IFM Conceptual Questions

Determine which of the following factor portfolios is NOT used in the Fama-French-Carhart (FFC) factor specification. A. High-minus-low portfolio B. Inflation risk portfolio C. Market portfolio D. Prior one-year momentum portfolio E. Small-minus-big portfolio

B. Inflation risk portfolio

You are given the following information about the four distinct portfolios: Portfolio Expected Return Volatility P 3% 10% Q 5% 10% R 5% 15% S 7% 20% Determine which two of the four given portfolios are NOT efficient. A. P and Q B. P and R C. P and S D. Q and R E. Q and S

B. P and R

Determine which of the following scenarios does NOT cause the market portfolio to be inefficient. A. A significant number of investors do not have rational expectations. B. Sensation-seeking investors hold inefficient portfolios. C. Investors keep the losers and sell the winners in their portfolio. D. Investors do not seek to maximize the Sharpe ratio of their portfolio. E. All of the above would cause the market portfolio to become inefficient.

B. Sensation-seeking investors hold inefficient portfolios.

An investor has written a covered call. Determine which of the following represents the investor's position. A. Short the call and short the stock B. Short the call and long the stock C. Short the call and no position on the stock D. Long the call and short the stock E. Long the call and long the stock

B. Short the call and long the stock

You are given the following linear regression of a security's return on the market return: R=α+β⋅RMkt+ϵ where: R is the security's return RMkt is the market return ϵ is the error term α and β are constants Assume the Capital Asset Pricing Model applies. Let rf be the risk-free rate. Determine an expression for α . A. −rf B. rf C. (1−β)rf D. (1+β)rf E. (β−1)rf

C. (1−β)rf

Farmer Cloe grows wheat, and will be selling her crop in 6 months. The current price of wheat is 7.50 per bushel. To reduce the risk of fluctuation in price, Cloe wants to use derivatives with a 6-month expiration date to sell wheat between 7.20 and 7.60 per bushel. Cloe also wants to minimize the cost of using derivatives. The continuously compounded risk-free interest rate is 4%. Which of the following strategies fulfills Farmer Cloe's objectives? A. A long forward B. Long a call with strike 7.6 C. A long 7.2-7.6 collar D. A short 7.2-7.6 collar E. A short synthetic forward

C. A long 7.2-7.6 collar

Assume the Black-Scholes framework. Which of the following statements is/are true? I. The Sharpe ratio for an asset is the ratio of its risk premium to its volatility. II. The Sharpe ratio of a call option is equal to the Sharpe ratio of its underlying stock. III. The Sharpe ratio of a call option is equal to the Sharpe ratio of an otherwise equivalent put option. A. I only B. II only C. I and II only D. I and III only E. II and III only

C. I and II only

Which of the following statements regarding the tangent portfolio is/are TRUE? I. The tangent portfolio is the risky portfolio that has the highest expected return on the efficient frontier of risky investments. II. The optimal portfolio of risky investments depends on how conservative or aggressive the investor is. III. All combinations of the risk-free investment and the tangent portfolio are efficient portfolios. A. I only B. II only C. III only D. I and II only E. I and III only

C. III only

A binomial tree is used to model stock prices. As the number of periods in the tree increases, which distribution of stock price will the binomial tree approximate? A. Uniform B. Normal C. Lognormal D. Exponential E. None of (A), (B), (C), and (D) are correct.

C. Lognormal

Company XYZ recently raised $4 million with a pre-money valuation of $10 million. If the company is looking to raise another $7 million and avoid a down round, determine the largest fraction of the firm the company can offer investors. A. 1/6 B. 1/5 C. 1/4 D. 1/3 E. 1/2

D. 1/3

You are given the following scenarios regarding investor behavior: I. A significant number of uninformed investors hold an inefficient portfolio because they are overconfident in their ability to manage a portfolio. II. Investors hold inefficient portfolios because they care about other factors other than expected return and volatility. III. Investors do not have rational expectations, thus misinterpret information to believe they are earning a positive alpha when they are actually holding a negative alpha. Determine which of the scenarios above would cause the market portfolio to become inefficient. A. I only B. III only C. I and II only D. II and III only E. I, II, and III

D. II and III only

Determine which of the following strategies creates a ratio spread, assuming all options are European. A. Buy a one-year call, and sell a three-year call with the same strike price. B. Buy a one-year call, and sell a three-year call with a different strike price. C. Buy a one-year call, and buy three one-year calls with a different strike price. D. Buy a one-year call, and sell three one-year puts with a different strike price. E. Buy a one-year call, and sell three one-year calls with a different strike price.

E. Buy a one-year call, and sell three one-year calls with a different strike price.

Which of the following options may have a negative premium? A. Asian option B. Barrier option C. Compound option D. Exchange option E. Gap option

E. Gap option

Which of the following statements is/are TRUE regarding the assumptions of Markowitz's mean-variance analysis? I. While investors may have different degrees of risk aversion, all investors are risk-averse to some extent. II. Investors prefer less risk to more risk for a given level of returns, and more return to less return for a given level of risk . III. The expected returns, variances, and covariances of all assets are known. IV. There are no transactions costs or taxes. A. I and II only B. II and IV only C. III and IV only D. II, III and IV only E. I, II, III, and IV

E. I, II, III, and IV

Which of the following statements regarding the lemons principle and asymmetric information is FALSE? A. Adverse selection increases the cost of issuing equity. B. Firms often issue equity directly after earnings announcements. C. The stock price declines after announcement of an equity issuance. D. The stock price rises prior to the announcement of an equity issuance. E. The pecking order of financing indicates firms should increase debt rather than equity in capital structure.

E. The pecking order of financing indicates firms should increase debt rather than equity in capital structure.

Determine which of the following statements about interest tax shield is FALSE. A. The gain to investors from the tax deductibility of interest payments is the interest tax shield. B. The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage. C. By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes decreases. D. If the firm maintains a fixed dollar amount of outstanding debt, given a 40% corporate tax rate, for every $1 in new permanent debt that the firm issues, the value of the firm increases by $0.40. E. The tax deductibility of interest increases the effective cost of debt financing for the firm.

E. The tax deductibility of interest increases the effective cost of debt financing for the firm.

For a two-stock portfolio, which of the following situations would have the lowest risk? A. The two stocks are perfectly positively correlated. B. The two stocks have a modest positive correlation. C. There is no correlation between the two stocks. D. The two stocks have a modest negative correlation. E. The two stocks are perfectly negatively correlated.

E. The two stocks are perfectly negatively correlated.

The following table provides information on four types of gap options on a nondividend-paying stock: Type Option Strike Trigger I Call $80 $80 II Call $90 $80 III Call $80 $90 IV Put $80 $80 You are also given: > The current price of the stock is $80. > The continuously compounded risk-free interest rate is 6%. Which of the gap options above would have the highest premium? A. Type I B. Type II C. Type III D. Type IV E. Cannot be determined from the information given.

A. Type I

Box spreads are used to guarantee a fixed cash flow in the future. Thus, they are purely a means of borrowing or lending money, and have no stock price risk. Consider a box spread based on two distinct strike prices (K,L) that is used to lend money, so that there is a positive cost to this transaction up front, but a guaranteed positive payoff at expiration. Determine which of the following sets of transactions is equivalent to this type of box spread. A. A long position in a (K,L) bull spread using calls and a long position in a (K,L) bear spread using puts. B. A long position in a (K,L) bull spread using calls and a short position in a (K,L) bear spread using puts. C. A long position in a (K,L) bull spread using calls and a long position in a (K,L) bull spread using puts. D. A short position in a (K,L) bull spread using calls and a short position in a (K,L) bear spread using puts. E. A short position in a (K,L) bull spread using calls and a short position in a (K,L) bull spread using puts.

A. A long position in a (K,L) bull spread using calls and a long position in a (K,L) bear spread using puts.

Determine which of the following statements about investor behavior and capital market efficiency is FALSE. A. According to the Capital Asset Pricing Model, when both are holding the market portfolio, a less informed investor with a less than average trading skill will underperform compared to an average investor. B. Relative wealth concerns can lead investors to choose undiversified portfolios. C. Investors may choose sub-optimal portfolios due to familiarity bias. D. People who grew up and lived during a time of high stock returns are more likely to invest in stocks than people who experienced times when stocks performed poorly. E. An informational cascade effect may lead investors to depart from the CAPM in systematic ways, thus imparting systematic uncertainty into prices.

A. According to the Capital Asset Pricing Model, when both are holding the market portfolio, a less informed investor with a less than average trading skill will underperform compared to an average investor.

Firms can do several things to mitigate the agency costs of debt. Determine which of the following statements is FALSE. A. Agency costs are largest for short-term debt. B. Short-term debt may increase the firm's risk of financial distress and its associated costs. C. Debt covenants may limit the firm's ability to pay large dividends or restrict the types of investments that the firm can make. D. Debt covenants may limit the amount of new debt the firm can take on. E. Debt covenants have the potential to get in the way of positive NPV opportunities and can have costs of their own.

A. Agency costs are largest for short-term debt.

Which one of the following is true regarding American and European options? A. American options can be exercised before the expiration of the option B. European options can only be purchased through a broker or exchange based in Europe. C. A single American option can be exercised multiple times. D. An example of a European option is an option with 2 years to maturity with quarterly exercise dates. E. The strike price of an American option changes over time depending on the price of the underlying.

A. American options can be exercised before the expiration of the option

Parker had a brilliant idea and started a firm. The firm is in its earliest stages of the lifecycle. Parker then decides to raise outside equity capital. Which source of funding will Parker most likely rely on? A. Angel investors B. Venture capital firms C. Private equity firms D. Institutional investors E. Corporate investors

A. Angel investors

Determine which of the following statements is TRUE regarding the forward price of a stock. A. As the dividend yield decreases, the forward price increases. B. As the risk-free interest rate decreases, the forward price increases. C. As the current stock price decreases, the forward price increases. D. Assuming the risk-free interest rate is greater than the dividend yield, as the time until maturity decreases, the forward price increases. E. The expected stock price is lower than the forward price.

A. As the dividend yield decreases, the forward price increases.

Determine which of the following statements about the Capital Asset Pricing Model is TRUE. A. Assuming the market risk premium is positive, if an investment has a negative beta, then its expected return would be less than the risk-free rate. B. The expected return on an investment with a beta of 2 is two times as high as the expected return on the market portfolio. C. A security with a beta of 0 will offer zero expected return. D. If a stock lies below the security market line, it is undervalued. E. None of (A), (B), (C), and (D) are correct.

A. Assuming the market risk premium is positive, if an investment has a negative beta, then its expected return would be less than the risk-free rate.

Suppose Landon wishes to create a synthetic long forward contract. What transactions does Landon have to make? A. Buy stock and short a zero-coupon bond B. Buy stock and long a zero-coupon bond C. Sell stock and short a zero-coupon bond D. Sell stock and long a zero-coupon bond E. None of the above correctly describes the transactions that Landon has to make.

A. Buy stock and short a zero-coupon bond

Consider a forward contract, a European call option with strike price K, and a European put option with strike price K. All of them are on the same underlying asset. Let C be the call premium and P be the put premium. If the present value of the difference between the forward price and the strike price is 10, determine which of the following may be TRUE. A. C=15 and P=5 B. C>15 and P<5 C. C<15 and P>5 D. C=10 and P=10 E. C<10 and P<10

A. C=15 and P=5

Determine which of the following statements regarding public debt is FALSE: A. Corporate bonds always pay coupons semiannually. B. Bearer bonds are like currency. C. Almost all bonds that are issued today are registered bonds. D. Debentures and notes are unsecured debt. E. For asset-backed bonds and mortgage bonds, specific assets are pledged as collateral that bondholders have a direct claim to in the event of bankruptcy.

A. Corporate bonds always pay coupons semiannually.

Determine which of the following statements about the capital structure in a perfect capital market is FALSE. A. Even with perfect capital markets, leverage would affect a firm's value. B. Leverage increases the risk of the equity of a firm. C. Leverage increases the risk of equity even when there is no risk that the firm will default. D. A risk-free debt has a risk premium of zero. E. Promised payments to debt holders must be made before any payments to equity holders are distributed.

A. Even with perfect capital markets, leverage would affect a firm's value.

Which of the following outlines the correct sequence of a traditional IPO process? A. Formation of underwriters and syndicates, SEC filings, Valuation B. Formation of underwriters and syndicates, Valuation, SEC filings C. SEC filings, Formation of underwriters and syndicates, Valuation D. SEC filings, Valuation, Formation of underwriters and syndicates E. Valuation, SEC filings, Formation of underwriters and syndicates

A. Formation of underwriters and syndicates, SEC filings, Valuation

Which of the following are evidence against the efficient market hypothesis? I. Lesser-known firms yield abnormally high returns. II. New issues have high returns on the first day but underperform over the 3-5 year period after issue. III. There was a one-time increase in the stock price at the time of takeover announcement but no significant abnormal returns afterwards. A. I and II only B. I and III only C. II and III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct.

A. I and II only

Which of the following statements is/are true about exotic options? I. Average price Asian options are worth less than or equal to the otherwise equivalent standard European options. II. Barrier options are path-dependent. III. The payoff of a gap option must be non-negative. IV. A compound "put-on-call" option gives the option holder the option to buy a put. A. I and II only B. II and III only C. II and IV only D. I, II and III only E. The correct answer is not given by (A), (B), (C), or (D).

A. I and II only

An investor purchased a stock two years ago for $100 per share and sold it today for $120 per share. The stock paid a $5 per share dividend today. Which of the following statements is/are true? The realized return over the 2-year period was 25%. The dividend yield over the 2-year period was 4.16%. The capital gain over the 2-year period was 16.67%. A. I only B. II only C. III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct.

A. I only

Which of the following anomalies is an example of overreaction to information? I. New-issue puzzle II. Earnings announcement puzzle III. Super Bowl effect IV. Monday effect A. I only B. I and II only C. I and III only D. I and IV only E. The correct answer is not given by (A), (B), (C), or (D).

A. I only

Which of the following effects are correct on the price of a stock option? I. The premiums would not decrease if the options were American rather than European. II. For European put, the premiums increase when the stock price increase. III. For American call, the premiums increase when the strike price increases. A. I only B. I and II only C. I and III only D. II and III only E. I, II and III

A. I only

Which of the following observations is/are TRUE with respect to the weak form of the efficient market hypothesis? I. Stock prices behave as though successive values differ by a random number. II. In a scatterplot with the return of day t on the x-axis and the return of day t+1 on the y-axis, the points are concentrated in the first quadrant. III. The variance of returns do not vary with the interval over which the returns are measured. A. I only B. II only C. I and II only D. I and III only E. II and III only

A. I only

Which of the following statements regarding the CAPM is/are TRUE? I. A stock with no correlation to the market is equivalent to a risk-free asset. II. A stock perfectly correlated to the market is equivalent to a risk-free asset. III. A stock perfectly negatively correlated to the market is equivalent to a risk-free asset. A. I only B. III only C. I and III only D. II and III only E. I, II, and III

A. I only

Which of the following statements about a forward contract is true? I. The short forward makes money when the price of the underlying asset increases. II. The long forward makes money when the price of the underlying asset decreases. III. For any spot price at expiration, the sum of the payoffs for the two parties who enter into the forward contract is zero. IV. The forward price is the price that one party immediately pays to the other party when the forward contract is entered into. A. III only B. IV only C. I & III only D. II & IV only E. III & IV only

A. III only

Determine which of following is an example of a behavioral bias that might cause the market portfolio not to be efficient. A. Investors are attracted to large growth stocks that receive greater news coverage. B. Investors are attracted to investments with skewed distributions that have a small probability of an extremely high payoff. C. The true market portfolio may be efficient, but the proxy an investor uses to mimic the market portfolio may be inaccurate. D. Investors are exposed to significant non-tradeable risks outside their portfolio, such as human capital. E. Investors systematically ignore positive-NPV investment opportunities.

A. Investors are attracted to large growth stocks that receive greater news coverage.

Research proves that the capital asset pricing model does not depend on homogeneous expectations of investors. However, it does require rational expectations and everyone to hold the market portfolio in aggregate. Determine the bias or effect that will NOT cause inefficiency in the market portfolio. A. Overconfidence bias B. Disposition effect C. Information cascade effect D. Herd behavior E. Size effect

A. Overconfidence bias

Determine which of the following statements regarding a multi-factor model is always TRUE: A. Securities are traded in a competitive market. B. Factor portfolios are efficient portfolios. C. Each factor portfolio can be interpreted as either a risk factor itself or a portfolio of stocks correlated with an observable risk factor. D. Each factor beta is the expected percentage change in the excess return of a security. E. The risk premium of a security can be expressed as the sum of the risk premium of each factor in the multi-factor model.

A. Securities are traded in a competitive market.

Determine which of the following statements regarding investment risk measures is TRUE. A. Semi-variance is always less than or equal to the variance. B. Both semi-variance and variance are symmetric risk measures. C. Value-at-Risk describes the expected adverse outcome given that the outcome is worse than the assumed quantile cutoff. D. Tail-Value-at-Risk of a random variable is equal to the quantile of a probability distribution. E. Both Value-at-Risk and Tail-Value-at-Risk are coherent risk measures.

A. Semi-variance is always less than or equal to the variance.

An investor currently holds portfolio P with an expected return of 15% and a volatility of 20%. The T-bills pay 3%. Her financial advisor suggests that she add an alternative investment fund to her portfolio. The alternative investment fund has an expected return of 9%, a volatility of 35%, and a correlation of 0.10 with her current portfolio. Determine whether the alternative investment fund will improve the investor's portfolio. A. The alternative investment fund will improve the investor's portfolio. The investor should add the fund to her portfolio. B. The alternative investment fund may improve the investor's portfolio. However, the investor should not add the fund to her portfolio. C. The alternative investment fund will not improve the investor's portfolio. The investor should not add the fund to her portfolio. D. The alternative investment fund may not improve the investor's portfolio. However, the investor should add the fund to her portfolio. E. None of (A), (B), (C), and (D) are correct.

A. The alternative investment fund will improve the investor's portfolio. The investor should add the fund to her portfolio.

Determine which of the following statements regarding the disposition effect impacting investor tax obligations is TRUE. A. The disposition effect causes investor tax obligations to increase. B. The disposition effect causes investor tax obligations to decrease. C. The disposition has no effect on investor tax obligations. D. The disposition effect increases tax obligations for losing stocks only. E. The disposition effect decreases tax obligations for winning stocks only.

A. The disposition effect causes investor tax obligations to increase.

Determine which of the following statements regarding the small-minus-big (SMB) portfolio is TRUE: A. This portfolio is created by taking a long position in stocks with low market capitalization and a short position in stocks with high market capitalization. B. This portfolio is created by taking a short position in stocks with low market capitalization and a long position in stocks with high market capitalization. C. This portfolio is created by taking a long position in high book‐to‐market stocks and a short position in low book‐to‐market stocks. D. This portfolio is created by taking a short position in high book‐to‐market stocks and a long position in low book‐to‐market stocks. E. This portfolio is not self-financing.

A. This portfolio is created by taking a long position in stocks with low market capitalization and a short position in stocks with high market capitalization.

Determine which of the following statements regarding multi-factor models is NOT true. A. Trading strategies based on market capitalization, book-to-market ratios, and momentum appear to have zero alphas. B. It is much easier to identify a collection of portfolios that captures systematic risk than just a single portfolio. C. All factor portfolios in the Fama-French-Carhart factor specification are self-financing. D. The first portfolio in the Fama-French-Carhart factor specification is a self-financing portfolio that consists of a long position in the market portfolio​ that is financed by a short position in the risk-free security. E. A high-minus-low (HML) portfolio is constructed​ by taking a long position in firms with high book-to-market and taking a short position in firms with low book-to-market.

A. Trading strategies based on market capitalization, book-to-market ratios, and momentum appear to have zero alphas.

Determine which of the following statements regarding the option to delay is FALSE: A. When you have the option of deciding when to invest, it is optimal to invest as long as the NPV is positive. B. Given the option to wait, an investment that currently has a negative NPV can have a positive value. C. The option to wait is most valuable when there is a great deal of uncertainty regarding what the value of the investment will be in the future. D. It is always better to wait unless the cost of waiting is greater than the value of waiting. E. The option to wait is equivalent to a call option.

A. When you have the option of deciding when to invest, it is optimal to invest as long as the NPV is positive.

Consider a 90-strike American put option on a stock with six months to expiration. You are given: > The underlying stock has a current price of 100. > The forward price of the stock is 102. > The continuously compounded risk-free rate is 5%. Determine which of the following intervals represents the range of possible premiums for this option. A. [0,90] B. [0,100] C. [0.52,90] D. [0.52,100] E. [2,10]

A. [0,90]

Determine which of the following statements about options is true. A. Naked writing is the practice of buying options without taking an offsetting position in the underlying asset. B. A covered call involves taking a long position in an asset together with a written call on the same asset. C. An American style option can only be exercised during specified periods, but not for the entire life of the option. D. A Bermudan style option allows the buyer the right to exercise at any time during the life of the option. E. An in-the-money option is one which would have a positive profit if exercised immediately.

B. A covered call involves taking a long position in an asset together with a written call on the same asset.

Which of the following describes a covered put? A. A long position in a put and a long position in the underlying asset. B. A short position in a put and a short position in the underlying asset. C. A long position in an asset and a short position in a call. D. A short position in a put and a long position in a call. E. None of these describe a covered put.

B. A short position in a put and a short position in the underlying asset.

Which of the following is NOT considered an IPO puzzle? A. Share underpricing B. Asymmetric information C. IPO cyclicality D. High transaction costs E. Long-run underperformance

B. Asymmetric information

The PS index has the following characteristics: > One share of the PS index currently sells for 1,000. > The PS index does not pay dividends. Sam wants to lock in the ability to buy this index in one year for a price of 1,025. He can do this by buying or selling European put and call options with a strike price of 1,025. The annual effective risk-free interest rate is 5%. Determine which of the following gives the hedging strategy that will achieve Sam's objective and also gives the cost today of establishing this position. A. Buy the put and sell the call, no cost B. Buy the call and sell the put, spend 23.81 C. Buy the call and sell the put, receive 23.81 D. Buy the put and sell the call, receive 23.81 E. Buy the put and sell the call, spend 23.81

B. Buy the call and sell the put, spend 23.81

Determine which of the following situations demonstrates evidence that is contrary to the efficient markets hypothesis. A. A takeover bid for a firm is announced at a higher price than the current market price. The firm's share price then increases sharply upon the announcement. B. By purchasing stocks with high returns over the past year, investors can earn positive excess returns over the next year. C. Skilled fund managers earn no excess returns relative to their benchmarks, even before fees and transaction costs are taken into account. D. In research studies completed several years after a severe market decline, many firms were determined to be overvalued prior to the decline. E. A firm announces that it will increase its dividend in the future, upon which its stock price increases immediately.

B. By purchasing stocks with high returns over the past year, investors can earn positive excess returns over the next year.

Shareholders may be unwilling to finance new, positive-NPV projects. Which of the following best describes the agency cost above? A. Asset substitution B. Debt overhang C. Cashing out D. Managerial entrenchment E. Asymmetric information

B. Debt overhang

Determine which of the following statements regarding bond markets is FALSE. A. Domestic bonds are bonds purchased by foreign investors. B. Foreign bonds are bonds issued by a foreign entity and traded in a foreign market. C. Eurobonds are not denominated in the local currency of the country in which they are issued. D. Global bonds are offered for sale in several different markets simultaneously. E. Yankee bonds are foreign bonds in the United States.

B. Foreign bonds are bonds issued by a foreign entity and traded in a foreign market.

A certain guaranteed benefit provides a guarantee on the value of the underlying account after a specified period of time has elapsed provided that the policyholder is still alive and the contract is still in force at that time. Which of the following best describes such guaranteed benefit? A. Guaranteed minimum death benefit B. Guaranteed minimum accumulation benefit C. Guaranteed minimum withdrawal benefit D. Guaranteed minimum income benefit E. Earnings-enhanced death benefit

B. Guaranteed minimum accumulation benefit

Which of the following statements regarding market efficiency is/are TRUE? I. If an investor believes in all three forms of market efficiency, the investor is likely to prefer passive investment strategies over active investment strategies. II. If an investor does not believe in any of the three forms of market efficiency, the investor is likely to use more information to make decisions. III. If the stronger form of market efficiency is violated, then the weaker forms are also violated. A. I only B. I and II only C. I and III only D. II and III only E. I, II, and III

B. I and II only

Consider the following four behavioral patterns of investors: I. Familiarity Bias II. Disposition Effect III. Overconfidence Bias IV.Herd Behavior Determine which two of these behavioral patterns are NOT systematic trading biases, and are thus LESS likely to cause stock prices to deviate from their fundamental values. A. I and II B. I and III C. II and III D. II and IV E. III and IV

B. I and III

Consider the following four industries: I. Tobacco firms II. Financial firms III.Established restaurant chains IV. Cell phone manufacturers Determine which two of these industries have high optimal debt levels according to the trade-off theory. A. I and II B. I and III C. II and III D. II and IV E. III and IV

B. I and III

Evidence shows that individual investors fail to diversify their portfolios adequately. Which of the following is an explanation for this behavior? I. Familiarity bias II. Overconfidence bias III. Relative wealth concerns A. I and II only B. I and III only C. II and III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

B. I and III only

Which of the following is/are advantages of going public? I. Greater liquidity II. Less regulations III. Better access to capital A. I and II only B. I and III only C. II and III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct

B. I and III only

For an equally-weighted portfolio that consists of N individual assets, which of the following statements is/are true? I. If the number of assets is small, then the contribution of each individual asset's variance to the volatility of the portfolio is negligible. II. With a large number of assets, the average covariance between all pairs of assets accounts for most of the portfolio's risk. III. With a large number of assets, all risk can be eliminated. A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

B. II only

Which of the following are inconsistent with the semi-strong form of the efficient market hypothesis but not with the weak form? I. There is a positive serial correlation in stock prices. II. It is possible to make consistent profits based on publicly available information. III. It is possible to make consistent profits based on information obtainable from a painstaking analysis of the company. A. I only B. II only C. III only D. II and III E. I, II, and III

B. II only

Which of the following may be possible in a semi-strong-form efficient market? I. An investor consistently earns abnormal profits by exploiting the trend in stock prices using technical analysis. II. An executive consistently earns abnormal profits by selling shares of the company's stock prior to the announcement of bad news. III. Stocks with unexpectedly good earnings consistently generate positive alphas following the announcement date. A. I only B. II only C. III only D. I and II only E. I and III only

B. II only

Which of the following statements about the optimal debt level is/are TRUE? I. The optimal level of debt is the same for all firms. II. Firms with high R&D costs and future growth opportunities typically maintain low debt levels. III. Mature, low-growth firms with stable cash flows and tangible assets often maintain low debt levels. A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

B. II only

Assume the Black-Scholes framework. Suppose that a market maker sells a European put option. Determine which of the following statements is TRUE. A. If the market maker immediately sells an equivalent European put option, then the delta of the portfolio decreases. B. If the market maker immediately sells an equivalent European call option, then the delta of the portfolio decreases. C. If the market maker immediately buys an equivalent European call option, then the delta of the portfolio decreases. D. If the market maker immediately buys an equivalent European call option, then the gamma of the portfolio decreases. E. If the market maker immediately sells an equivalent European call option, then the gamma of the portfolio increases.

B. If the market maker immediately sells an equivalent European call option, then the delta of the portfolio decreases.

Determine which of the following statements is TRUE. A. Beta measures market risk whereas volatility measures firm-specific risk. B. In a well-diversified portfolio, market risk accounts for a considerably greater proportion of total risk than firm-specific risk. C. A portfolio's beta is the arithmetic average of all the betas for the individual stocks in the portfolio. D. A stock's beta is the ratio of the covariance between the stock returns and the market returns to the standard deviation of market returns. E. The average beta of a stock in the market is greater than 1.

B. In a well-diversified portfolio, market risk accounts for a considerably greater proportion of total risk than firm-specific risk.

Determine which of the following statements regarding public debt is TRUE. A. Notes and debentures are secured debts. B. In the event of bankruptcy, bondholders for mortgage bonds and asset-backed bonds have a direct claim to specific assets which have been pledged as collateral. C. Notes and debentures have higher seniority than mortgage bonds and asset-backed bonds. D. The new debt that has higher seniority than existing debenture issues is called a subordinated debenture. E. Notes typically have longer maturities than debentures.

B. In the event of bankruptcy, bondholders for mortgage bonds and asset-backed bonds have a direct claim to specific assets which have been pledged as collateral.

Determine which of the following behaviors is idiosyncratic and does not cause the market portfolio to be inefficient. A. Investors buy stocks that have recently been in the news. B. Investors seek sensation and desire intense risk-taking experiences. C. Stock returns tend to be higher on a sunny day at the stock exchange. D. Investors actively try to follow each other's behavior. E. Investors tend to hold on to investments that have lost value and sell investments that have increased in value.

B. Investors seek sensation and desire intense risk-taking experiences.

Consider a nondividend-paying stock. Determine which of the following positions has the same cash flows as a long stock position. A. Long forward B. Long zero-coupon bond and long forward C. Long zero-coupon bond and short forward D. Short zero-coupon bond and long forward E. Short forward and short zero-coupon bond

B. Long zero-coupon bond and long forward

Determine which of the following statements regarding U.S. corporate bonds is FALSE. A. Most corporate bonds have maturities of 30 years or less. B. Most corporate bonds pay quarterly coupons. C. The face amount or principal amount of the bond is denominated in standard increments, most often $1,000. D. To receive a coupon payment, the holder of a bearer bond must provide explicit proof of ownership. E. The issuer of registered bonds maintains a list of all holders of its bonds.

B. Most corporate bonds pay quarterly coupons.

Determine which of the following is NOT an example of a systematic bias that will lead to market inefficiency. A. Disposition effect B. Overconfidence bias C. Investor's mood D. Herd behavior E. None of the above

B. Overconfidence bias

You are given the following regarding stock of Widget World Wide (WWW): The stock is currently selling for $50. One year from now the stock will sell for either $40 or $55. The stock pays dividends continuously at a rate proportional to its price. The dividend yield is 10%. The continuously compounded risk-free interest rate is 5%. While reading the Financial Post, Michael notices that a one-year at-the-money European call written on stock WWW is selling for $1.90. Michael wonders whether this call is fairly priced. He uses the binomial option pricing model to determine if an arbitrage opportunity exists. What transactions should Michael enter into to exploit the arbitrage opportunity (if one exists)? A. No arbitrage opportunity exists. B. Short shares of WWW, lend at the risk-free rate, and buy the call priced at $1.90. C. Buy shares of WWW, borrow at the risk-free rate, and buy the call priced at $1.90. D. Buy shares of WWW, borrow at the risk-free rate, and short the call priced at $1.90. E. Short shares of WWW, borrow at the risk-free rate, and short the call priced at $1.90.

B. Short shares of WWW, lend at the risk-free rate, and buy the call priced at $1.90.

Which one of the following is an assumption of the Black-Scholes option pricing model? A. Stock prices are normally distributed. B. Stock price volatility is a constant. C. Changes in stock price are log-normally distributed. D. All transaction costs are included in stock returns. E. The risk-free interest rate is a random variable.

B. Stock price volatility is a constant.

Determine which one of the following statements regarding diversification is FALSE: A. It is possible for the covariance of returns between two stocks to be negative. B. Stocks in the same industry tend to have less highly correlated returns than stocks in different industries. C. Almost all pairs of randomly selected stocks will have positive correlation coefficients. D. The lower the correlation coefficients among pairs of stocks in a portfolio, the lower the variability of the portfolio. E. The diversification benefit is least valuable when adding a second stock to a one-stock portfolio when the correlation coefficient is 1.

B. Stocks in the same industry tend to have less highly correlated returns than stocks in different industries.

Determine which of the following statements regarding project risk analysis is TRUE. A. When break-even analysis is used, we calculate the value of each parameter so that the project has an IRR of zero. B. The IRR is the rate at which NPV is zero. C. Scenario analysis involves changing the input variables one at a time to see how NPV changes. D. Sensitivity analysis explores how IRR changes when various desired subsets of the complete set of model variables are changed simultaneously E. In a Monte Carlo simulation, input variables are assumed to be independent with each other.

B. The IRR is the rate at which NPV is zero.

Which of the following statements about Arbitrage Pricing Theory (APT) is FALSE? A. The CAPM yields an equation equivalent to the one-factor APT with the factor being the stock market index. B. The factors in the APT must be based on market capitalization, book-to-market ratios, and momentum. C. A portfolio with no exposure to any APT risk factors should earn the risk-free rate on average. D. The APT can be used to estimate the cost of equity capital for a firm. E. None of (A), (B), (C), or (D)

B. The factors in the APT must be based on market capitalization, book-to-market ratios, and momentum.

Determine which of the following statements regarding asset-backed securities (ABS) is TRUE. A. An ABS is a security that is made up of home mortgages. B. The largest sector of the ABS market is the mortgage-backed security market. C. Fannie Mae is explicitly backed by the full faith and credit of the U.S. government. D. Freddie Mac is the largest issuer of mortgage-backed securities in the U.S. E. When banks re-securitize asset-backed and other fixed income securities, the new asset-backed security is known as asset securitization.

B. The largest sector of the ABS market is the mortgage-backed security market.

Determine which of the following statements regarding private debt is FALSE. A. Compared to public debt, it is cheaper to issue private debt. B. The private debt market is smaller than the public debt market. C. The private debt market is illiquid. D. If a group of banks funds a single loan, the loan is called a syndicated bank loan. E. A private placement does not need to be registered.

B. The private debt market is smaller than the public debt market.

Determine which of the following risks is mostly likely a systematic risk. A. The risk that your main production plant is shut down due to a winter storm. B. The risk that the economy underperforms, reducing demand for your company's product. C. The risk that your key employees will be hired by competitors. D. The risk that a drug trial fails. E. The risk of an airliner crash.

B. The risk that the economy underperforms, reducing demand for your company's product.

Determine which of the following statements regarding capital structure in a perfect capital market is FALSE. A. The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure. B. The total value of a firm's securities is equal to the book value of the total cash flows generated by its assets. C. The cost of issuing equity is zero. D. Firms with identical assets but different amounts of debts have the same value. E. The cost of capital of levered equity increases with the firm's market value debt-to-value ratio in a non-linear manner.

B. The total value of a firm's securities is equal to the book value of the total cash flows generated by its assets.

Determine which of the following statements about perfect capital markets is FALSE. A. Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. B. The total value of the levered firm exceeds the value of the firm without leverage due to the present value of the tax savings from debt. C. A firm's financing decisions do not change the cash flows generated by its investments. D. A firm's financing decisions do not reveal new information about the investments. E. The total value of a firm's securities is equal to the market value of the total cash flows generated by its assets.

B. The total value of the levered firm exceeds the value of the firm without leverage due to the present value of the tax savings from debt.

Determine which of the following BEST demonstrates evidence for the semi-strong form of the efficient market hypothesis. A. Two stocks with claims to a common cash flow have different prices. B. There was a one-time increase in price at the time when a company announces better-than-expected quarterly earnings but no significant abnormal returns afterwards. C. A company executive with insider information cannot consistently beat the market by selling shares of the company's stock prior to the announcement of bad news. D. An investor is able to consistently beat the market by analyzing corporate balance sheets and buying undervalued stocks. E. A fund manager exploits a mean-reversion trend in stock prices to routinely earn excess returns.

B. There was a one-time increase in price at the time when a company announces better-than-expected quarterly earnings but no significant abnormal returns afterwards.

Consider a chooser option on a stock that pays no dividends. At time 1, the option-holder will choose whether it becomes a European call option or a European put option. Both the call and put options have a strike price of $60 will expire at time-2. The chooser option is priced at $17 at time-0. The current stock price is $58. Let P(t1,t2) denote the time t1 price of a 60-strike European put option on the stock expiring at time t2. You are given: > The risk-free interest rate is 0. > P(0,1)=5. Calculate P(0,2). A. 12 B. 13 C. 14 D. 15 E. 16

C. 14

A company is attempting to fund capital investment. What is the preference order for the following options (from most preferable to least preferable), using the pecking order theory? 1. Debt 2. Retained earnings 3. Issue new shares A. 1, 2, 3 B. 1, 3, 2 C. 2, 1, 3 D. 2, 3, 1 E. 3, 1, 2

C. 2, 1, 3

The current price of a medical company's stock is 75. The expected value of the stock price in three years is 90 per share. The stock pays no dividends. You are also given: I. The risk-free interest rate is positive. II. There are no transaction costs. III. Investors require compensation for risk. The price of a three-year forward on a share of this stock is X, and at this price, an investor is willing to enter into the forward. Determine what can be concluded about X. A. X<75 B. X=75 C. 75<X<90 D. X=90 E. X>90

C. 75<X<90

Determine which one of the following statements regarding guarantees on variable annuity products is FALSE: A. A guaranteed minimum death benefit (GMDB) with a return of premium guarantee is similar to a European put option with expiration contingent on the death of the policyholder or annuitant. B. A guaranteed minimum accumulation benefit (GMAB) with a return of premium guarantee is similar to a European put option with payment contingent on the policyholder surviving to the guarantee expiration date and the policy still being in force at that time. C. A guaranteed minimum withdrawal benefit (GMWB) provides a guarantee that the account value will not be less than the guaranteed withdrawal benefit base at any future time. D. A guaranteed minimum income benefit (GMIB) provides a guarantee on the future purchase rate for a traditional annuity. E. An earnings-enhanced death benefit is an optional benefit available with some variable annuity products that acts as a European call option with strike price equal to the original amount invested.

C. A guaranteed minimum withdrawal benefit (GMWB) provides a guarantee that the account value will not be less than the guaranteed withdrawal benefit base at any future time.

Which of the following statements about the Fama-French-Carhart factor specification is FALSE? A. Trading strategies based on market capitalization, book-to-market ratios, and momentum appear to have positive alphas. B. A trading strategy that each year buys a portfolio of small stocks and finances this position by short selling a portfolio of big stocks has produced positive risk-adjusted returns historically. C. A trading strategy that each year buys a portfolio of low book-to-market stocks and finances this position by short selling a portfolio of high book-to-market stocks has produced positive risk-adjusted returns historically. D. A momentum strategy is constructed by longing the top 30% of stocks and shorting the bottom 30% and then holding the portfolio for a year. E. All factor portfolios in the FFC model are self-financing.

C. A trading strategy that each year buys a portfolio of low book-to-market stocks and finances this position by short selling a portfolio of high book-to-market stocks has produced positive risk-adjusted returns historically.

If the value of a market put on a stock is lower than the value of a corresponding synthetic put, determine an arbitrage opportunity that you could take to earn a risk-free profit. A. Buy a market put, sell some stock, and borrow money B. Buy a market put, buy some stock, and lend money C. Buy a market put, buy some stock, and borrow money D. Sell a market put, buy some stock, and lend money E. Sell a market put, buy some stock, and borrow money

C. Buy a market put, buy some stock, and borrow money

Determine which of the following is NOT a distinguishing characteristic of futures contracts, relative to forward contracts. A. Contracts are settled daily, and marked-to-market. B. Contracts are more liquid, as one can offset an obligation by taking the opposite position. C. Contracts are more customized to suit the buyer's needs. D. Contracts are structured to minimize the effects of credit risk. E. Contracts have price limits, beyond which trading may be temporarily halted.

C. Contracts are more customized to suit the buyer's needs.

You trade in a market by randomly choosing five stocks to buy and five stocks to sell every day. The market has the following traits: > Small transaction costs > Highly skilled traders are better informed than you Determine which of the traits above would cause your portfolio to underperform the market portfolio over the long run. A. I only B. II only C. I and II D. Your portfolio will outperform the market. E. Your portfolio will have the same return as the market.

C. I and II

Which of the following options is/are path-dependent? I. Asian option II. Barrier option III. Gap option IV. Compound option A. I only B. II only C. I and II only D. I, II, and III only E. II, III, and IV only

C. I and II only

For call and put options on the same underlying asset with the same time to expiration, with strike K1 and K2 where K2>K1. Suppose C(K) and P(K) denotes the K-strike call and put premium respectively. An arbitrageur notices the following: > C(K1)−C(K2)>K2−K1 > P(K2)−P(K1)>K2−K1 Which of the following strategies results in arbitrage profits? I. Buy call with strike K1 and sell call with strike K2 II. Sell call with strike K1 and buy call with strike K2 III. Buy put with strike K1 and sell put with strike K2 IV. Sell put with strike K1 and buy put with strike K2 A. I & III B. I & IV C. II & III D. II & IV E. No arbitrage opportunity exists.

C. II & III

Under the Capital Asset Pricing Model, which of the following statements is/are TRUE? I. All traded securities should lie on the capital market line. II. All traded securities should lie on the security market line. III. All traded securities have risk premiums that are scaled according to their systematic risks. A. I and II only B. I and III only C. II and III only D. I, II, and III E. None of (A), (B), (C), or (D) is correct

C. II and III only

You are given: [Graph of a Bull Spread] Which of the following statements is/are true regarding the profit diagram above? 1. The name of this option strategy is a bear spread. 2. The name of this option strategy is a bull spread. 3. This option strategy bets on the volatility of the price of the underlying asset. 4. The shape of the profit diagram can be created by buying a call at one strike price and selling a call at a higher strike price. A. I and III only B. I and IV only C. II and IV only D. I, III and IV only E. II, III and IV only

C. II and IV only

According to Corporate Finance by Berk and DeMarzo, which of the following statements regarding a financially distressed airline is TRUE? I. The direct cost of bankruptcy is often much larger than the indirect costs of financial distress. II. Customers will still be willing to buy plane tickets in advance. III. An airline may sell their aircraft at prices that are lower than the prices received by healthier rivals in an effort to avoid bankruptcy and its associated costs. A. I only B. II only C. III only D. I and II only E. I and III only

C. III only

An analyst is evaluating two equally-weighted portfolios: Portfolio X and Portfolio Y. The stocks in both portfolios have an average variance of α and an average covariance of β, where α>0 and β>0. Portfolio X consists of 5 stocks, while Portfolio Y consists of 100 stocks. Which of the following statements is/are true? I. The contribution of each asset's variance to its portfolio's risk is more significant for Portfolio Y than it is for Portfolio X. II. The contribution of covariance among the assets to its portfolio's risk is more significant for Portfolio X than it is for Portfolio Y. III. If α>β, then the variance of Portfolio X's return is greater than that of Portfolio Y's return. A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

C. III only

Consider a firm that is subject to corporate tax. Which of the following statement(s) is/are FALSE? I. The higher the firm's leverage, the more the firm can exploit the tax advantage of debt. II. The higher the firm's leverage, the lower the firm's net income. III. The higher the firm's leverage, the higher the firm's weighted average cost of capital. A. I only B. II only C. III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct.

C. III only

Which of the following demonstrates evidence for the semi-strong form of the efficient market hypothesis? I. A fund manager is reliably able to make abnormal profits by trading based on historical patterns in stock prices. II. A talented analyst routinely earns excess returns through analysis of corporate financial statements. III. There is an instantaneous increase in stock price when a company announces unexpectedly good earnings but not significant abnormal returns afterwards. A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

C. III only

Which of the following should NOT be possible in a strong-form efficient market? I. An investor invests in stocks with high systematic risk and earns high returns from the investment. II. An investor selects four stocks and all four stocks earn abnormal profits over the next year. III. An investor consistently beats the market by using difficult to acquire or expensive information. A. I only B. II only C. III only D. I and II only E. II and III only

C. III only

Which of the following statements about market anomalies is/are true? I. For IPOs, the high returns observed in the first few days after a new issue are often followed by relatively poor performance in the years ahead, suggesting that investors underreact to the initial news. II. Investors typically overreact to earning announcements, causing a subsequent price adjustment. III. The momentum effect is inconsistent with weak-form market efficiency. A. I only B. II only C. III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct.

C. III only

Which of the following statements regarding the valuation in a traditional IPO process is/are true? I. The only way to set the initial price range for the offer price is by estimating the present value of future cash flows. II. Once an initial price range is set, the underwriters try to determine what the market thinks of the valuation by using a greenshoe provision. III. The underwriters undergo a process called book building where they adjust the share price to customer demand so that the IPO is most likely to succeed. A. I only B. II only C. III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct

C. III only

Determine which of the following statements regarding the mechanics of an IPO is TRUE. A. When underwriters provide a firm commitment, they often intentionally overprice the IPO. B. The over-allotment allocation is also known as red herring. C. If the issue is a success and the price rises above the IPO offer price, the underwriters will exercise the greenshoe provision. D. During a lock-up period following an IPO, the new shareholders cannot sell their shares. E. In an IPO, the service fee charged by underwriters is known as the management fee.

C. If the issue is a success and the price rises above the IPO offer price, the underwriters will exercise the greenshoe provision.

Assume that stock prices are lognormally distributed. Which of the following statements about gap options is FALSE? A. When the strike is equal to the trigger, the premium for a gap option is the same as for an ordinary option with the same strike. B. If the trigger exceeds the strike for a gap put, then increasing the trigger reduces the premium. C. If the trigger is fixed for a gap put, then increasing the strike price decreases the premium. D. If the strike is equal to the trigger, then increasing the trigger reduces the premium of a gap call. E. For any positive strike, there is a trigger that makes the premium for a gap put equal to zero.

C. If the trigger is fixed for a gap put, then increasing the strike price decreases the premium.

Determine which of the following statements regarding coherent risk measure is FALSE. A. Translation invariance implies that adding a constant amount to a risk adds an equivalent amount to the risk measure. B. Subadditivity suggests that it is not possible to reduce the capital required to manage a risk by splitting it into separate parts. C. Positive homogeneity implies that there is some diversification benefit from combining risks as long as the two risks are not perfectly correlated. D. TVaR satisfies all four desirable characteristics for a risk measure. E. If loss distributions are assumed to be normal, then the VaR measure can be coherent.

C. Positive homogeneity implies that there is some diversification benefit from combining risks as long as the two risks are not perfectly correlated.

Determine which of the following statements regarding the semi-strong form of the efficient market hypothesis is NOT true. A. Prices reflect information contained in the record of past prices. B. Prices reflect not just past prices but also all other publicly available information, such as that found in easily accessible financial statements or in the financial press. C. Prices reflect all information obtainable from a painstaking analysis of the company, industry, and economy, or any information acquired from private sources. D. Prices will adjust immediately upon the release of any public announcements, such as earnings reports, new issues, or mergers. E. It would be impossible to make consistent profits from analyzing past returns.

C. Prices reflect all information obtainable from a painstaking analysis of the company, industry, and economy, or any information acquired from private sources.

Determine which of the following statements is TRUE. A. The capital market line is the graph of the risk and return of portfolio combinations consisting of the risk-free asset and any risky portfolio. B. A portfolio on the capital market line with returns greater than the returns on the market portfolio represents a lending portfolio. C. Relative to portfolios on the capital market line, any portfolio that plots above the capital market line is considered unachievable. D. Relative to portfolios on the capital market line, any portfolio that plots below the capital market line is considered efficient. E. With respect to capital market theory, an investor's optimal portfolio is the combination of a risk-free asset and a risky asset with the highest expected return.

C. Relative to portfolios on the capital market line, any portfolio that plots above the capital market line is considered unachievable.

The ask price for a share of ABC company is 100.50 and the bid price is 100. Suppose an investor can borrow at an annual effective rate of 3.05% and lend (i.e., save) at an annual effective rate of 3%. Assume there are no transaction costs and no dividends. Determine which of the following strategies does not create an arbitrage opportunity. A. Short sell one share, and enter into a long one-year forward contract on one share with a forward price of 102.50. B. Short sell one share, and enter into a long one-year forward contract on one share with a forward price of 102.75. C. Short sell one share, and enter into a long one-year forward contract on one share with a forward price of 103.00. D. Purchase one share with borrowed money, and enter into a short one-year forward contract on one share with a forward price of 103.60. E. Purchase one share with borrowed money, and enter into a short one-year forward contract on one share with a forward price of 103.75.

C. Short sell one share, and enter into a long one-year forward contract on one share with a forward price of 103.00.

Determine which one of the following statements regarding multi-factor models is NOT true. A. A collection of well-diversified portfolios, from which an efficient portfolio can be constructed, can be used to measure risk. B. These models are also referred to as the Arbitrage Pricing Theory. C. Taxes and transaction costs are incorporated when estimating the expected rate of return for a multi-factor model. D. The market portfolio of securities is not necessarily efficient. E. Small-Minus-Big (SMB) and High-Minus-Low (HML) portfolios are part of the Fama-French-Carhart multi-factor model.

C. Taxes and transaction costs are incorporated when estimating the expected rate of return for a multi-factor model.

Which of the following statements about weighted average cost of capital (WACC) is true? A. The WACC provides a good evaluation measure for a specific capital budgeting project that is safer than other projects of the firm. B. One purpose of the WACC is to adjust the cost of equity by the appropriate tax rate. C. The WACC provides correct discount rate only for projects with business risks that are similar to those of the average existing assets of the firm. D. Only before-tax costs should be considered. E. If a company issues additional debts, the increased leverage causes the WACC to rise.

C. The WACC provides correct discount rate only for projects with business risks that are similar to those of the average existing assets of the firm.

Tong is a financial analyst using fundamental analysis to identify undervalued fixed income and equity securities. Tong uses data on inflation, dividend yields, duration, and beta to develop trading strategies. Tong is able to consistently outperform his equity benchmark but consistently matches the performance of his fixed income benchmark over a ten-year period. Tong is most likely to agree with which observation? A. The equity market is inefficient. B. The equity market is strong form efficient. C. The fixed income market is semi-strong form efficient. D. The fixed income market is strong form efficient. E. Both the equity and fixed income markets are semi-strong form efficient.

C. The fixed income market is semi-strong form efficient.

Philip Hand is a financial analyst researching two equity markets: Finland and Norway. Hand interviews several portfolio managers from Finland regarding efficiency and the speed with which information is reflected in stock prices. Hand also interviews a Norwegian investor who sits on three boards of publicly held companies in his country. Hand arrives at the following conclusions: Finland: The use of technical trading strategies based on historical prices by portfolio managers consistently results in outperformance. Norway: The use of private information by board members consistently results in outperformance. Which statement is most likely accurate regarding Hand's conclusions? A. The market in Finland may be weak form efficient. B. The market in Finland may be semi-strong form efficient. C. The market in Norway may be semi-strong form efficient. D. The market in Norway may be strong form efficient. E. Neither market is efficient.

C. The market in Norway may be semi-strong form efficient.

A company's common stock is currently selling for 25 per share. All of the financial analysts following the firm are surprised when the company unexpectedly announces that it expects its future economic income to be lower after the next quarter. Assume that the stock market is semi-strong efficient. How should this news affect the stock price? A. The price should not change at all. B. The price should not change until the next quarter. C. The price should fall immediately to adjust for the expected slowing earnings growth. D. The price should fall gradually over the next quarter. E. The price should go up following the announcement.

C. The price should fall immediately to adjust for the expected slowing earnings growth.

Determine which of the following statements regarding private debt is FALSE: A. Private debt is cheaper to issue than public debt. B. The private debt market is larger than the public debt market. C. The private debt market is more liquid than the public debt market. D. A private placement is a bond issue that is sold privately to a small group of investors. E. A revolving line of credit is a credit commitment for a specific time period up to some limit.

C. The private debt market is more liquid than the public debt market.

It has been suggested that companies often overstate earnings in bad years and understate them in good years because they want investors to believe that the cash flows are less variable than they actually are. Which of the following, if true, would cast the most doubt on the sensibility of this strategy? A. Investors are risk-averse. B. Earnings follow a random walk. C. The strong efficient market hypothesis holds. D. Investors rely on historically observed betas. E. Corporate tax rates increase with earnings.

C. The strong efficient market hypothesis holds.

Determine which version of the efficient markets hypotheses is contradicted by a momentum strategy whereby investors can use past stock returns to form a portfolio with positive alpha. A. Weak form only B. Weak form and semi-strong form only C. Weak form, semi-strong form, and strong form D. Strong form only E. It does not contradict any of the three forms of the efficient markets hypothesis

C. Weak form, semi-strong form, and strong form

Determine which of the following statements regarding financial forwards is FALSE. A. The sale of a prepaid forward contract permits the owner to sell an asset while retaining physical possession for a period of time. B. When there are no dividends, the price of the prepaid forward contract is the stock price today. C. When a stock pays a dividend, the prepaid forward price is greater than the stock price today. D. When a stock pays a dividend, the owner of the stock receives the dividend, but the owner of a prepaid forward contract on the stock does not. E. The difference between a prepaid forward contract and a forward contract is the timing of the payment for the stock, which is immediate with a prepaid forward but deferred with a forward.

C. When a stock pays a dividend, the prepaid forward price is greater than the stock price today.

Determine which of the following statements about Modigliani and Miller propositions in a perfect capital market is FALSE. A. If investors would prefer an alternative capital structure to the one the firm has chosen, investors can borrow or lend on their own and achieve the same result. B. As long as investors can borrow or lend at the same interest rate as the firm, homemade leverage is a perfect substitute for the use of leverage by the firm. C. With perfect capital markets, because different choices of capital structure offer no benefit to investors, they do not affect the value of the firm. D. A firm's WACC increases with the firm's market value debt-equity ratio. E. With perfect capital markets, a firm's WACC is independent of its capital structure and is equal to its equity cost of capital if it is unlevered, which matches the cost of capital of its assets.

D. A firm's WACC increases with the firm's market value debt-equity ratio.

Determine which one of the following statements regarding guarantees on variable annuity products is FALSE: A. A guaranteed minimum death benefit provides a guarantee on the amount that the beneficiary of the contract receives when the policyholder dies. B. A guaranteed minimum accumulation benefit provides a guarantee on the value of the underlying account after a specified period of time has elapsed provided that the policyholder is still alive and the contract still in force at that time. C. A guaranteed minimum withdrawal benefit provides a guarantee on the size of withdrawals that the policyholder can make from the underlying account during the payout period and the length of time these withdrawals can be made provided that withdrawals do not commence until the policyholder reaches a specified age. D. A guaranteed minimum income benefit is similar to a European put option with expiration contingent on the death of the policyholder or annuitant. E. An earnings-enhanced death benefit is an optional benefit available with some variable annuity products that pays the beneficiary an additional amount when the policyholder/annuitant dies based on the increase in the account value over the original amount invested.

D. A guaranteed minimum income benefit is similar to a European put option with expiration contingent on the death of the policyholder or annuitant.

Determine which one of the following statements about raising capital is TRUE: A. A private equity firm invests in publicly traded corporations. B. A venture capital firm is a corporation. C. Convertible notes held by angel investors are converted into equity at the price paid by new investors. D. A major disadvantage of an initial public offering is that the equity holders of the corporation become more widely dispersed. E. The lead underwriter of an initial public offering is generally the venture capital firm that has already provided funding to the firm.

D. A major disadvantage of an initial public offering is that the equity holders of the corporation become more widely dispersed.

Determine which one of the following statements about raising capital is TRUE: A. A private equity firm invests in publicly traded corporations. B. A venture capital firm is a corporation. C.Convertible notes held by angel investors are converted into equity at the price paid by new investors. D. A major disadvantage of an initial public offering is that the equity holders of the corporation become more widely dispersed. E. The lead underwriter of an initial public offering is generally the venture capital firm that has already provided funding to the firm.

D. A major disadvantage of an initial public offering is that the equity holders of the corporation become more widely dispersed.

Determine which of the following statements regarding multi-factor models is NOT true. A. If we use multiple portfolios as factors, then together these factors may capture all systematic risk, with each factor captures different components of the systematic risk. B. The model is also referred to as the Arbitrage Pricing Theory (APT). C. A self-financing portfolio is any portfolio with portfolio weights that sum to zero. D. A self-financing portfolio is constructed​ by going long some stocks, and going short other stocks with equal book value. E. Multifactor models rely on the weaker condition that we can construct an efficient portfolio from a collection of well-diversified portfolios or factors.

D. A self-financing portfolio is constructed​ by going long some stocks, and going short other stocks with equal book value.

Assume all options are European, have the same time to expiration, and have the same underlying asset. Consider a box spread based on two distinct strike prices, K1 and K2, where K1<K2. Determine which of the following strategies is equivalent to a short position in the box spread. A. A long position a risk-free zero-coupon bond. B. A short position in a (K1,K2) put bull spread and a short position in a (K1,K2) call bear spread. C. A long position in a (K1,K2) call bull spread and a long position in a (K1,K2) put bear spread. D. A short position in a (K1,K2) call bull spread and a short position in a (K1,K2) put bear spread. E. A long position in a K1-strike forward and a short position in K2-strike forward.

D. A short position in a (K1,K2) call bull spread and a short position in a (K1,K2) put bear spread.

Which of the following statements is an implication of the semi-strong form of the Efficient Market Hypothesis? A. Market price reflects all information. B. Prices slowly adjust over time to incorporate past information. C. Past price data should have predictive power for stock returns. D. Actively managed portfolios using publicly available information cannot consistently outperform the market. E. The correct answer is not given by (A), (B), (C), or (D).

D. Actively managed portfolios using publicly available information cannot consistently outperform the market.

Determine which of the following statements about the effect of increasing the amount of leverage in a firm's capital structure in the presence of taxes is FALSE. A. With no debt, both the pre-tax WACC and the effective after-tax WACC are equal to the unlevered equity cost of capital. B. As leverage increases, the firm's equity cost of capital rises. C. As leverage increases, the firm's pre-tax WACC remains unchanged. D. As leverage increases, the firm's effective after-tax WACC remains unchanged. E. As the debt and equity costs of capital both rise when leverage is high, the effective after-tax WACC declines.

D. As leverage increases, the firm's effective after-tax WACC remains unchanged.

The dividend yield on a stock and the interest rate used to discount the stock's cash flows are both continuously compounded. The dividend yield is greater than the interest rate, but both are positive. The following table shows four methods to buy the stock and the total payment needed for each method. The payment amounts are as of the time of payment and have not been discounted to the present date. METHOD TOTAL PAYMENT Outright purchase A Forward contract B Prepaid forward contract C Fully leveraged purchase D Determine which of the following is the correct ranking, from smallest to largest, for the amount of payment needed to acquire the stock. A. C < A < B < D B. A < C < D < B C. D < C < A < B D. C < B < A < D E. A < C < B < D

D. C < B < A < D

Which of the following best describes the credibility principle? A. A seller with private information is likely to sell you worse-than-average goods. B. Managers will prefer to use retained earnings first, and will issue new equity only as a last resort. C. Wasteful spending is more likely to happen when firms have high levels of cash flow in excess of what is needed. D. Claims in one's self-interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue. E. When a seller has private information about the value of a good, buyers will discount the price they are willing to pay due to adverse selection.

D. Claims in one's self-interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue.

Determine which of the following statements is NOT a typical reason for why derivative securities are used to manage financial risk. A. Derivatives are used as a means of hedging. B. Derivatives are used to reduce the likelihood of bankruptcy. C. Derivatives are used to reduce transaction costs. D. Derivatives are used to satisfy regulatory, tax, and accounting restraints. E. Derivatives are used as a form of insurance.

D. Derivatives are used to satisfy regulatory, tax, and accounting restraints.

Determine which of the following statements regarding the present value of financial distress costs is FALSE. A. The probability of financial distress increases with the amount of a firm's liabilities relative to its assets. B. The probability of financial distress increases with the volatility of a firm's cash flows and asset values. C. Firms whose value comes largely from human capital are likely to incur high costs when they risk financial distress. D. Firms whose ​main assets are physical capital are likely to incur high costs when they risk financial distress. E. The beta of distress costs will have an opposite sign to that of the firm.

D. Firms whose ​main assets are physical capital are likely to incur high costs when they risk financial distress.

Determine which of the following statements regarding the present value of financial distress costs is FALSE. A. The probability of financial distress increases with the amount of a firm's liabilities relative to its assets. B. The probability of financial distress increases with the volatility of a firm's cash flows and asset values. C. Firms whose value comes largely from human capital are likely to incur high costs when they risk financial distress. D. Firms whose ​main assets are physical capital are likely to incur high costs when they risk financial distress. E. The beta of distress costs will have an opposite sign to that of the firm.

D. Firms whose ​main assets are physical capital are likely to incur high costs when they risk financial distress.

Determine which of the following statements regarding the efficient market hypothesis is FALSE: A. If markets are efficient, the difference between the required return and expected return of a company's security is zero. B. Semi-strong-form inefficient markets are not necessarily weak-form inefficient. C. Technical analysts who attempt to profit by looking at patterns of prices and trading volume assume that markets are weak-form inefficient. D. Fundamental analysts who attempt to profit by using publicly available information to estimate a security's intrinsic value to determine if the security is mispriced assume that markets are semi-strong-form efficient. E. A company whose share price reacts gradually to the public release of its annual report most likely indicates that the market where the company trades is semi-strong-form inefficient.

D. Fundamental analysts who attempt to profit by using publicly available information to estimate a security's intrinsic value to determine if the security is mispriced assume that markets are semi-strong-form efficient.

A variable annuity contract might guarantee that when the policyholder reaches age 65, the policyholder will be able to purchase a traditional annuity that pays $700 per month per $100,000 of account value at age 65 for the remainder of the policyholder's life. If at the time the policyholder turns age 65, the going rate for a traditional annuity is less than $700 per month then the insurer is obliged to provide the policyholder a traditional annuity for the guaranteed $700 per month rate. However, if the going rate is greater than $700 per month, then the policyholder simply purchases a traditional annuity at the going rate. Which of the following best describes such guarantee? A. Guaranteed minimum death benefit B. Guaranteed minimum accumulation benefit C. Guaranteed minimum withdrawal benefit D. Guaranteed minimum income benefit E. Earnings-enhanced death benefit

D. Guaranteed minimum income benefit

A variable annuity contract might guarantee that the policyholder can withdraw 5% of the original investment every year for the remainder of the policyholder's life provided that withdrawals do not begin until the policyholder reaches age 65 and do not exceed the specified size. If the account is depleted before the policyholder dies, then the insurer continues to make the guaranteed minimum payments to the policyholder until the policyholder death. If it is not depleted before the policyholder dies, then the beneficiary of the contract receives the remaining account balance. Which of the following best describes such guarantee? A. Guaranteed minimum death benefit B. Guaranteed minimum accumulation benefit C. Guaranteed minimum maturity benefit D. Guaranteed minimum withdrawal benefit E. Guaranteed minimum income benefit

D. Guaranteed minimum withdrawal benefit

Which of the following statements regarding Asian options is/are true? I. The value of a geometric average price Asian call option is always less than or equal to the value of an otherwise equivalent arithmetic average price Asian call option. II. As the number of averaging periods increases, the price of an average strike Asian call option increases. III. As the number of averaging periods increases, the price of an average price Asian call option increases. A. I only B. II only C. III only D. I and II only E. I and III only

D. I and II only

For a symmetric distribution, which of the following statements is/are TRUE? I. The semi-variance is always equal to half the variance. II. The variance is always greater than the mean. III. The Value-at-Risk at α=50% is always equal to the mean. A. I only B. III only C. I and II only D. I and III only E. II and III only

D. I and III only

Which of the following is NOT an assumption that underlies the Capital Asset Pricing Model? I. Investors can borrow and lend at the rate of return on the market portfolio. II. Investors hold only efficient portfolios of traded securities. III. As long as we can identify a collection of well-diversified portfolios from which an efficient portfolio can be constructed, we can use the collection itself to measure risk. A. I only B. III only C. I and II only D. I and III only E. I, II, and III

D. I and III only

Bank X has 80 loans outstanding, each for $1 million. Bank X expects these loans to be repaid today. The probability of default for each loan is 4%. The probability of default is independent for all loans. Bank Y has only 1 loan of $80 million outstanding, which it expects to be repaid today. The probability of default for the loan is also 4%. If the loan defaults, the bank will be repaid nothing. Which of the following statements is/are true? I. The expected overall payoff of Bank X is the same as that of Bank Y. II. The volatility of the overall payoff of Bank X is approximately $1.75 million. III. The volatility of the overall payoff of Bank Y is approximately $15.68 million. A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D).

D. I, II, and III

A market-maker purchases or writes European options. Which of the following statements is/are true? I. If the market-maker purchases call options, then the market-marker could buy shares of stocks to delta-hedge the position. II. If the market-maker writes call options, then the market-marker could buy shares of stocks to delta-hedge the position. III. If the market-maker purchases put options, then the market-marker could buy shares of stocks to delta-hedge the position. IV. If the market-maker writes put options, then the market-marker could buy shares of stocks to delta-hedge the position. A. II only B. III only C. I and IV only D. II and III only E. II, III, and IV only

D. II and III only

Determine which, if any, of the following positions has a limited loss potential from an adverse price movement in the underlying asset, regardless of the initial premium received. I. Short 1 forward contract II. Long 1 put option III. Short 1 put option A. None B. I and II only C. I and III only D. II and III only E. The correct answer is not given by (A), (B), (C), or (D)

D. II and III only

Which of the following behaviors may cause the market portfolio to be inefficient? I. Investors invest in stocks of companies that are in the same industry or are geographically close. II. Investors tend to hold on to investments that have lost value and sell investments that have increased in value III. Investors tend to buy stocks that have recently been in the news. A. I only B. I and II only C. I and III only D. II and III only E. None of (A), (B), (C), and (D) are correct

D. II and III only

Which of the following describes the conditions under which the market portfolio might not be an efficient portfolio? I. A significant number of investors do not have homogeneous expectations. II. A significant number of investors do not have rational expectations. III. A significant number of investors care about aspects of their portfolios other than expected return and volatility. A. I only B. III only C. I and III only D. II and III only E. I, II, and III

D. II and III only

Which of the following statements about the Capital Asset Pricing Model (CAPM) is/are true? I. The expected return of a security depends on the total risk. II. Beta describes the only differentiation between the expected returns of securities. III. Beta can be estimated through regression by calculating the line of best fit for the stock's return versus the market return. A. I only B. II only C. I and II only D. II and III only E. I, II, and III

D. II and III only

You are given the following scenarios regarding investor behavior: I. A significant number of uninformed investors hold an inefficient portfolio because they are overconfident in their ability to manage a portfolio. II. Investors hold inefficient portfolios because they care about other factors other than expected return and volatility. III. Investors do not have rational expectations, thus misinterpret information to believe they are earning a positive alpha when they are actually holding a negative alpha. IV. Determine which of the scenarios above would cause the market portfolio to become inefficient. A. I only B. III only C. I and II only D. II and III only E. I, II, and III

D. II and III only

Which of the following risks will affect the risk premium that investors will demand? I. The risk that the key employees leave the company II. The risk that oil prices increase, increasing production costs III. The risk that the design of a product is faulty and the product needs to be recalled IV. The risk that the economy slows, decreasing demand for a product A. I and II only B. I and III only C. II and III only D. II and IV only E. III and IV only

D. II and IV only

Consider the following 5 asset classes: I. International stocks II. Small-cap stocks III. Large-cap stocks IV. Treasury bills V. AAA-rated corporate bonds Looking at a very long time period (at least several decades), rank the asset classes above from highest to lowest expected return, assuming the future is consistent with the past. A. I, II, III, IV, V B. I, II, III, V, IV C. II, III, I, IV, V D. II, III, I, V, IV E. III, II, I, V, IV

D. II, III, I, V, IV

Investors actively try to follow each other's behavior and imitate each other's actions. Determine which of the following are explanations for this behavior: I. Investors desire intense risk-taking experiences. II. Investors believe others have superior information that they can take advantage of. III. Investors want to avoid the risk of underperforming their peers. IV. Professional fund managers may face reputational risk if their actions are far different from those of their peers. A. I and II only B. II and III only C. II and IV only D. II, III, and IV only E. I, II, III, and IV

D. II, III, and IV only

Determine which of the following statements regarding investment risk measures is TRUE. A. The downside standard deviation is the square root of the variance. B. Since the semi-variance only cares about the downside risk rather than the upside variability, the semi-variance can be negative. C. If X is a random variable that represents the investment gain in a security over one period and the Value-at-Risk of X at α=5% is 1%, then there is a 95% probability that the investment gain over one period will be no more than 1%. D. If X is a random variable that represents the investment gain in a security over one period and the Value-at-Risk of X at α=5% is 1%, then there is a 95% probability that the investment gain over one period will be more than 1%. E. Value-at-Risk is more conservative than Tail-Value-at-Risk.

D. If X is a random variable that represents the investment gain in a security over one period and the Value-at-Risk of X at α=5% is 1%, then there is a 95% probability that the investment gain over one period will be more than 1%.

Let X and Y be two random variables, each representing a loss, with risk measures g(X) and g(Y). Determine which of the following is NOT a required condition for the risk measure g to be coherent. A. For any positive constant c, g(X+c)=g(X)+c. B. For any positive constant c, g(cX)=cg(X). C. g(X+Y)≤g(X)+g(Y) D. If X≤Y for all possible outcomes, then g(Y)≤g(X). E. All of the above are required conditions for the risk measure g to be coherent.

D. If X≤Y for all possible outcomes, then g(Y)≤g(X).

Determine which of the following statements regarding behavioral biases is FALSE: A. Uninformed investors are more likely to purchase stocks that have advertised a lot or have experienced unusually high recent trading volume or returns. B. Investors who follow the herd do not consistently outperform those who take more contrarian (i.e., anti-herd) views. C. The information cascade effect occurs when traders ignore their own information and act on information from others that they trust more. D. If fund managers are going to fail, they would much rather have done something different than their peers than to demonstrate herd behavior. E. Studies have indicated that men, on average, earn lower returns than women do.

D. If fund managers are going to fail, they would much rather have done something different than their peers than to demonstrate herd behavior.

The following table shows two methods to buy a stock and the total payment needed for each method. Payments that do not take place immediately take place at time T, T>0. The payment amounts are as of the time of payment and have not been discounted to the present date. MethodForward contract fully leveraged purchase Total Payment: 1.) X 2.) Y Method of Payment: 1.) Forward contract X 2.) Fully leveraged purchase Y Which of the following statements is correct? A. X<Y B. X=Y C. X>Y D. If the underlying stock does not pay dividends, then X=Y E. If the underlying stock does not pay dividends, then X<Y .

D. If the underlying stock does not pay dividends, then X=Y

Determine which of the following statements about the U.S. bankruptcy code is FALSE. A. In Chapter 7 liquidation, a trustee is appointed to oversee the liquidation of the firm's assets through an auction. B. In Chapter 7 liquidation, the proceeds from the liquidation are used to pay the firm's creditors, and the firm ceases to exist. C. In Chapter 11 reorganization, all pending collection attempts are automatically suspended, and the firm's existing management is given the opportunity to propose a reorganization plan. D. In Chapter 11 reorganization, while developing the plan, the firm ceases to exist. E. In Chapter 11 reorganization, the reorganization plan specifies the treatment of each creditor of the firm, and the creditors must vote to accept the plan.

D. In Chapter 11 reorganization, while developing the plan, the firm ceases to exist.

Determine which of the following situations demonstrates evidence for the strong form of the efficient market hypothesis. A. Successive changes in the value of the stock price time series are dependent. B. Past price changes could systematically be used to predict future price changes in a competitive market. C. After a takeover bid is publicly announced, it is possible for the tardy investor to then buy in and make further profits. D. In some years, the diversified equity-based mutual funds beat the market, as measured by the Wilshire 5000 index, but about 60% of the time they underperformed the market. E. Firms with the most unexpectedly good earnings outperformed the 10% with the most unexpectedly bad earnings by about 1% per month over the 6 months following the earnings announcement.

D. In some years, the diversified equity-based mutual funds beat the market, as measured by the Wilshire 5000 index, but about 60% of the time they underperformed the market.

Determine which one of the following statements about debt financing is FALSE: A. Corporate notes are unsecured debt. B. Holders of mortgage backed securities face prepayment risk. C. The coupon of a floating-rate municipal bond is periodically adjusted. D. Income from U.S. Treasury securities is taxed at the state level. E. Most debentures contain clauses restricting the company from issuing new debt with equal or higher priority than existing debt.

D. Income from U.S. Treasury securities is taxed at the state level.

Determine which of the following statements is FALSE: A. American options are worth at least as much as otherwise equivalent European options. B. For a nondividend-paying stock, an American call option on the stock is worth the same as an otherwise equivalent European call option C .For a nondividend-paying stock, an American put option on the stock may be worth more than an otherwise equivalent European put option. D. It is not rational to early exercise an American call option on a dividend-paying stock. E. It may be rational to early exercise an American put option on a dividend-paying stock.

D. It is not rational to early exercise an American call option on a dividend-paying stock.

Determine which of the following statements is FALSE: A. American options are worth at least as much as otherwise equivalent European options. B. For a nondividend-paying stock, an American call option on the stock is worth the same as an otherwise equivalent European call option C. For a nondividend-paying stock, an American put option on the stock may be worth more than an otherwise equivalent European put option. D. It is not rational to early exercise an American call option on a dividend-paying stock. E. It may be rational to early exercise an American put option on a dividend-paying stock.

D. It is not rational to early exercise an American call option on a dividend-paying stock.

Jason longs a 6-month forward contract for a commodity with a forward price of $100. The effective interest rate for a 6-month period is 4%. Determine the maximum gain and maximum loss for his forward contract. A. Maximum gain is 100; Maximum loss is 0. B. Maximum gain is 100; Maximum loss is ∞. C. Maximum gain is ∞; Maximum loss is 0. D. Maximum gain is ∞; Maximum loss is 100. E. Maximum gain is ∞; Maximum loss is ∞.

D. Maximum gain is ∞; Maximum loss is 100.

An investor has a short position in a put option. Which of the following is correct about the Greeks with respect to the investor's position? A. Positive Vega, Positive Rho, Positive Psi B. Positive Vega, Negative Rho, Positive Psi C. Positive Vega, Positive Rho, Negative Psi D. Negative Vega, Positive Rho, Negative Psi E. Negative Vega, Negative Rho, Positive Psi

D. Negative Vega, Positive Rho, Negative Psi

Determine which of the following statements regarding futures contracts is FALSE. A. Futures contracts are essentially exchange-traded forward contracts. B. Frequent marking-to-market and settlement of a futures contract can lead to pricing differences between a futures contract and an otherwise identical forward. C. For a futures contract, it is possible to offset an obligation on a given date by entering into the opposite position. D. Over-the-counter futures contracts can be customized to suit the buyer or seller. E. Futures contracts are structured so as to minimize the effects of credit risk.

D. Over-the-counter futures contracts can be customized to suit the buyer or seller.

Determine which of the following statements regarding equity financing for private companies is TRUE. A. Angel financing often occurs at such an early stage in the business that it is difficult to assess a value for the firm. Angel investors often circumvent this problem by holding equity. B. A venture capital firm is a general partnership that specializes in raising money to invest in the private equity of young firms. C. A venture capital firm is run by the limited partners. D. Private equity firms often initiate their investment by finding a publicly traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called a leveraged buyout. E. Corporate investors will only invest ​in companies for the financial return that they will earn on their investments.

D. Private equity firms often initiate their investment by finding a publicly traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called a leveraged buyout.

In an article discussing Berkshire Hathaway, the author mentions that Warren Buffet often encourages individual investors to invest in passive index funds, as they will continually outperform any mutual fund manager over time. However, the author then claims that Warren Buffett continually outperforms the market due to his influence by receiving information that is not in the public domain through a simple phone call. Determine which version of the efficient market hypothesis is contradicted by the author's comments. A. Weak and semi-strong form only B. Weak, semi-strong, and strong form C. Semi-strong and strong form only D. Strong form only E. It does not contradict any of the three forms of the efficient market hypothesis.

D. Strong form only

You are given the following risk measure: ρ(X)=VaRα(X)for0<α<1 Determine which property of coherence the risk measure fails to satisfy. A. Translation invariance B. Positive homogeneity C. Monotonicity D. Subadditivity E. None. The risk measure is coherent.

D. Subadditivity

An insurance company is concerned about a catastrophe that may result in large losses for the company. The company decides to hedge the risk by selling a catastrophe bond. Which of the following strategy should the company use? A. The company should sell a catastrophe bond with interest rate that is higher than the market interest rate. If large losses occur, the company will repay the principal. B. The company should sell a catastrophe bond with interest rate that is lower than the market interest rate. If large losses occur, the company will repay the principal. C. The company should sell a catastrophe bond with interest rate that is equal to the market interest rate. If large losses occur, the company will repay the principal. D. The company should sell a catastrophe bond with interest rate that is higher than the market interest rate. If large losses occur, the company will not repay the principal. E. The company should sell a catastrophe bond with interest rate that is lower than the market interest rate. If large losses occur, the company will not repay the principal.

D. The company should sell a catastrophe bond with interest rate that is higher than the market interest rate. If large losses occur, the company will not repay the principal.

Which of the following statements regarding the information cascade effect is TRUE? A. The information cascade effect is a result of relative wealth concerns. B. The information cascade effect leads to the pecking order of financing. C. The information cascade effect does not affect the efficiency of the market portfolio. D. The information cascade effect occurs when traders ignore their own information to profit from the information of others. E. The information cascade effect occurs when investors overweigh their own experience over considering all historical evidence.

D. The information cascade effect occurs when traders ignore their own information to profit from the information of others.

Determine which of the following statements regarding the high-minus-low (HML) portfolio is TRUE: A. This portfolio is created by taking a long position in stocks with low market capitalization and a short position in stocks with high market capitalization. B. This portfolio is created by taking a short position in stocks with low market capitalization and a long position in stocks with high market capitalization. C. This portfolio is created by taking a long position in low book‐to‐market stocks and a short position in high book‐to‐market stocks. D. This portfolio is created by taking a short position in low book‐to‐market stocks and a long position in high book‐to‐market stocks. E. This portfolio is not self-financing.

D. This portfolio is created by taking a short position in low book‐to‐market stocks and a long position in high book‐to‐market stocks.

Determine which of the following statements regarding sovereign debt is TRUE. A .Sovereign debt is issued by state and local governments. B. Treasury securities that do not pay any coupons and have an original maturity of 26 weeks are called STRIPS. C. Treasury securities that pay semiannual coupons and have an original maturity of 7 years are called Treasury bonds. D. Treasury securities that pay semiannual coupons and have an original maturity of 15 years are called Treasury bonds. E. The dollar coupon of TIPS is fixed.

D. Treasury securities that pay semiannual coupons and have an original maturity of 15 years are called Treasury bonds.

Assume a perfect capital market. Determine which of the following statements regarding Modigliani-Miller I is FALSE. A. In the absence of taxes or other transaction costs, the total cash flow paid out to all of a firm's security holders is equal to the total cash flow generated by the firm's assets. B. By the Law of One Price, the firm's securities and its assets must have the same total market value. C. As long as the firm's choice of securities does not change the cash flows generated by its assets, this decision will not change the total value of the firm or the amount of capital it can raise. D. Using leverage may result in net gain or loss. E. The value of the firm is determined by the present value of the cash flows from its current and future investments.

D. Using leverage may result in net gain or loss.

The table below lists 5 European options and their respective prices. All of the options are on the same stock and have the same strike price and same time to expiration. The knock-in call and the knock-out call have the same trigger. Type of Option Price Ordinary call 8 Knock-in call W Knock-out call X Asian arithmetic average daily price call Y Asian arithmetic average weekly price call Z Which of the following are possible values for W, X, Y, and Z ? A. W = 2, X = 6, Y = 9, Z = 6 B. W = 3, X = 6, Y = 4, Z = 6 C. W = 4, X = 3, Y = 5, Z = 6 D. W = 5, X = 3, Y = 4, Z = 7 E. W = 6, X = 2, Y = 6, Z = 5

D. W = 5, X = 3, Y = 4, Z = 7

Determine which of the following best describes the leverage ratchet effect. A. When a firm faces financial distress, shareholders can gain from decisions that increase the risk of the firm sufficiently, even if they have a negative NPV. B. When a firm faces financial distress, it may choose not to finance new, positive-NPV projects. C. When a firm faces financial distress, shareholders have an incentive to withdraw​ cash from the firm if possible. D. When a firm has existing debt is in place, shareholders may have an incentive to increase leverage even if it decreases the value of the firm. E. Wasteful spending is more likely to occur when firms have high levels of cash flow in excess of what is needed to make all positive-NPV investments and payments to debt holders.

D. When a firm has existing debt is in place, shareholders may have an incentive to increase leverage even if it decreases the value of the firm.

You are given the following information: -> C(K) denotes the price of call option with strike price K. -> P(K) denotes the price of put option with strike price K -> The time to expiry of the call and put options is the same. -> K1<K2<K3 Which of the following statements is false? A. C(K1)≥C(K2) B. P(K2)≥P(K1) C. C(K1)−C(K2)≤K2−K1 D. [C(K1)−C(K2)]/[K2−K1]≤[C(K2)−C(K3)]/[K3−K2] E. [P(K2)−P(K1)]/[K2−K1]≤[P(K3)−P(K2)]/[K3−K2]

D. [C(K1)−C(K2)]/[K2−K1]≤[C(K2)−C(K3)]/[K3−K2]

The following relates to one share of a stock which pays continuous dividends: > The current price is S(0). > The forward price for delivery in one year is Y⋅S(0). > The expected price in one year is X⋅S(0). > The continuously compounded expected return on the stock is α. > The continuously compounded risk-free rate is r. > The continuously compounded dividend yield is δ. > All investors are risk-averse. Assume r>δ>0. Determine which of the following statements is TRUE. A. X<Y B. X⋅Y<1 C. YX≥1 D. ln(X/Y)<0 E . [ln(X)/ln(Y)]−1>0

E . [ln(X)/ln(Y)]−1>0

A multi-factor model is sometimes used as an alternative to the Capital Asset Pricing Model. Determine which of the following statements must be TRUE regarding the multi-factor model. A. Investors incur taxes and/or transaction costs in trading securities. B. Investors have varying expectations regarding the volatilities, correlations, and expected returns of securities. C. The market portfolio of securities is efficient. D. It is necessary to identify the efficient portfolio to calculate the expected return of a security. E. A collection of well-diversified portfolios can be used to calculate the expected return of a security.

E. A collection of well-diversified portfolios can be used to calculate the expected return of a security.

Determine which of the following is NOT an assumption that underlies the Capital Asset Pricing Model. A. Investors hold only efficient portfolios of traded securities. B. Investors can borrow and lend at the risk-free rate of return. C. Investors can buy and sell all securities at competitive market prices without incurring taxes or transaction costs. D. Investors have homogeneous expectations regarding the volatilities, correlations, and expected returns of securities. E. A collection of well-diversified portfolios can be used to calculate the expected return of a security.

E. A collection of well-diversified portfolios can be used to calculate the expected return of a security.

Let S(t) denote the price at time t of an equity index fund that do not pay dividends. A bank offers a financial instrument with expiration date T, T>0. If the equity index fund at time T rises more than 3% at the end of one year, the payoff of the financial instrument is S(1)−1030; otherwise, the payoff is zero. You are given that S(0) = 1000. The president of the bank is concerned about the risk associated with the financial instrument. Thus, a strategy to hedge the financial instrument is considered. Which of the following options would be the best for the bank to purchase in order to hedge the risk from the financial instrument? A. A one-year European call option with strike price 1000 B. A one-year European put option with strike price 1030 C. A one-year gap call option with strike price 1000 and trigger 1030 D. A one-year gap call option with strike price 1030 and trigger 1000 E. A one-year up-and-in barrier call option with barrier 1030 and strike 1030

E. A one-year up-and-in barrier call option with barrier 1030 and strike 1030

Determine which of the following statements is TRUE. A. Diversification reduces a portfolio's total risk by averaging out systematic fluctuations. B. When we combine many stocks in a large portfolio, all risks will be diversified away. C. Both the expected return and the volatility of a portfolio can be less than the corresponding weighted average expected return and volatility. D. The decrease in volatility when going from one to two stocks is much lower than the decrease from going from 100 to 101 stocks. E. A very large, equally-weighted portfolio with independent and identical risks will have no risk.

E. A very large, equally-weighted portfolio with independent and identical risks will have no risk.

Determine which one of the following statements about the agency costs of leverage is FALSE: A. When a firm faces financial distress, shareholders have an incentive to withdraw cash from the firm. B. When an unlevered firm issues new debt, equity holders will bear any agency or bankruptcy costs via a discount in the price they receive for the new debt. C. When a levered firm issues new debt, existing debt holders will bear agency or bankruptcy costs. D. Equity holders may have an incentive to increase financial leverage, even if doing so would decrease the value of the firm. E. Agency costs are larger for short-term debt than for long-term debt.

E. Agency costs are larger for short-term debt than for long-term debt.

Determine which of the following statements regarding uses of derivatives is TRUE. A. Derivatives are a tool for companies and other users to reduce risks. B. Derivatives can provide a way to make bets that are highly leveraged and tailored to a specific view. C. Derivatives sometimes provide a lower-cost way to undertake a particular financial transaction. D. Derivatives are often used to achieve the economic sale of stock while still maintaining physical possession of the stock. E. All (A), (B), (C), and (D) are true.

E. All (A), (B), (C), and (D) are true.

The Fama-French-Carhart (FFC) factor specification is the most commonly used multi-factor model. Determine which of the following portfolios is NOT self-financing. A. A portfolio consists of a long position in the market portfolio and a short position in the risk-free asset. B. High-minus-low portfolio C. Small-minus-big portfolio D. Prior one-year momentum portfolio E. All of the portfolios above are self-financing.

E. All of the portfolios above are self-financing.

Determine which of the following statements regarding comparing options with respect to style and maturity is TRUE: A. An American call option's price cannot exceed the prepaid forward price of the underlying asset. B. A European put option's price must be at least as great as the present value of the strike price. C. An American put option on a nondividend-paying stock should never be exercised prior to expiration. D. A European call with more time to expiration is at least as valuable as an otherwise identical call with less time to expiration. E. An American put with more time to expiration is at least as valuable as an otherwise identical put with less time to expiration.

E. An American put with more time to expiration is at least as valuable as an otherwise identical put with less time to expiration.

Suppose Alice observes the following call and put prices for options on XYZ Company: Strike 90 110 120 Call Premium 25 10 5 Put Premium 6 23 28 Alice notices that there is a mispricing in option premiums. Which of the following strategies should Alice use to exploit the arbitrage? A. Call Bear Spread B. Call Bull Spread C. Put Bear Spread D. Put Bull Spread E. Asymmetric Butterfly Spread

E. Asymmetric Butterfly Spread

Determine which one of the following statements regarding the use of derivatives to manage risk is FALSE: A. The process of buying or selling derivatives or other assets for the purpose of transferring a risk on a company's balance sheet to the financial markets is referred to as hedging. B. Hedging does not eliminate risk. C. A hedge that is put in place and held until all the contracts associated with it expire is known as a static hedge. D. A dynamic hedging strategy is a hedging strategy that involves frequent buying and selling of assets in the portfolio that backs a particular liability with the objective of matching any changes in the value of the liability with corresponding changes in the value of the assets. E. Dynamic hedging strategies are sometimes known as hedge-and-forget strategies.

E. Dynamic hedging strategies are sometimes known as hedge-and-forget strategies.

Which of the following statements regarding exotic options is/are TRUE? I. Chooser options are useful hedging tools for variable annuities with two-sided guarantees. II. Lookback options are useful for hedging variable annuity guarantees in situations where the guarantee value is recalculated at the discretion of the policyholder. III. Rainbow options are useful hedging tools when policyholders can hold multiple assets in their accounts and the guarantee applies to the account as a whole rather than individual assets in the account. A. I only B. II only C. III only D. I and II only E. I and III only

E. I and III only

You are given: C(K, T) denotes the current price of a K-strike T-year European call option on a nondividend-paying stock. P(K, T) denotes the current price of a K-strike T-year European put option on the same stock. S denotes the current price of the stock. The continuously compounded risk-free interest rate is r. Which of the following is (are) correct? > 0≤C(50,T)−C(55,T)≤5e^−rT > 50e^−rT≤P(45,T)−C(50,T)+S≤55e^−rT > 45e^−rT≤P(45,T)−C(50,T)+S≤50e^−rT A. I only B. II only C. III only D. I and II only E. I and III only

E. I and III only

Which of the following statements about efficient markets is/are true? I. In the strong form of the efficient market theory, prices reflect all public information. II. In an efficient market, a portfolio manager is not expected to consistently outperform the market. III. In the weak form of the efficient market theory, prices reflect all information contained in the record of past prices. A. I only B. I and II only C. I and III only D. II and III only E. I, II, and III

E. I, II, and III

Which of the following positions is/are long with respect to the underlying stock? I. Own a stock outright II. Purchase a call option III. Write a put option IV. Short a forward contract A. I and II only B. I and III only C. I and IV only D. II and III only E. I, II, and III only

E. I, II, and III only

Investors actively try to follow each other's behavior. Determine which two of the four below are explanations for this behavior: I. Disposition effect II. Familiarity bias III. Information cascade effect IV. Relative wealth concerns A. I and II B. I and III C. II and III D. II and IV E. III and IV

E. III and IV

Determine which of the following statements regarding IPO puzzles is TRUE. A. The average IPO seems to be priced too high. B. The number of IPOs is solely driven by the demand for capital. C. The cost of an IPO is typically lower compared to the cost of other security issues such as bonds. D. The fees for IPOs seem to be sensitive to the difference in issue sizes. E. In the subsequent 3-5 years after their IPOs, newly listed firms appear to underperform.

E. In the subsequent 3-5 years after their IPOs, newly listed firms appear to underperform.

Leverage has agency benefits and can improve incentives for managers to run a firm more efficiently and effectively. The agency benefits of leverage are least likely due to: A. Increased ownership concentration B. Reduced wasteful investment C. Reduced managerial entrenchment D. Increased commitment E. Increased empire building

E. Increased empire building

Determine which of the following statements regarding the average behavior of individual investors is FALSE. A. Investors fail to diversify their portfolios adequately. B. Investors favor investments in companies they are familiar with. C. Investors care most about the performance of their portfolio relative to that of their peers. D. Investors tend to trade very actively. E. Investors tend to hang on to winners and sell losers.

E. Investors tend to hang on to winners and sell losers.

Determine which of the following is TRUE regarding semi-variance. A. It satisfies translation invariance. B. It satisfies positive homogeneity. C. It satisfies subadditivity. D. It satisfies monotonicity. E. It does not satisfy all four characteristics of a coherent risk measure.

E. It does not satisfy all four characteristics of a coherent risk measure.

Which of the following is an assumption of the Black-Scholes framework? A. Continuously compounded returns on the stock are lognormally distributed and independent over time. B. The borrowing rate is known but not a constant. C. The yield curve is upward sloping. D. Short-selling is allowed at a cost that is known and constant. E. Market is frictionless.

E. Market is frictionless.

Determine which of the following statements regarding project risk analysis is TRUE: A. Break-even analysis does not consider the time value of money. B. Sensitivity analysis and scenario analysis are useful tools for estimating the impact on a project's NPV of changing the value of one capital budgeting input variable at a time. C. Sensitivity analysis accounts for the fact that the underlying variables are interrelated. D. Scenario analysis is designed to identify the variables that are most influential on the success or failure of a project. E. Monte Carlo simulation allows for combining the risk of various sources of uncertainty.

E. Monte Carlo simulation allows for combining the risk of various sources of uncertainty.

Since the development of the CAPM model, it is not uncommon that practitioners use market capitalization, book-to-market ratio and past returns to form portfolios that have a positive alpha. Thus, the market portfolio may not be efficient, and therefore a stock's beta is not an adequate measure of systematic risk. Determine which of the following is NOT a reason why a market portfolio may not be efficient. A. Alternative Risk Preferences B. Non-Tradable Wealth C. Proxy Error D. Behavioral Biases E. No portfolios are efficient

E. No portfolios are efficient

Which of the following statements about calendar/time anomalies is/are true? I. Stock returns have been observed to be lower in December than in other months. II. Stock returns have been observed to be higher on Friday than on other days. III. Stock returns have been observed to be more volatile during the middle of the trading day than toward either the beginning or the end of the trading day. A. I only B. II only C. III only D. I, II, and III E. None of (A), (B), (C), and (D) are correct

E. None of (A), (B), (C), and (D) are correct

Determine which of the following statements is TRUE with respect to the implications of adverse selection in equity markets. A. The stock price rises on the announcement of an equity issue. B. The stock price tends to fall prior to the announcement of an equity issue. C. Firms tend to issue equity when information asymmetries are maximized. D. Managers who perceive that the firm's equity is undervalued will have a preference to fund investment using equity, rather than retained earnings or debt. E. None of (A), (B), (C), or (D) are true.

E. None of (A), (B), (C), or (D) are true.

The current exchange rate is 167 yen per euro. Consider the premiums of the following yen-denominated European options on the euro: x = premium of a 4-month 170-yen strike down-and-in put option with a barrier of 165 yen. y = premium of a 4-month 170-yen strike down-and-in put option with a barrier of 160 yen. z = premium of a 4-month 170-yen strike put option. Determine which of the following is TRUE. A. x>y>z B. x>z>y C. y>z>x D. z>y>x E. None of A, B, C, or D.

E. None of A, B, C, or D.

You are given the following risk measure: ρ(X)=TVaRα(X) for 0<α<1 Determine which property of coherence the risk measure fails to satisfy. A. Translation invariance B. Positive homogeneity C. Monotonicity D. Subadditivity E. None. The risk measure is coherent.

E. None. The risk measure is coherent.

The following relates to one share of XYZ stock: > The current price of one share of XYZ stock is 100. > The forward price for delivery in one year is 105. > P is the expected price in one year. Determine which of the following statements about P is TRUE. A. P<100 B. P=100 C. 100<P<105 D. P=105 E. P>105

E. P>105

If the value of a market call on a stock is higher than the value of a corresponding synthetic call, determine an arbitrage opportunity that you could take to earn a risk-free profit. A. Buy a market call, sell some stock, and borrow money B. Buy a market call, buy some stock, and lend money C. Sell a market call, sell some stock, and borrow money D. Sell a market call, buy some stock, and lend money E. Sell a market call, buy some stock, and borrow money

E. Sell a market call, buy some stock, and borrow money

Determine which of the following positions has the same cash flows as a short stock position. A. Long forward and long zero-coupon bond B. Long forward and short forward C. Long forward and short zero-coupon bond D. Long zero-coupon bond and short forward E. Short forward and short zero-coupon bond

E. Short forward and short zero-coupon bond

Determine which of the following is NOT a reason why the market portfolio might not be efficient. A. We cannot include most of the traded investment wealth in the economy in the market proxy because competitive price data is not available. B. Some investors may be subject to systematic behavioral biases. C. Some investors may be attracted to investments with skewed distributions that have a small probability of an extremely high payoff. D. Some investors are exposed to other significant risks outside their portfolio that are not tradable, the most important of which is due to their human capital. E. Some investors fail to diversify their portfolios adequately.

E. Some investors fail to diversify their portfolios adequately.

Let R be a continuous random variable that reflects the per-period return of an individual security, and μ be the mean return. Determine which of the following statements regarding investment risk measures is FALSE. A. The variance of R is given by E[(R−μ)2]. B. The semi-variance of R is given by E[min(0,R−μ)2]. C. The Value-at-Risk of R based upon confidence level α is given by F−1(α), where F is the cumulative distribution function of R. D. The Tail Value-at-Risk of R based upon confidence level α is given by [1/α]∫{Bounds:(−∞,VaRα)} r⋅f(r) dr. E. The Value-at-Risk of R must be less than or equal to the Tail Value-at-Risk of R.

E. The Value-at-Risk of R must be less than or equal to the Tail Value-at-Risk of R.

Determine which of the following statements regarding coherent risk measure is FALSE. A.Variance does not satisfy monotonicity. B. Semi-variance does not satisfy translational invariance. C. Value-at-Risk does not generally satisfy subadditivity. D. Value-at-Risk is generally not coherent. E. The conditional​ tail expectation is not coherent.

E. The conditional​ tail expectation is not coherent.

Determine which of the following statements is TRUE. A. Diversification would reduce risk even if the stocks were perfectly positively correlated. B. Diversification over a large number of assets completely eliminates risk. C. Diversification only works when assets are uncorrelated. D. A stock with a low volatility always contributes less to portfolio risk than a stock with a higher volatility. E. The contribution of a stock to the risk of a well-diversified portfolio depends on its market risk.

E. The contribution of a stock to the risk of a well-diversified portfolio depends on its market risk.

Determine which of the following risk management techniques can hedge the financial risk of an oil producer arising from the price of the oil that it sells. I. Short forward position on the price of oil II. Long put option on the price of oil III. Long call option on the price of oil A. I only B. II only C. III only D. I, II, and III E. The correct answer is not given by (A), (B), (C), or (D)

E. The correct answer is not given by (A), (B), (C), or (D)

Determine which of the following statements regarding investor behavior and capital market efficiency is FALSE: A. If an investor can use past returns to construct a trading strategy that makes consistent profit, it is evidence that market portfolio is not efficient. B. Investors might expect stocks to have non-zero alphas if the market proxy portfolio is not highly correlated with the true market portfolio, even if the true market portfolio is efficient. C. If some investors are subject to systematic behavioral biases while others select efficient portfolios, then the market portfolio will not be efficient. D. An employee who cares about the risk due to human capital will likely underweight the amount of money he invests in his own company's stock relative to an investor who does not work for his company. E. The disposition effect reduces investor's tax obligations.

E. The disposition effect reduces investor's tax obligations.

An investor has long positions in a two-asset portfolio. During a market decline, the correlation between the two assets increases. If there is no change in the proportion of each asset held in the portfolio or the expected return and standard deviation of the individual assets, determine which of the following statements is true. A. Both the expected return of the portfolio and the volatility of the portfolio increase. B. The expected return of the portfolio decreases but the volatility of the portfolio increases. C. The expected return of the portfolio increases but the volatility of the portfolio decreases. D. The expected return of the portfolio remains the same but the volatility of the portfolio decreases. E. The expected return of the portfolio remains the same but the volatility of the portfolio increases.

E. The expected return of the portfolio remains the same but the volatility of the portfolio increases.

Determine which one of the following statements regarding mortgage guaranty insurance is FALSE: A. Mortgage guaranty insurance is designed to limit losses to the lender, and by extension the depositors and creditors of the lending institution, after a mortgage has gone into default and the foreclosure process has begun. B. Mortgage guaranty insurance is most often purchased for loans that are considered higher risk. C. Mortgage guaranty insurance is different from mortgage life insurance and mortgage disability insurance. D. A mortgage guaranty insurance contract is a put option with payment contingent on borrower default. E. The mortgage loan itself is a put option, one which the lender holds.

E. The mortgage loan itself is a put option, one which the lender holds.

Basho has a yen-denominated European option on US dollars. You are given: > The time until expiration is 3 years. > The continuously compounded interest rate on yen is 2%. > The continuously compounded interest rate on US dollars is 5%. > The current exchange rate is 103 yen per US dollar. Determine which of the following statements is TRUE. A. The premium of a call option with a strike price of 95 yen could not be 85 yen. B. The premium of a put option with a strike price of 150 yen could not be 140 yen. C. The premium of a call option with a strike price of 95 yen could not be 1 yen. D. The premium of a put option with a strike price of 150 yen could not be 55 yen. E. The premium of an at-the-money put is greater than the premium of an at-the-money call.

E. The premium of an at-the-money put is greater than the premium of an at-the-money call.

Determine which of the following statements regarding diversification in stock portfolios is FALSE. A. The risk premium for a diversifiable risk is zero. B. Investors are not compensated for holding diversifiable risk. C. The risk premium of a security is not affected by its diversifiable risk. D. Investors will not require a risk premium for holding diversifiable risk. E. The risk premium of a security is determined by its total risk.

E. The risk premium of a security is determined by its total risk.

Determine which one of the following statements regarding guarantees on variable annuity products is FALSE: A. A guaranteed minimum death benefit (GMDB) with a return of premium guarantee is a put option with expiration contingent on the death of the policyholder. B. The value of the embedded death benefit guarantee for a guaranteed minimum death benefit (GMDB) with a return of premium guarantee is the probability-weighted average of the values of European put options of varying times to expiration with probability weights defined by the random variable that represents the future lifetime of a policyholder. C. An earnings-enhanced death benefit is an optional benefit available with some variable annuity products that pays the beneficiary an additional amount when the policyholder/annuitant dies based on the increase in the account value over the original amount invested. D. The value of the earnings-enhanced death benefit is equal to a multiplier times the probability-weighted average of the values of European call options of varying times to expiration with probability weights defined by the random variable that represents the future lifetime of a policyholder. E. The value of the embedded accumulation benefit guarantee for a guaranteed minimum accumulation benefit (GMAB) with a return of premium guarantee is equal to the probability that the policyholder is alive and the policy is still in force times the value of a European call option.

E. The value of the embedded accumulation benefit guarantee for a guaranteed minimum accumulation benefit (GMAB) with a return of premium guarantee is equal to the probability that the policyholder is alive and the policy is still in force times the value of a European call option.

A company uses derivatives to manage its financial risk. Determine in which of the following scenarios the company is MOST LIKELY to use a derivative security. A. To comply with generally accepted accounting principles. B. To minimize its tax deductions. C. To hedge against the increase of an asset the company already owns. D. To guarantee that an asset it will be purchasing can be bought at higher price. E. To adequately fund a guarantee it has sold to its customers.

E. To adequately fund a guarantee it has sold to its customers.

Determine which of the following behaviors is idiosyncratic and does NOT cause the market portfolio to be inefficient. A. A loss in the World Cup elimination stage lowers the next day's stock returns in the losing country. B. People who grew up and lived during a time of high stock returns are more likely to invest in stocks than people who experienced times when stocks performed poorly. C. Investors are actively trying to follow each other's behavior. D. Investors tend to hold on to stocks that have lost value and sell stocks that have risen in value since the time of purchase. E. Trading activity increases with the number of speeding tickets an individual receives.

E. Trading activity increases with the number of speeding tickets an individual receives.