the market's excess return is called the ___.

Security characteristic line

IPOs are usually __ relative to the levels at which their price stabilize after they begin trading in the secondary market.

Underpriced

Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of Stock A are ___ sensitive to changes in the market than are the returns of stock B.

20% more Explanation: 1.2 - 1 = .2 = 20%

Consider a no-load mutual fund with h$600 million in assets and 25 million shares at the start of the year with $650 million in assets and 26 million shares at the end of the year. During the year investors have received income distributions of $4 per share and capital gain distributions of $0.30 per share. Assuming that the fund carries no debt, and that the total expense ratio is 1%, what is the rate of return on the fund?

21.04% Explanation: NAV(0) = $600 million/ 25 million shares = $24.00 NAV(1) = [$650 million - ($650 million x 0.01)] / 26 million shares = $24.75 Gross return = ($24.75 - $24 + $4 + $0.30) / $24 = 21.04%

Consider the following two investment alternatives: First, a risky portfolio that pays a 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a Treasury bill that pays 6%. The premium in the risky investment is ___. Hint: The risk premium is the expected return minus the risk-free rate.

3% Explanation: Risk premium: [(.4 x .15) + (.6 x .05)] - .06 = .03

An investor buys a T-bill at a bank discount quote of 4.80% with 150 days to maturity. The investor's bond equivalent yield on this investment is ___.

4.97% Explanation: .048 x (150 days/360 days) = .02 $10,000 x (1 - .02) = $9,800 ($10,000 - $9,800) / [$9,800 x (150 days/365 days)] = .04965 or 4.97%

Financial markets allow for all but which of the following? A. Shift consumption through time from higher-income periods to lower. B. Price securities according to their riskiness. C. Channel funds from lenders of funds to borrowers of funds. D. Allow most participants to routinely earn high returns with low risks.

Allow most participants to routinely earn high returns with low risk.

The ___ is equal to the square root of the systematic variance divided by the total variance.

Correlation coefficient

Specialists try to maintain a narrow bid-ask spread because: I. If the spread is too large, they will not participate in as many trades, losing commission income. II. The exchange requires specialists to maintain price continuity. III. Specialists are nonprofit entities designed to facilitate market transactions rather than make a profit.

I and II only

Which of the following are financial assets? I. Debt securities II. Equity securities III. Derivative securities

I, II, and III

Active trading in markets and competition among securities analysts helps ensure that: I. Security prices approach informational efficiency. II. Riskier securities are priced to offer higher potential returns. III. Investors are unlikely to be able to consistently find under- or overvalued securities.

I, II, and III.

The cost of buying and selling a stock includes: I. Broker's commissions. II. Dealer's bid-asked spread. III. Price concessions that investors may be forced to make.

I, II, and III.

The interest rate charged by large banks in London to lend money among themselves is called ___.

LIBOR

Beta is a measure of security responsiveness to ___.

Market risk

An investor is in a 30% combined federal plus state tax bracket. If corporate bonds offer 9% yields, what must municipals offer for the investor to prefer them to corporate bonds?

Minimum municipals offer 6.3% yields. Explanation: 0.09 x (1 - 0.30) = 0.063 0.063 x 100 = 6.3%

Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni's owners. Choose the correct answer in the following statements about financial and real assets. c. Lanni sells the software product to Microsoft, which will market it to the public under the Microsoft name. Lanni accepts payment in the form of 2,000 shares of Microsoft stock. Lanni sells the software, which is a ___, to Microsoft. In exchange Lanni receives a ___, 2,000 shares of Microsoft stock. A new financial asset is ___ if Microsoft issues new shares.

Real asset; Financial asset; Created

Investors who want to liquidate their holdings in a closed-end fund may ___________________.

Sell their shares on the open market

Investors who want to liquidate their holdings in a closed-end fund may ___.

Sell their shares on the open market.

A measure of the riskiness off an asset held in isolation is ___.

Standard deviation

A T-bill quote sheet has 90-day T-bill quotes with a 5.62 ask and a 5.56 bid. If the bill has a $10,000 face value, an investor could sell this bill for ___.

$9,861.00 Explanation: $10,000 x [1 - ((.0556 x 90) / 360)] = $9,861.00

A T-bill with face value $10,000 and 87 days to maturity is selling at a bank discount ask yield of 3.4%. a. What is the price of the bill? (Use 360 days a year.) b. What is its bond equivalent yield? (Use 365 days a year.)

a. Price of the bill is $9,917.83. Explanation: Bank discount of 87 days: 0.034 x (87 days/360 days) = 0.008 Price: $10,000 x (1 - 0.008217) = $9,917.83 b. Bond equivalent yield is 3.48%. Explanation: ($10,000 - $9,917.83) / [$9,917.83 x (87 days / 365 days)] = 0.0348 or 3.48%

Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni's owners. Choose the correct answer in the following statements about financial and real assets. a. Lanni takes out a bank loan. It receives $50,000 in cash and signs a note promising to pay back the loan over three years. The bank loan is a _____ for Lanni. Lanni's $50,000 IOU is the bank's ____. The cash Lanni receives is a ____. The new financial asset ____ is Lanni's promissory note held by the bank.

Financial liability; Financial Asset; Financial Asset; Created