Module 7 - FP513

Your client, Trace, owns a portfolio that earned 12% during the current year. His portfolio has a beta of 1.3 and a standard deviation of 14%. During the current year, the market (as represented by the S&P 500 index) earned 9%. If the current risk-free rate is 5%, which of the following accurately illustrates the Treynor ratios for Trace's portfolio and the market? A) 0.0538; 0.0400 B) 0.0050; 0.0400 C) 0.0538; 0.0100 D) 0.0050; 0.0100

A) 0.0538; 0.0400 The answer is 0.0538; 0.0400. Calculations are as follows. Trace's Treynor = (0.12 - 0.05) ÷ 1.3 = 0.0538 Market's Treynor = (0.09 - 0.05) ÷ 1 = 0.0400. The market has a beta of 1.0.

What is the taxable equivalent yield on a municipal bond with an 8.75% return for an investor in the 24% marginal tax bracket? A) 11.51% B) 6.65% C) 8.75% D) 2.10%

A) 11.51% The formula for solving this problem is 8.75% ÷ (1 - 0.24) = 8.75% ÷ 0.76 = 11.51%.

Johnny owns a municipal bond with a coupon rate of 4.25%. Assuming the annual inflation rate is 1.65%, calculate Johnny's real rate of return on his bond. A) 2.56% B) 1.58% C) 2.60% D) 4.25%

A) 2.56% Johnny realized a real rate of return of 2.56%. Real rate of return = {[(1 + 0.0425) ÷ (1 + 0.0165)] - 1} × 100 = 2.5578, or 2.56%.

If the market interest rate is 7.27%, the current yield of a bond with a 9% coupon, $1,000 par, selling for $1,120, and maturing in 10 years is A) 8.04%. B) 7.27%. C) 9.00%. D) 6.49%.

A) 8.04%. The current yield is the coupon payment divided by the market price of the bond: ($90 ÷ $1,120) x 100 = 8.04%.

A $1,000 U.S. Treasury note maturing in eight years is selling for $938.12. The semiannual coupon payment is $35. What is the yield to maturity (YTM) for the note? A) 8.06% B) 8.33% C) 4.03% D) 6.26%

A) 8.06% The note's YTM is computed using the following TVM inputs: PV = −$938.12 PMT = $35 FV = $1,000 N = 16 (8 x 2 periods per year) Solve for I/YR = 8.06%

The current yield of an 8% coupon bond, maturing in five years, and selling currently for $850 is A) 9.41%. B) 8.56%. C) 6.73%. D) 10.14%

A) 9.41%. The answer is 9.41%. Current yield = annual interest payment ÷ current market price = $80 ÷ $850 = 0.09412, or 9.41%.

You own a small-cap fund and are trying to compare its performance to an appropriate benchmark. Which of the following benchmarks would be the best to use? A) Russell 2000 B) Treasury bills C) CS First Boston High Yield D) The S&P 500 Index

A) Russell 2000 The Russell 2000 is generally considered the benchmark for small-cap funds.

Which of the following statements regarding security market indexes is CORRECT? A) The S&P 500 Index automatically adjusts for stock splits and dividends by focusing on market value instead of price. B) The Russell 2000 Index is a well-known index used to benchmark large capitalization companies. C) Market indexes reflect the average price behavior of a group of stocks at a given point in time. D) The Wilshire 100 Index is used as a measure of the financial stock sector.

A) The S&P 500 Index automatically adjusts for stock splits and dividends by focusing on market value instead of price. The Russell 2000 Index is a well-known index used to benchmark small capitalization companies. A market average, not a market index, reflects the average price behavior of a group of stocks at a given point in time. An index measures the current price behavior of a group of stocks in relation to a base value. The Wilshire 5000 index is used as a measure of the U.S. broad market.

All of the following statements concerning bond yield measurements are CORRECT except A) if the current yield is less than the yield to maturity (YTM), the bond is selling at par. B) if the current yield is 7% and the coupon rate is 6%, the bond is selling at a discount. C) if the bond is selling at a discount, the market price is less than the par value. D) if the bond is selling at a premium, the coupon rate is greater than the YTM.

A) if the current yield is less than the yield to maturity (YTM), the bond is selling at par. A bond is selling at par when the current yield equals the YTM.

A 15-year, 10% annual coupon bond is sold for $1,150. The bond can be called at the end of five years for $1,100. What is the bond's approximate yield to call (YTC)? A. 8.0% B. 8.4% C. 9.2% D. 10.0%

A. 8.0% The calculation is as follows: N = 5; FV = 1,100; PMT = 100; PV = -1,150; then, solve for I/YR = 7.9539, rounded to 8.0%. Interest is compounded on an annual basis according to the problem, so the I/YR does not need to be multiplied by two. The calculator should be in END mode and 1 P/Yr

Franklin is considering investing in bonds. He may purchase a corporate bond paying a 7% coupon or a municipal bond paying 5.3%. If Franklin's marginal federal income tax rate is 32% and his state does not collect income taxes, Franklin would prefer A. the municipal, because its taxable equivalent yield is 7.79%. B. the corporate, because its after-tax yield is 10.45%. C. the municipal, because its taxable equivalent yield is 16.06%. D. the corporate, because its after-tax yield is 21.21%.

A. the municipal, because its taxable equivalent yield is 7.79%. One can either compare the taxable equivalent yield (TEY) of the municipal bond with the nominal yield for the corporate bond or compare the after-tax yield of the corporate bond with the nominal yield of the municipal bond. The TEY of the municipal bond = 5.3% ÷ (1 - 0.32) = 7.79%, which is more than the nominal yield of the corporate bond. The after-tax yield of the corporate bond is 7% × (1 - 0.32) = 4.76%.

Keegan is an analyst for Global Growth and Income Mutual Fund. For the past five years, the fund has returned -20%, 17%, 5%, 15%, and -7%, respectively. Calculate the geometric mean of these returns. A) 5.1105% B) 1.0018% C) 2.0000% D) 1.0221%

B) 1.0018% The geometric mean return is calculated using the following TVM inputs: PV = -1 FV = (1 - 0.20)(1 + 0.17)(1 + 0.05)(1 + 0.15)(1 - 0.07) = 1.0511 N = 5 Solve for I/YR = 1.0018, or 1.0018%

Assume an investor purchased $10,000 of Fund ABC at the beginning of Year 1. Subsequently, he made investments at the beginning of Years 2, 3, and 4 of $1,000, $5,000, and $8,000, respectively. At the beginning of Year 5, the fund was worth $33,000. What was the internal rate of return (IRR) on this fund? A) 20.55% B) 12.79% C) 10.08% D) 14.31%

B) 12.79% This problem involves calculating the IRR/YR for uneven cash flows per the following inputs. Using a financial calculator, include the following cash flows: (10,000) CFj, (1,000) CFj (5,000) CFj (8,000) CFj 33,000 CFj IRR/YR = 12.79%

Select the CORRECT statement regarding security market indexes and averages. A) The S&P 500 Index is used by most professionals as a benchmark for U.S. large-cap equity investments. B) All of these statements are correct. C) The Russell 2000 Index is used to benchmark small capitalization companies. D) The Wilshire 5000 Index is often used as a measure of the overall market within the United States.

B) All of these statements are correct. Averages and indexes are constructed to inform investors about changes in the market. They also serve as benchmarks for the performance of investors' portfolios and the performance of money managers.

Cindy has been an active investor for many years. She currently has a money market mutual fund and several equity mutual funds. She wants to maximize her return on an intermediate-term bond and plans to hold the bond to maturity. Which of these two bonds would be more appropriate for Cindy, and why? - Bond 1: callable at par value; BBB rated; coupon = 6%; matures in six years; selling for $863; duration = 5.16 - Bond 2: callable at par value; A rated; coupon = 10%; matures in four years; selling for $1,103; duration = 3.5 I. Bond 1, because it is selling for a discount and is less likely to be called. II. Bond 1, because it has a higher yield to maturity than Bond 2. III. Bond 2, because its higher coupon gives it a better total return. IV. Bond 2, because it has a higher yield to maturity than Bond 1. A) II only B) I and II C) I only D) III and IV

B) I and II Below are the TVM inputs used on the financial calculator for each bond. YTM for Bond 1: PV = -$863 FV = $1,000 PMT = $1,000 x 6% = $60 / 2 = $30 N = 12 (6 x 2 periods per year) Solve for I/YR = 9% YTM for Bond 2: PV = -$1,103 FV = $1,000 PMT = $1,000 x 10% = $100 / 2 = $50 N = 8 (4 x 2 periods per year) Solve for I/YR =7% In addition, Bond 1 is selling at a discount—unlike Bond 2 selling at a premium—so it is not likely to be called.

Which of the following would be an appropriate index to track an investment in an international developed markets mutual fund? A) IFC Investable B) MSCI EAFE C) IFC Emerging Markets Free Global D) Russell 2000

B) MSCI EAFE The MSCI EAFE Index tracks markets in Europe, Australasia, and the Far East (primarily Japan).

When using a security market index to represent a market's performance, the performance of that market over time is best represented by A) the change in the standard deviation of the index. B) the percent change in the index value. C) the change in the index value. D) the index value.

B) the percent change in the index value. Percentage changes in the value of a security market index over time represent the performance of the market, segment, or asset class from which the securities are chosen.

Mark owns a corporate bond with a coupon rate of 6.78%. Assume the annual inflation rate is 2.5% and he is in the 35% federal marginal income tax bracket. Calculate his after-tax, inflation-adjusted rate of return on this bond. A) 2.04% B) 1.50% C) 1.86% D) 4.17%

C) 1.86% First, calculate Mark's after-tax rate of return on the corporate bond [0.0678 × (1 - 0.35)] = 0.04407, or 4.41%. Next, calculate the after-tax, inflation-adjusted rate of return {[(1 + 0.0441) ÷ (1 + 0.025)] - 1} × 100 = 1.8634, or 1.86%.

An investor who would like to know how a portfolio manager performed relative to how the manager was expected to perform on a risk-adjusted basis would use which one of the following indicators? A) Sharpe ratio B) Beta C) Jensen's alpha D) Treynor ratio

C) Jensen's alpha The indicator that measures performance in relation to what was expected on a risk-adjusted basis is Jensen's alpha. A positive number (alpha) indicates that the manager performed better than expected on a risk-adjusted basis.

What type of index is the Dow Jones Industrial Average (DJIA)? A) Equal-weighted B) Capitalization-weighted C) Price-weighted D) Value-weighted

C) Price-weighted The DJIA is price-weighted, meaning that higher-priced stocks will have more impact on the average than lower-priced stocks. Cap-weighted, which is the same as value-weighted, means the prices of stocks with the largest capitalization relative to the market capitalization of the entire index will have the greatest impact on the index. Equally weighted means that the price movement of each stock in an index has the same impact as that of any other stock in the index.

Mildred manages a mutual fund whose goal is to provide a return similar to the U.S. small capitalization market. Choose the index that would provide the best benchmark for Mildred's fund. A) Wilshire 5000 B) S&P 500 C) Russell 2000 D) Dow Jones Industrial Average (DJIA)

C) Russell 2000 The Russell 2000 is an index of small capitalization U.S. stocks. The DJIA represents 30 major blue-chip stocks. The S&P 500 is an index of 500 large capitalization U.S. stocks. The Wilshire 5000 is a broad market index.

To measure the performance of an investment manager, which of the following methods of computing returns should be used? A) Arithmetic average B) Dollar-weighted return C) Time-weighted return D) Holding period return

C) Time-weighted return The time-weighted return should be used to measure the performance of an investment manager.

Larry invested $5,000 in the ABC mutual fund one year ago. The fund paid dividends of $100, $150, $50, and $100 at the end of each quarter, all of which were distributed to Larry. At the time of the last dividend payment, his fund had grown to $5,175. What was the dollar-weighted return for this investment? A. 2.85% B. 3.50% C. 11.38% D. 14.00%

C. 11.38% The dollar-weighted rate of return equals 11.38%, calculated as follows: CF0 = (5,000), CF1 = 100, CF2 = 150, CF3 = 50, and CF4 = 5,275 (5,175 + 100). Solve for IRR (DOWNSHIFT, IRR/YR) IRR/YR = 2.8455 × 4 = 11.3821, or 11.38%.

JK Mutual Fund has a return of 15.5% and a beta of 1.1. If the market return is 14%, and the risk-free rate is 4%, what is the alpha for JK Mutual Fund? A) -0.50 B) +1.00 C) 0.00 D) +0.50

D) +0.50 The answer is +0.50. Calculate alpha: 15.5 - [4 + (14 - 4)1.1] = +0.50.

Brenda is interested in calculating the inflation-adjusted rate of return of a recent investment. Assuming the after-tax return on her investment is 6.25% and the inflation rate is 5%, calculate the inflation-adjusted rate of return. A) 1.25% B) 12.25% C) 11.25% D) 1.19%

D) 1.19% The inflation-adjusted rate of return is calculated as follows: [(1.0625 ÷ 1.05) − 1] × 100 = 1.19%

Assuming Mary earned a 3% return from dividend reinvestment, a 2% return from capital gain reinvestment, and a 9% return from share price appreciation on her mutual fund, calculate her total return. A) 3% B) 12% C) 5% D) 14%

D) 14% Total return on a stock or mutual fund may be thought of as the sum of the capital appreciation/depreciation on the underlying principal of the investment and any income or earnings generated from that investment. Therefore, Mary's total return equals 14% (3% + 2% + 9%).

Frank purchased 100 shares of ABC common stock five years ago at a cost of $5,000. The stock paid these dividends: Year | Amount 1 | $200.00 2 | $200.00 3 | $250.00 4 | $275.00 5 | $300.00 At the time the fifth-year dividend was paid, Frank sold the stock for $8,500. What is the dollar-weighted return on ABC stock? A) 18.15% B) 15.51% C) 12.67% D) 15.11%

D) 15.11% This problem involves calculating the IRR/YR for uneven cash flows per the following inputs. Using the HP 10bII+: - 5000, CF0 200, CF1 200, CF2 250, CF3 275, CF4 8800 ($300 + $8,500), CF5 Solve for IRR/YR = 15.1076 = 15.11%

Billie purchased a 10-year U.S. Treasury bond with a 6.5% coupon paid semiannually. Assuming the bond is currently trading at $1,075, calculate its yield to maturity (YTM). A) 6.50% B) 2.76% C) 3.25% D) 5.51%

D) 5.51% Use the following TVM inputs in the financial calculator: PV = -$1,075 FV = $1,000 PMT = $32.50 (6.5% × $1,000 = $65 ÷ 2) N = 20 (10 x 2 periods per year) Solve for I/YR = 5.51%. The YTM on the bond is 5.51%, which is lower than the coupon rate of 6.5%, further validating that the bond is trading at a premium.

Jane considers herself to be a conservative investor. To generate additional income, she wants to add an investment-grade bond to her portfolio. She lives in a state that does not have an income tax and she is in the 35% federal income tax bracket. Select the best choice for her portfolio. A) Bond C, D rated corporate debenture with a 6% coupon rate B) Bond B, A rated corporate debenture with a 4.75% coupon rate C) Bond D, AAA rated Treasury bond with a 1.5% coupon rate D) Bond A, AA rated municipal bond with a 3.5% coupon rate

D) Bond A, AA rated municipal bond with a 3.5% coupon rate The answer is Bond A, AA rated municipal bond with a 3.5% coupon rate. Even though Bond C has the highest after-tax rate of return, this bond would not be appropriate for Jane based on her desire for an investment-grade bond. Therefore, Bond A would be the best choice. Calculations: Bond A: 3.5% Bond B: 4.75% × (1 - 0.35) = 3.0875% Bond C: 6% × (1 - 0.35) = 3.90% Bond D: 1.5% × (1 - 0.35) = 0.9750%

Which of the following statements regarding the various performance measures are CORRECT? I. A positive alpha indicates that the manager consistently underperformed the market on a risk-adjusted basis. II. Jensen's alpha indicates how much the realized return differs from the expected return, as per the capital asset pricing model (CAPM). III. The Sharpe ratio is not useful for evaluating the performance of nondiversified portfolios. IV. The Treynor ratio does not indicate whether a portfolio manager outperformed or underperformed the market portfolio. A) II, III, and IV B) I and III C) I and II D) II and IV

D) II and IV A positive alpha indicates that the manager outperformed the market on a risk-adjusted basis. The Sharpe ratio uses total risk, as measured by standard deviation, and is useful for evaluating the performance of both nondiversified and well-diversified portfolios.

To evaluate the performance of a portfolio manager, you should calculate the portfolio's A) dollar-weighted return. B) portfolio return. C) holding period return. D) time-weighted return.

D) time-weighted return. Because portfolio managers have no control over the deposits and withdrawals made by clients, the time-weighted return is a more appropriate measure of performance.

Michael purchased 800 shares of ABC stock at $75 per share. The stock paid a $1.20 dividend per share at the end of the year. During this same year, there was a 2-for-1 stock split. If the value of Michael's investment at the end of the year was $66,000, what was his holding period return (HPR)? A. 8.3% B. 10.0% C. 12.0% D. 13.2%

D. 13.2% Michael's HPR was 13.2%, computed as follows: HPR =$66,000 − $60,000 + ( $1.20 × 800 × 2 ) ________________________________ $60,000 = $7,920 / $60,000 = 13.2% Note that the dividend (or positive cash flow) is based on 1,600 shares because of the subsequent 2-for-1 stock split after Michael purchased the initial shares of ABC stock.

Michael purchased 800 shares of ABC stock for $75 per share. The stock paid a $1.20 dividend per share at the end of the year, and there was a 2-for-1 stock split during the year. Assuming the value of his investment at the end of the year was $66,000, calculate the holding period return for the investment. A) 13.2% B) 8.3% C) 14.0% D) 12.0%

A) 13.2% The investment's holding period return is calculated as [($66,000 − $60,000) + ($1.20 × 800 × 2)] ÷ $60,000 = 13.2%. The dividend is based on 1,600 shares because of the 2-for-1 stock split.

Select the CORRECT statements pertaining to time-weighted and dollar-weighted returns. I. Most returns reported on mutual funds are time-weighted because the portfolio manager does not have any control over the future cash flows to the fund with respect to investor dollars. II. The time-weighted return is determined without regard to any subsequent cash flows of the investor. III. The dollar-weighted return considers subsequent contributions to and withdrawals from an investment. IV. The dollar-weighted approach focuses on the return of the investor over time. A) I, II, III, and IV B) I and IV C) II, III, and IV D) II and III

A) I, II, III, and IV All of these statements are correct pertaining to time-weighted and dollar-weighted returns.

Shannon is evaluating the absolute performance of the Shining Star mutual fund. The return of the fund for the past year was 13%, beta is 1.10, and standard deviation is 23. The market return is 9.5%, and the risk-free rate is 4.5%. Which of the following statements is true? A) The fund's alpha is +3, meaning that the fund manager achieved a higher return than required for the risk taken. B) The fund's alpha cannot be determined; however, 13% is a good relative return. C) The fund's Sharpe ratio is 0.37, meaning this fund should be chosen when compared with another fund with a Sharpe ratio of 0.48. D) The fund's Treynor ratio is 7.73, meaning the fund manager achieved a 7.73% higher return than required for the amount of risk taken.

A) The fund's alpha is +3, meaning that the fund manager achieved a higher return than required for the risk taken. The answer is the fund's alpha is +3, meaning that the fund manager achieved a higher return than required for the amount of risk taken. Alpha is an absolute measure that is simply the difference between the return of the portfolio and the required return (CAPM). The formula is rp - [rf + (rm - rf)β. 13 - [4.5 + (9.5 - 4.5)1.1] = 3. Treynor and Sharpe are comparative or relative measures, and you would choose the investment with the highest number. Alpha is an absolute measure, giving you the actual return above the required return.

Portfolio A has a standard deviation of 5.5%, a beta of 1.15, an actual return of 8%, and an expected return of 10%. Portfolio B has a standard deviation of 7.5%, a beta of 1.50, an actual return of 9%, and an expected return of 12%. Assume a risk-free rate of return of 2.75% and an R2 of 0.40 with respect to the market. Given this information, which of the following statements is CORRECT? A. Portfolio A has a higher Sharpe ratio than Portfolio B, indicating that Portfolio A outperformed Portfolio B. B. Portfolio B has a higher Sharpe ratio than Portfolio A, indicating that Portfolio B outperformed Portfolio A. C. Portfolio A has a higher Jensen's alpha than Portfolio B, indicating that Portfolio A outperformed Portfolio B. D. Portfolio B has a higher Treynor ratio than Portfolio A, indicating that Portfolio B outperformed Portfolio A.

A. Portfolio A has a higher Sharpe ratio than Portfolio B, indicating that Portfolio A outperformed Portfolio B. Because R2 is less than 0.70, the Sharpe ratio must be used to compare the performance of the portfolios. The formula for the Sharpe ratio is as follows: Sp = (rp - rf) ÷ σp Sharpe for Portfolio A = (0.08 - 0.0275) ÷ 0.055 = 0.9545 Sharpe for Portfolio B = (0.09 - 0.0275) ÷ 0.075 = 0.8333 As a result, the Sharpe ratio for Portfolio A is higher than Portfolio B, indicating that Portfolio A outperformed Portfolio B

Mildred is the portfolio manager of a small-cap fund that invests strictly within the United States. Which index would provide the best benchmark for Mildred's fund? A. Russell 2000 Index B. MSCI EAFE Index C. S&P 500 Index D. Wilshire 5000 Index

A. Russell 2000 Index The Russell 2000 is an index of small-capitalization U.S. stocks. The MSCI EAFE is an index of European, Australasian, and Far East stocks. The S&P 500 is an index of large-capitalization U.S. stocks. The Wilshire 5000 is a broad market index.

Anita bought ULA stock for $25,000 six years ago. Today, she sold the stock for $67,000. Calculate Anita's holding period return on ULA. A) 16.80% B) 168.00% C) 28.00% D) 8.40%

B) 168.00% Anita's holding period rate of return was 168% {[(67,000 - 25,000) ÷ 25,000] × 100

Michael owns a municipal bond, trading at par, with a 4.25% coupon rate and is in the 32% federal marginal income tax bracket. Calculate the taxable equivalent yield (TEY) for this bond. A) 2.85% B) 6.25% C) 12.88% D) 5.65%

B) 6.25% TEY = tax-exempt yield ÷ (1 − marginal tax rate) = 0.0425 ÷ (1 − 0.32) = 0.0625, or 6.25%. Therefore, the TEY for Michael's bond is 6.25%. Michael would require this rate of return or higher for an equivalent taxable bond.

Andy purchased a four-year bond with a coupon rate of 7.5% paid semiannually. The bond is trading for $1,025 in the secondary market. Calculate the bond's yield to maturity (YTM). A) 3.39% B) 6.78% C) 8.05% D) 4.34%

B) 6.78% The bond's YTM is calculated using the following TVM inputs on the financial calculator: PV = -$1,025 FV = $1,000 PMT = $37.50 (1,000 × 7.5% = $75 ÷ 2) N = 8 (4 x 2 periods per year) Solve for I/YR = 6.78%.

Al Jenkins owns a corporate bond that currently sells for $1,175. The coupon rate is 9%, interest is paid semiannually, and the bond matures in 20 years. The bond is callable in 11 years at $1,050. What is the yield to call on this bond? A) 7.32% B) 7.00% C) 7.42% D) 6.72%

B) 7.00% The yield to call is calculated using the following TVM inputs in the financial calculator: N = 22 (11 x 2 periods per year) PV = -$1,175 FV= $1,000 PMT = 9% x $1,000 = $90 / 2 = $45 Solve for I/YR = 7.00%

Adam is trying to evaluate the performance of his portfolio on a risk-adjusted basis. He has a nondiversified portfolio of large-cap stocks. He knows there are different measures of risk-adjusted performance and is not sure which one to use. Which of the following is the most appropriate measure to use? A) Jensen, because it compares a portfolio's return to that of a market index. B) Sharpe, because when a portfolio represents the entire investment fund, standard deviation is a better measure of risk. C) Sharpe, because it is used to compute alpha by comparing the Sharpe ratio for a portfolio with the Sharpe ratio for the S&P 500. D) Treynor, because when a portfolio represents one subportfolio of a large diversified portfolio, beta is a better measure of risk.

B) Sharpe, because when a portfolio represents the entire investment fund, standard deviation is a better measure of risk. The Sharpe ratio must be computed for a benchmark, which is then compared to the performance of a portfolio. The Treynor ratio is used when the performance of a subportfolio is measured. Alpha is computed using the Jensen performance measure.

Jensen's alpha is an absolute measurement. What does it tell you? A) The percentage of return that can be attributed to systematic risk B) The percentage a manager over- or underperformed based on the amount of risk taken C) The percentage by which a manager beat the market D) The percentage of return that can be attributed to unsystematic risk

B) The percentage a manager over- or underperformed based on the amount of risk taken Jensen's alpha is a measure of the risk-adjusted value added by a portfolio manager. Specifically, alpha is measured as the portfolio's actual or realized return in excess of (or deficient to) the expected return calculated by the capital asset pricing model (CAPM).

To design a market capitalization weighted index, which of the following approaches should be used? A) Weight the components by their intrinsic value B) Weight the components by the total fair market value of their outstanding shares C) Weight the components by their geometric mean return over the past year D) Weight the components by their per share market prices

B) Weight the components by the total fair market value of their outstanding shares A stock with a market capitalization value of $50 million will have 10 times the impact of a stock with a market capitalization value of a $5 million company.

A mutual fund with an investment objective of growth and income has an alpha of +4, a beta of 1.5, and a Sharpe ratio of 1.15. The fund A) should be purchased, because it has a relatively low level of risk in relation to return. B) should be purchased, because the rate of return is high in relation to risk. C) should not be purchased, because it has a low level of return in relation to risk. D) should not be purchased even though the rate of return compensates for the level of risk.

B) should be purchased, because the rate of return is high in relation to risk. A positive alpha indicates the fund performed better than it should have on a risk-adjusted basis. Also, an alpha of +4, which is very high, means it performed 4% better than expected.

Capitalization-weighted indexes are A) constructed by giving each investment equal weighting. B) the preferred type of index to use in modern portfolio theory applications. C) characterized by higher-priced stocks having more influence on the overall movement of the index than lower-priced stocks. D) uncommon and not suitable for performance measurement.

B) the preferred type of index to use in modern portfolio theory applications. Capitalization weighted indexes are the most prevalent type of index and are best suited for modern portfolio theory applications. In a price-weighted index, higher-priced stocks within this index have more influence on the overall movement of this index than lower-priced stocks.

August Corporation's common stock experienced the following returns over the past three years: 6%, −10%, 20%. Which is CORRECT in identifying the August Corporation's arithmetic and geometric mean? A. Arithmetic mean: 4.61%; geometric mean: 5.33% B. Arithmetic mean: 5.33%; geometric mean: 4.61% C. Arithmetic mean: 7.00%; geometric mean: 12.00% D. Arithmetic mean: 12.00%; geometric mean: 7.00%

B. Arithmetic mean: 5.33%; geometric mean: 4.61% This is solved as follows: (6% − 10% + 20%) ÷ 3 = 5.33%. Geometric mean: PV = −1, N = 3, PMT = 0, FV = (1.06)(0.90)(1.20) = 1.1448. Solve for I/YR = 0.0461, or 4.61%.

Myles purchased 1,000 shares of XYZ growth fund for $15 per share. At the end of the two years, he sold all of the shares for $22 per share. At the end of each year, the fund paid a dividend of $0.50 per share. Calculate the fund's time-weighted return over the two-year period. A) 18.07% B) 13.62% C) 24.15% D) 20.82%

C) 24.15% The fund produced a 24.15% time-weighted rate of return over the two-year period, calculated as follows: CF0 = -15 × 1,000 = −15,000 CF1 = 0.50 × 1,000 = 500 CF2 = (0.50 × 1,000) + (22 × 1,000) = 22,500 Solve for the internal rate of return (IRR/YR) = 24.1525% (rounded to 24.15%)

Zenith Mutual Fund has had the following annual returns: +12%, +18%, +22%, and -13%. What is the Zenith Fund's geometric mean return? A) 9.75% B) 11.66% C) 8.83% D) 10.17%

C) 8.83% The simplest way to do this problem is to see how much $1 would have grown to over the four years, and then do a simple time value of money calculation. $1.00 × 1.12 × 1.18 × 1.22 × 0.87 = $1.4027. (1) PV, 1.4027 FV, 4 N, I/YR = 8.8281%.

An investor who owns a sector fund that has substantial unsystematic risk and would like to know how a portfolio manager performed on a risk-adjusted basis would use which of the following indicators? A) Jensen's alpha B) Treynor ratio C) Sharpe ratio D) Beta

C) Sharpe ratio Sharpe uses standard deviation and assumes the portfolio is not well diversified and measures total risk.

Quincy has narrowed his choice down to the following four mid-cap funds, which is a category he wants to add to his portfolio. Which fund should Quincy choose? A Fund | J Fund | Q Fund | Z Fund Return 12% | 9% | 13% | 11% Alpha 0.52 | -1.04 | 0.66 | 1.10 Treynor 0.68 | 0.21 | 0.58 | 0.62 Sharpe 0.44 | 0.32 | 0.21 | 0.37 R-squared 0.88 | 0.78 | 0.82 | 0.84 A) A Fund B) Q Fund C) Z Fund D) J Fund

C) Z Fund The R-squared for all four funds is greater than 0.70, meaning beta is reliable. Alpha uses beta, and is a measure of absolute return, and the best measure to use if beta is reliable. The fund with the highest alpha is the Z fund.

A(n) ______________________ average allows small companies to have as much influence as large companies in the average; a(n)_________________ average gives greater influence to large companies than to small companies in the average; and a(n) ______________________ average gives greater influence to high-priced stocks than to low-priced stocks in the average. A) price-weighted; equally weighted; capitalization-weighted B) price-weighted; capitalization-weighted; equally weighted C) equally weighted; capitalization-weighted; price-weighted D) capitalization-weighted; price-weighted; equally weighted

C) equally weighted; capitalization-weighted; price-weighted For a price-weighted index, higher priced stocks have more influence on the overall movement of this index than lower priced stocks. For a market capitalization weighted index, such as the S&P 500, a stock with a market capitalization value of $25 million will have 10 times the impact of a stock with a market capitalization value of a $2.5 million company.

Susan is earning a before-tax (nominal) return of 10% on a recently purchased investment. Her combined federal and state marginal income tax rate is 37%. What is her after-tax rate of return on this investment? A. 2.7% B. 3.7% C. 6.3% D. 6.7%

C. 6.3% Susan's after-tax rate of return on the investment is 6.3%, calculated as follows: 0.10 × (1 - 0.37) = 0.10 × 0.63 = 0.063, or 6.3%.

Jerry purchased a 30-year junk bond for $977.36 with a stated coupon rate of 8.5%. What is the YTM for this bond if he receives semiannual coupon payments and expects to hold the bond to maturity? A. 4.36% B. 5.68% C. 8.71% D. 8.93%

C. 8.71% This is calculated as follows: Set the calculator in END Mode and 2 P/Yr. PV = -977.36; FV = 1,000; PMT = 8.5% × 1,000 ÷ 2 = 42.50; 30, DOWNSHIFT, N = 60. Solve for I/YR = 8.71%

Carolyn owns a corporate bond with a coupon rate of 3.60%. Currently, the inflation rate is 1.50%. Calculate the real rate of return on this bond. A) 3.60% B) 5.10% C) 2.10% D) 2.07%

D) 2.07% The real rate of return on this bond is calculated as follows: [((1 + 0.036) ÷ (1 + 0.015)) - 1] × 100 = 0.0207 × 100 = 2.07%

In general, rising interest rates result in which of the following combinations? A) Rising bond prices and falling stock prices B) Rising stock and bond prices C) Falling bond prices and rising stock prices D) Falling stock and bond prices

D) Falling stock and bond prices In general, rising interest rates result in falling stock and bond prices.

Arthur purchases 200 shares of HMS stock for $23 per share. He then makes subsequent purchases at the end of the following years: Year 1: 50 shares at $26 per share Year 2: 75 shares at $29 per share Year 3: 25 shares at $36 per share At the end of the fourth year, HMS is trading at $41 per share. What is the annualized time-weighted return on the stock over the four-year period? (Assume that no dividends were paid over the four-year period.) A. 13.85% B. 14.25% C. 15.00% D. 15.55%

D. 15.55% Because time-weighted returns do not consider the cash flows of the investor (Arthur), only appreciation and dividends on the investment are relevant. CF0 = -23 (beginning share value), CF1 = 0, CF2 = 0, CF3 = 0, and CF4 = 41 (ending share value). IRR/YR = 15.5484, or 15.55%.

Bond ABC is selling at par, offers an 8% coupon, and matures in 20 years. Bond ABC has a call feature that allows the bond to be called after 10 years at a price of $1,050. Which of the following statements is CORRECT? A. The YTC for Bond ABC is 8.00%, which is equal to Bond ABC'S YTM. B. The YTC for Bond ABC is 8.00%, which is more than Bond ABC's YTM. C. The YTC for Bond ABC is 8.34%, which is less than Bond ABC's YTM. D. The YTC for Bond ABC is 8.34%, which is more than Bond ABC's YTM.

D. The YTC for Bond ABC is 8.34%, which is more than Bond ABC's YTM The answer is the YTC for Bond ABC is 8.34%, which is more than Bond ABC's YTM. Set the calculator in END Mode and 2 P/Yr. Because ABC is selling at par, its YTM = 8.0%. ABC's YTC is as follows: PV = −1,000; FV = 1,050; 10, DOWNSHIFT, N = 20; PMT = 8% × 1,000 ÷ 2 = 40. Solve for I/YR = 8.34%.

Harry purchased 100 shares of MNL common stock five years ago at a cost of $4,300. The stock paid these dividends: Year | Amount 1 | $180 2 | $180 3 | $200 4 | $225 5 | $230 At the time the fifth-year dividend was paid, Harry sold the stock for $8,900. What was Harry's average annual compound rate of return (IRR) on MNL stock? A) 19.21% B) 15.66% C) 12.68% D) 9.35%

A) 19.21% The answer is 19.21%. Calculation follows: Financial Calculator Inputs 4,300 (+/-) = CF0 180 = CF1 180 = CF2 200 = CF3 225 = CF4 230 + 8,900 =, CF5 Solve for IRR/YR(Answer = 19.21%)

Kumar purchased 100 shares of YTR stock from his broker. He earned returns of 7%, -3%, 8%, -10%, and 12% in years 1 through 5 respectively. Calculate Kumar's geometric mean return on his investment over the five-year period. A) 2.47% B) 2.80% C) 2.26% D) 1.40%

A) 2.47% First, calculate the future value per $1 of Kumar's investment: (1.07)(0.97)(1.08)(0.90)(1.12) = 1.13. Next, calculate the geometric mean: PV = -1, FV = 1.13, N = 5, solve for I/YR = 2.4745, or 2.47%.

Kellie purchased a five-year bond with a coupon rate of 2.50% paid semiannually. The bond has a current market price of $985. Calculate the yield to maturity (YTM) for Kellie's bond. A) 2.8238% B) 2.8259% C) 2.5000% D) 2.8990%

A) 2.8238% The bond's YTM is calculated using the following TVM inputs in the financial calculator: PV = −$985 FV = $1,000 PMT = 2.50% × $1,000 = $25 / 2 = $12.50 N = 10 (5 x 2 periods per year) Solve for I/YR = 2.8238% The YTM for Kellie's bond is higher than its coupon rate because the bond is trading at a discount.

Rose purchased TRM stock for $40. A year later the stock paid a dividend of $4. At the end of the second year, Rose sold her TRM stock for $60 per share. What is the time-weighted return for TRM stock for the two-year period? A) 27.58% B) 20.81% C) 18.56% D) 23.26%

A) 27.58% Time-weighted return is calculated as follows: CF0 = (40) CF1 = 4 CF2 = 60 IRR/YR = 27.58%

Harry has an investment that has produced the following returns: Year 1: 10%, Year 2: 5%, Year 3: -7%, Year 4: -3%, Year 5: 12%. Calculate the arithmetic mean return on this investment. A) 3.40% B) 6.75% C) 8.50% D) 17.00%

A) 3.40% The arithmetic mean is calculated by dividing the sum of the periodic returns by the total number of periods being evaluated. Therefore, Harry earned an average of 3.40% [(10% + 5% - 7% - 3% + 12%) ÷ 5] per year on his investment.

Eight years ago, ABC Company issued a 20-year bond with a 4% coupon rate. Due to a recent decline in market interest rates, the company decided to call the bonds for 103% of par value. Calculate the rate of return for an investor who purchased the bond at issue for par and surrendered it today for the call price. A) 4.32% B) 4.44% C) 4.00% D) 4.10%

A) 4.32% The yield to call on this issue is calculated using the following TVM inputs: PV = -$1000 FV = $1,030 PMT = 4% x 1000 ÷ 2 = $20 N = 16 (8 x 2 periods per year) Solve for I/YR = 4.32%

Nancy bought $4,000 worth of common stock two years ago. She received dividends of $30 each quarter for the first year and $35 each quarter for the second year. The stock currently is worth $4,100. The graph below summarizes inflows and outflows. What is the internal rate of return that the stock has earned? A) 4.45% B) 1.11% C) 0.99% D) 3.61%

A) 4.45% Below are the keystrokes for the HP 10BII+; refer to the Financial Calculator Workbook to figure inputs for the TI BAII+: HP 10bII+ (set for 4 P/YR) 4000,+/-, CFj 30, CFj, 4, SHIFT, Nj 35,CFj, 3, SHIFT, Nj 4100,+, 35, =, CFj SHIFT, IRR/YR

Jefferson originally purchased 100 shares of XYZ stock for $45 per share. The stock is currently trading at $60 per share. The stock paid dividends of $2 per share in year 1 and $2.30 per share in year 2 (all paid at year end). If Jefferson has held the stock for two years, what is his holding period return? A) 42.9% B) 19.0% C) 23.5% D) 22.0%

A) 42.9% This is calculated as: [($60 - $45) + $2 + $2.30] ÷ $45 = 42.9%.

Jill is in the 24% marginal tax bracket. She owns a $1,000 par value public purpose municipal bond that pays $35 interest semiannually. What pretax yield on corporate bonds would be comparable to the yield on Jill's current investment? A) 9.21% B) 6.28% C) 5.32% D) 8.96%

A) 9.21% pretax yield = after tax yield / (1 −marginal tax rate) $35 × 2 = $70 annual interest = 7.0% coupon rate taxable equivalent yield (TEY) = 7.0% ÷ (1 - .24) = 7.0% ÷ 0.76 = 9.21%

If a mutual fund's beta and standard deviation are expected to decrease in the future, its average annual return and the market average annual return are expected to remain the same, and the risk-free rate is expected to remain constant, which of the following shows the real effect this would have on the following performance measures? Option | Alpha | Sharpe Ratio A | increase decrease B decrease decrease C decrease increase D increase increase A) Option D B) Option B C) Option A D) Option C

A) Option D A decrease in the risk level decreases the denominator of the Sharpe ratio, while the numerator stays constant, thereby increasing the Sharpe ratio. The decreased risk level, as measured by beta, decreases the expected return for the fund, while the actual portfolio return remains constant, thereby increasing the alpha.

Consider the following information for the CPM International Growth Fund: Average annual rate of return = 7.45% Average market rate of return = 8.50% Beta = 1.25 Standard deviation = 4.55% Risk-free rate of return = 3.50% Select the statement that is NOT correct. A) The Treynor ratio for the fund is 0.0400. B) The Sharpe ratio for the fund is 0.8681. C) The fund manager underperformed the market over the given time frame. D) Jensen's alpha for the fund is -2.30%.

A) The Treynor ratio for the fund is 0.0400. The answer is the Treynor ratio for the fund is 0.0400. Based on the information provided, the Treynor ratio for the fund is 0.0316, calculated as follows: Sharpe ratio = (0.0745 - 0.0350) ÷ 0.0455 = 0.8681 Treynor ratio = (0.0745 - 0.0350) ÷ 1.25 = 0.0316 Jensen's alpha = 7.45% - [3.50% + (8.50% - 3.50%) 1.25] = -2.30% When Jensen's alpha is positive, the fund manager outperformed the overall market. In this case, alpha indicates that the fund manager has underperformed.

CDE Inc. bonds have these characteristics: 10% coupon $1,000 par value Current price of $1,136.92 Eight years to maturity Callable in five years at $1,100 Calculate the bond's yield to maturity (YTM) and yield to call (YTC). A) YTM: 7.68%; YTC: 8.26% B) YTM: 7.65%; YTC: 8.24% C) YTM: 3.84%; YTC: 4.13% D) YTM: 7.97%; YTC: 8.54%

A) YTM: 7.68%; YTC: 8.26% Yield to maturity is calculated using the following TVM inputs on the financial calculator: PMT = $1,000 x 10% = $100 / 2 = $50 FV = $1,000 PV = -$1,136.92 N = 16 (8 x 2 periods per year) Solve for I/YR (YTM) = 7.68, or 7.68% Yield to call is calculated using the following TVM inputs on the financial calculator: PMT = $1,000 x 10% = $100 / 2 = $50 FV = $1,100 PV = -$1,136.92 N =10 (5 x 2 periods per year) Solve for I/YR (YTC) = 8.26, or 8.26%

Lauren invested $15,000 in a growth and income fund four years ago. She received a dividend of $800 the first year and $900 each in the second, third, and fourth years. Today, her investment has a total value of $27,234.56. Calculate the approximate internal rate of return (IRR) on Lauren's investment. (Round to the nearest percent.) A) 13% B) 21% C) 18% D) 12%

B) 21% IRR is the discount rate that equates the present value of all the cash inflows with the present value of the cash outflows. The cash flow inputs for the financial calculator are as follows: - 15,000 CF0, 800 CF1, 900 CF2, 900 CF3, 27,234.56 + 900 = 28,134.56 CF4, Solve for IRR/YR = 20.80 (rounded to 21%). Note the final cash flow consists of both the dividend ($900) and the ending value ($27,234.56).

Strahan Corporation's current annual common stock dividend is $3 and is expected to grow by 15% during the next year. The stock's current market price is $35 per share. If Strahan stock had a $30 market price one year ago, calculate the stock's total return. A) 14.29% B) 26.67% C) 22.86% D) 8.57%

B) 26.67% A stock's total return (TR) = (the dividend received during a given period + the change in the stock's price during the same period) ÷ by the stock's current market value at the beginning of the period. Therefore, TR = ($3 + $5) ÷ $30 = 26.67%.

Five years ago, XYZ Company issued a 20-year bond with a 4.75% coupon paid semiannually. The bond may be called at 104% of par, 10 years after issue. Assuming the bond is currently selling for $990, calculate the bond's yield to call. A) 5.18% B) 5.68% C) 4.95% D) 2.84%

B) 5.68% The bond's yield to call is calculated using the following TVM inputs on the financial calculator: Note: XYZ Company has the option to call the issue in five years. PV = -$990 N = 10 (5 x 2 periods per year) PMT = $23.75 (4.75% x $1,000 = $47.50 ÷ 2) FV = $1,040 ($1,000 × 1.04) Solve for I/YR = 5.68%

ABC Corporation has issued a 30-year callable bond with a 5.75% coupon at par. The current market price of the bond is $989.50. Calculate the current yield of this bond. A) 5.75% B) 5.81% C) 5.69% D) 2.91%

B) 5.81% The current yield is calculated as follows: $57.50 ÷ $989.50 = 0.05811, or 5.81%.

Brandon owns ABC mutual fund that has produced these returns over the past three years: - Year 1: 4.7% - Year 2: −10.0% - Year 3: 6.5% Based on this information, calculate both the arithmetic mean (AM) and geometric mean (GM) returns for this series. A) Arithmetic mean: −3.93%; geometric mean: −0.1182% B) Arithmetic mean: 0.40%; geometric mean: 0.1182% C) Arithmetic mean: −0.40%; geometric mean: −7.04% D) Arithmetic mean: 7.07%; geometric mean: 7.04%

B) Arithmetic mean: 0.40%; geometric mean: 0.1182% The answer is arithmetic mean: 0.40%; geometric mean: 0.1182%. The arithmetic mean is calculated as follows: (4.7% - 10.0% + 6.5%) ÷ 3. The geometric mean is calculated using the following TVM inputs: PV = -1 FV = (1.047)(0.90)(1.065) PMT = 0 N = 3 Solve for I/YR = 0.1182

Which of the following statements regarding performance measures is CORRECT? A) The reliability of their betas is important for the Jensen and Sharpe performance measures. B) Jensen's alpha may be used by itself to judge an investment. C) A negative alpha indicates the investment lost money. D) The Sharpe ratio uses beta as its measure of risk.

B) Jensen's alpha may be used by itself to judge an investment. Beta is the risk measure for alpha, but Sharpe uses standard deviation as its risk measure. Therefore, the reliability of beta is relevant for alpha. Jensen's alpha can be used by itself to judge an investment; the Sharpe ratio must be used in comparison with another Sharpe ratio in judging an investment. A negative alpha indicates the investment did not perform as well as expected given the risk taken. For example, an alpha of -1 means the investment underperformed by 1% compared to what it was expected to return. Accordingly, a negative alpha does not necessarily mean the investment lost money.

Mutual fund QUE has a correlation coefficient with the market of 0.82, a beta of 1.05, and a standard deviation of 4%. The risk-free rate of return is 3.5%, and the return on the market is 12%. Mutual fund POI has a Sharpe ratio of 2.05, a Treynor ratio of 0.11, and an alpha of 0.70%. Decide which of the following a rational investor would select if the market's standard deviation is 2% and QUE realized a 13% return. A) POI over QUE because QUE's alpha is 0.58%. B) QUE over POI because QUE's Sharpe ratio is 2.38. C) POI over QUE because QUE's Treynor ratio is 0.09. D) QUE over POI because QUE's coefficient of variation is 0.31.

B) QUE over POI because QUE's Sharpe ratio is 2.38. QUE's alpha = 13% - [3.5% + (12% - 3.5%) 1.05] = 0.58% QUE's Treynor ratio = (0.13 - 0.035) ÷ 1.05 = 0.09 QUE's Sharpe ratio = (0.13 - 0.035) ÷ 0.04 = 2.38 QUE's coefficient of variation = 4% ÷ 13% = 0.31 Because QUE's R2 equals 67% (0.82 × 0.82), alpha and Treynor are not appropriate performance measures for comparison purposes. Because we do not know POI's coefficient of variation, we must use the Sharpe ratio to select the better risk-adjusted return.

Mary owns a portfolio consisting of two stocks, FUR and STC. FUR stock has a beta of 0.90, a standard deviation of 5%, and an actual return of 10%. STC stock has a beta of 1.10, a standard deviation of 7%, and an actual return of 12%. Assume a risk-free rate of return of 3%. Using the Treynor ratio, evaluate which stock had the better risk-adjusted performance. A) Cannot be determined with the information provided B) STC stock C) Both stocks exhibit the same performance D) FUR stock

B) STC stock The answer is STC stock. The formula for the Treynor ratio is: Tp = (rp − rf ) ÷ βp Treynor for FUR stock = (0.10 − 0.03) ÷ 0.90 = 0.0777 Treynor for STC stock = (0.12 − 0.03) ÷ 1.10 = 0.0818 As a result, the Treynor ratio for STC stock is higher than FUR stock, indicating that STC has outperformed FUR on a risk-adjusted basis.

The yield to maturity on a zero-coupon bond ($1,000 par value) currently selling at $677 and maturing in four years is approximately A) 15.00%. B) 37.48%. C) 10.00%. D) 4.00%.

C) 10.00%. Solve for yield to maturity using the following TVM inputs in the financial calculator: PV = −$677 FV = $1,000 PMT = 0 N = 8 (4 x 2 periods per year) Solve for I/YR = 10% (rounded) (4.99%x2?)

What is the internal rate of return (IRR) on an investment that was purchased for $10,000, generated income at the end of Year 1 of $600, required an additional expenditure at the end of Year 2 of $300, and was sold at the end of Year 3 for $13,000? A) 12.11% B) 6.28% C) 10.24% D) 9.50%

C) 10.24% The following cash flows are used on the financial calculator: CF0 = (10,000) CF1 = 600 CF2 = (300) CF3 = 13,000 Solve for IRR/YR = 10.2432, or 10.24%.

Brantley recently purchased a new video game system on his credit card. Assuming the nominal annual percentage rate (APR) is 14.95% (compounded daily), calculate the effective annual rate (EAR). A) 15.02% B) 14.95% C) 16.12% D) 13.26%

C) 16.12% The answer is 16.12%. The effective annual rate on his credit card is 16.12%, calculated as follows: EAR = [1 + (0.1495 ÷ 365)]365 - 1 = 0.1612, or 16.12%.

Ashley purchased a five-year corporate bond with a 6.25% coupon paid semiannually. The bond is callable after three years for a price of $1,025. Assuming the bond is currently trading at $1,045, calculate its yield to call. A) 2.31% B) 2.69% C) 5.38% D) 4.62%

C) 5.38% Yield to call can be calculated using the following TVM inputs on the financial calculator: PV = -$1,045 FV = $1,025 PMT = $31.25 (6.25% × $1,000 = $62.50 ÷ 2) N = 6 (3 x 2 periods per year) Solve for I/YR = 5.38% The yield to call is 5.38%, which is lower than the coupon rate of 6.25%, further validating that the bond is trading at a premium.

Assuming Von made a $10,000 investment four years ago that presently has a value of $31,500, calculate the geometric mean return over the four-year investment period. A) 78.75% B) 33.22% C) 53.75% D) 57.50%

C) 53.75% An investment growing from $10,000 to $31,500 over a four-year period has a geometric mean return equal to 33.22%, calculated as follows: PV = −10,000 FV = 31,500 N = 4 Solve for I/YR = 33.2225, or 33.22%

Your client purchased a call of KLN Corp. for $800. The exercise price was $35, and the market price of KLN Corp. stock was $38. Six months later, the market price of KLN Corp. stock was $40 and the client sold the call for $1,250. What was the holding period return on this investment? A) 63.82% B) 8.57% C) 56.25% D) 14.28%

C) 56.25% HPR = sale price − purchase price / purchase price = 1,250−800 / 800 = 56.25%

Sammy owns a 7% corporate bond that is currently trading at $1,040. The bond matures in 22 years; however, it is callable in nine years at a 3% premium over par. What is the yield-to-call on Sammy's bond? A) 6.57% B) 6.97% C) 6.65% D) 6.82%

C) 6.65% The call premium is 3%, which would be a price of $1,030. The inputs can be used on the financial calculator: TVM Inputs- $1,040 PV $1,030 FV $35 = $1,000 x 7% = $70 / 2 PMT N = 18 (9 x 2 periods per year) N Solve for I/YR= 6.65%

Seven years ago, KLO Industries issued a 15-year bond with a 6% coupon rate. The bonds are currently rated BB+. Due a decline in interest rates, the company decided to call the bonds for 106% of par value. Calculate the rate of return for an investor who purchased the bond at issue for par and surrendered it today for the call price. A) 5.74% B) 6.00% C) 6.69% D) 6.25%

C) 6.69% The answer is 6.69%. The yield to call on this issue is calculated using the following TVM inputs on the financial calculator: FV = $1,060 PV = −$1,000 PMT = $30 (6% x $1,000 = $60 ÷ 2) N =14 (7 x 2 periods per year) Solve for I/YR = 6.69%

Seven years ago, KLO Industries issued a 15-year bond with a 6% coupon rate. The bonds are currently rated BB+. Due a decline in interest rates, the company decided to call the bonds for 106% of par value. Calculate the rate of return for an investor who purchased the bond at issue for par and surrendered it today for the call price. A) 6.25% B) 6.00% C) 6.69% D) 5.74%

C) 6.69% The yield to call on this issue is 6.69%, calculated using the following TVM inputs: FV = $1,060 PV = −$1,000 PMT = $30 (6% x $1,000 = $60 ÷ 2) N = 14 (7 x 2 periods per year) Solve for I/YR = 6.69%

The performance of two growth and income mutual funds is displayed below: ABC Fund | XYZ Fund Average annual rate of return 8.65% 6.78% Standard deviation of returns 5.86% 9.98% Beta 0.75 1.00 Assuming a risk-free rate of return of 5%, which of these statements is CORRECT? A) XYZ Fund has a higher level of systematic risk than ABC Fund. B) Based on the Treynor ratio, ABC Fund has a better risk-adjusted performance than XYZ Fund. C) All of these statements are correct. D) The Sharpe ratio for XYZ Fund is 0.1784 and 0.6229 for ABC Fund.

C) All of these statements are correct. When compared with another investment, the higher the Treynor ratio, the better the risk-adjusted performance of the asset. Therefore, ABC Fund with a Treynor ratio of 0.0487 has a better risk-adjusted performance than XYZ Fund. XYZ Fund has a beta greater than ABC Fund, indicating a higher level of systematic risk. Calculations: Treynor ratio for ABC Fund is 0.0487 [(0.0865 - 0.05) ÷ 0.75] Treynor ratio for XYZ Fund is 0.0178 [(0.0678 - 0.05) ÷ 1.00] Sharpe ratio for ABC Fund is 0.6229 [(0.0865 - 0.05) ÷ 0.0586] Sharpe ratio for XYZ Fund is 0.1784 [(0.0678 - 0.05) ÷ 0.0998]

Allison purchases 200 shares of ADM stock for $23 per share and makes subsequent purchases at the end of the following years: Year 1: 50 shares at $26/share Year 2:75 shares at $29/share Year 3: 25 shares at $36/share At the end of Year 4, ADM is trading for $41 per share. There have been no dividends paid during the holding period. Calculate the annualized dollar-weighted return on Allison's investment for this four-year period. A) 14.55% B) 15.05% C) 15.55% D) 16.05%

D) 16.05% To use the uneven cash flow method to solve for the internal rate of return: CF0 (4,600) (200 × 23) CF1 (1,300) (50 × 26) CF2 (2,175) (75 × 29) CF3 (900) (25 × 36) CF4 14,350 (350 × 41) Solve for IRR/YR = 16.0531, or 16.05%

Jonathan purchased 500 shares of CPM stock for $12 per share. At the end of the first year, he made another purchase of 500 shares at a stock price of $12 per share. At the end of the third year, he sold all of the stock for $17 per share. In addition, the stock paid a dividend of 0.35 per share at the end of each year. Calculate the dollar-weighted return to Jonathan over the three-year period. A) 13.50% B) 11.63% C) 15.60% D) 17.46%

D) 17.46% Jonathan earned a dollar-weighted rate of return of 17.46% on CPM stock over the three-year period, calculated as follows: CF0 = −12 × 500 = −6,000 CF1 = (−12 × 500) + (0.35 × 500) = −5,825 CF2 = (0.35 × 1,000) = 350 CF3 = (0.35 × 1,000) + (17 × 1,000) = 17,350 Solve for the internal rate of return (IRR/YR) = 17.4626, or 17.46%

Janice, who is in the 35% marginal income tax bracket, would like to purchase a bond for her investment portfolio. Assuming all of the bonds are of similar investment quality, which would produce the highest after-tax yield? A) 2.25% U.S. Treasury note B) 5.25% corporate bond C) 2.75% U.S. Treasury bond D) 3.55% municipal bond

D) 3.55% municipal bond Janice should purchase the municipal bond based on the following after-tax yield calculations: U.S. Treasury bond [2.75% × (1 − 0.35)] 1.79% Corporate bond [5.25% × (1 − 0.35)] 3.41% Municipal bond (tax-free) 3.55% U.S Treasury note [2.25% × (1 − 0.35)] 1.46%

Your client purchased the Zenith Fund three years ago at $13.16. Here are the year-end prices of the fund up until today: 20X7 = $14.21 20X8 = $15.86 20X9 = $14.78 What is the geometric return of Zenith Fund for this three-year period? A) 5.26% B) 4.61% C) 5.88% D) 3.95%

D) 3.95% The $13.16 has grown to $14.78 over a three-year period, so ($13.16) is the PV: $14.78 FV, 3 N, and solve for I/YR, which equals 3.95%.

Robinson owns a municipal bond with a coupon rate of 2.75%. He is currently in the 32% federal marginal income tax bracket and resides in a state that does not impose a state income tax. Calculate his municipal bond's taxable equivalent yield (TEY). A) 2.75% B) 3.66% C) 6.75% D) 4.04%

D) 4.04% The bond's TEY is calculated as follows: 2.75% ÷ (1 - 0.32).

Steve has an AA rated bond with an annual coupon rate of 4.35% that is currently trading for $965. Calculate the bond's current yield. A) 4.20% B) 3.50% C) 4.35% D) 4.51%

D) 4.51% The bond's current yield is calculated as $43.50 ÷ $965. Annual interest payment as a percent of par equals $43.50 ($1,000 × 4.35%) divided by the current market price of $965.

Crowder made an investment that paid him an 8% nominal rate of return for the year in which he held the investment. During that year, the inflation rate was 3%. Based on this information, calculate Crowder's inflation-adjusted return (real return). A) 3.08% B) 2.67% C) 5.10% D) 4.85%

D) 4.85% The inflation-adjusted return (IAR) is computed as: IAR = [((1 + nominal rate of return) ÷ (1 + inflation rate)) − 1] × 100 = ((1.08 ÷ 1.03) − 1) × 100 = 4.8544, or 4.85%

Tripp is an investor in the 32% marginal tax bracket. If he invests in a 4.75% municipal bond, his taxable equivalent yield (TEY) would be A) 3.23%. B) 6.27%. C) 4.75%. D) 6.99%.

D) 6.99%. taxable equivalent yield = tax-exempt yield ÷ (1 − marginal tax rate) = 4.75% ÷ (1 − 0.32) = 6.99%

SmallCap Value SmallCap Growth Current yield 1.1% .6% Five-year total return 14.2% 16.7% Beta .89 1.14 Sharpe ratio 1.12 .93 Standard deviation 8.2 12.6 Alpha +2.7 +.4 Which mutual fund is more appropriate & why A Smallcap growth fund, bc its total return is higher B Smallcap growth fund, bc growth stocks fit her goal of maximum capital appreciation C Smallcap value fund, bc its coefficient of variation is higher D Smallcap value fund, bc its risk-adjusted performance statistics are superior

D) Smallcap value fund, bc its risk-adjusted performance statistics are superior Perhaps a fund other than one with a lower-than-market beta fund should have been considered since she is an aggressive investor. However, no such alternative is shown. Total return alone is insufficient reason to select one fund over another. Risk-adjusted return is the appropriate measure. The value fund has a higher alpha, a higher Sharpe ratio, and a higher risk-adjusted performance when the total return is divided by beta. The current yield is relatively low for both funds.

The Allegro Mutual Fund has an alpha of +1.50, a Sharpe ratio of 0.44, and an R2 with the Russell 2000 of 0.45. The Moderato Mutual Fund has an alpha of +0.40, a Sharpe ratio of 0.48, and an R2 with the Russell 2000 of 0.52. Which fund should be chosen and why? A) The Moderato Fund because it has a lower alpha. B) The Allegro Fund because it has a lower Sharpe ratio. C) The Allegro Fund because it has a higher alpha. D) The Moderato Fund because it has a higher Sharpe ratio.

D) The Moderato Fund because it has a higher Sharpe ratio. This can be determined by R2, which gives the level of systematic risk. The R2 for both funds is low (0.45 and 0.52), meaning beta, and formulas using beta, should not be used. You want an R2 of 0.70 or higher in order to use beta. This then leaves you with Sharpe, and the Moderato Fund has the highest Sharpe ratio of the two.

Bond ABC is selling at par, offers an 8% coupon, and matures in 20 years. The bond has a call feature that allows the issuer to call the bond after 10 years at a price of $1,050. Which of these statements explains the relationship between the bond's yield to call (YTC) and yield to maturity (YTM)? A) The YTC for Bond ABC is 8.33%, which is less than Bond ABC's YTM. B) The YTC for Bond ABC is 8.00%, which is equal to Bond ABC's YTM. C) The YTC for Bond ABC is 8.00%, which is more than Bond ABC's YTM. D) The YTC for Bond ABC is 8.33%, which is more than Bond ABC's YTM.

D) The YTC for Bond ABC is 8.33%, which is more than Bond ABC's YTM. The answer is the YTC for Bond ABC is 8.33%, which is more than Bond ABC's YTM. Because Bond ABC is selling at par, the YTM is equal to the coupon rate of 8%. Use the following TVM inputs in the financial calculator: PV = -$1,000 FV = $1,050 N = 20 (10 x 2 periods per year) PMT = 8% × $1,000 = $80 ÷ 2 = $40 Solve for I/YR = 8.33%

You are about to choose a new mutual fund to add to client portfolios. As you review the Morningstar reports for the funds you are considering, you have focused on each fund's alpha as reported by Morningstar. Alpha tells you A) each fund's performance relative to the S&P 500. B) a fund's percentage return above the risk-free rate of return. C) by what percentage a fund's capital appreciation exceeded the capital appreciation of the average fund in its asset class. D) the difference between a fund's realized return and its risk-adjusted expected return.

D) the difference between a fund's realized return and its risk-adjusted expected return. Alpha does not compare directly to the S&P 500, but rather to the fund's expected return, which is risk-adjusted for the fund's beta. The total return, not just the capital appreciation component, is used in the Jensen formula. The risk-adjusted required return is the risk-free rate plus the risk premium multiplied by the fund's beta.