Section two
Which of the following is most likely a primary market transaction? A. A private placement of shares B. A market order sale of bonds C. The exercise of an exchange-traded call option
A Private placements qualify as primary market transactions because they are sales of securities by issuers directly to a small group of qualified investors. B is incorrect. Market order sales take place in secondary markets. C is incorrect. The exercise of an exchange-traded call option is a secondary market transaction involving the purchase by option owner of previously issued security.
A portfolio manager generated a rate of return of 15.5% on a portfolio with beta of 1.2. If the risk-free rate of return is 2.5% and the market return is 11.8%, Jensen's alpha for the portfolio is closest to: A. 1.84%. B. 4.34%. C. 3.70%.
A = 0.155 - [0.025 + 1.2 × (0.118 - 0.025)] = 0.0184
Holding all other characteristics the same, the bond exposed to the greatest level of reinvestment risk is most likely the one selling at: A. a premium. B. a discount. C. par.
A A bond selling at a premium has a higher coupon rate and, all else being equal, bonds with higher coupon rates face higher reinvestment risk. The higher the coupon rate, the more dependent the bond's total dollar return will be on the reinvestment of the coupon payments in order to produce the yield to maturity at the time of purchase. B is incorrect because, all else being equal, a bond selling at a discount has a lower coupon rate than a bond selling at a premium. C is incorrect because, all else being equal, a bond selling at par has a lower coupon rate than a bond selling at a premium.
A company that pursues differentiation as its competitive strategy is most likely to emphasize: A. strong market research. B. efficient operating and reporting systems. C. defensive market positions.
A A company that follows a product or service differentiation strategy needs to emphasize market research to identify and match customer needs with product development and marketing for which customers are willing to pay a premium.
Which type of bond is most likely to be preferred by investors in a falling interest rate environment? A. A floored floating-rate note B. A capped floating-rate note C. A floating-rate note with no cap or floor
A A floored floating-rate note prevents the coupon rate from falling below the specified minimum rate. In a falling interest rate environment, this feature will benefit investors because it guarantees that the coupon rate will not fall below the specified minimum rate. B is incorrect because a capped floating-rate note prevents the coupon rate from rising above a pre-specified maximum rate. This feature would be preferred by the issuer because it sets a limit on the interest rate to be paid in a rising interest rate environment. C is incorrect because in a floating-rate note the coupon rate varies with a benchmark market interest rate that is reset at regular intervals. In a falling interest rate environment, the coupon rate would decrease and a floating-rate note would not be preferred by investors.
Which of the following derivatives is least likely to be classified as a contingent claim? A. A futures contract B. A call option contract C. A credit default swap
A A futures contract is classified as a forward commitment in which the buyer undertakes to purchase the underlying asset from the seller at a later date and at a price agreed on by the two parties when the contract is initiated. B is incorrect. A call option contract is a contingent claim in which the buyer of the option has a right to purchase the underlying asset at a fixed price on or before a pre-specified expiration date. C is incorrect. A credit default swap is a contingent claim in which the credit protection seller provides protection to the credit protection buyer against the credit risk of a third party.
A good risk governance process would most likely: A. provide guidance on the size of the largest acceptable loss for the organization. B. provide different risk targets for each unit within the organization. C. be a bottom-up process that reflects the current risk exposures of all parts of the organization.
A A quality risk governance process takes a top-down approach and is charged with risk oversight for the entire organization. It should operate on an enterprise-wise basis rather than viewing each unit in isolation. It will determine the organization's risk tolerance and provide a sense of the maximum loss the organization can absorb. B is incorrect because a good risk governance process looks at the enterprise as a whole rather than viewing individual units in isolation. C is incorrect because a risk governance process is a top-down process.
A company's $100 par value perpetual preferred stock has a dividend rate of 7% and a required rate of return of 11%. The company's earnings are expected to grow at a constant rate of 3% per year. If the market price per share for the preferred stock is $75, the preferred stock is most appropriately described as being: A. overvalued by $11.36. B. undervalued by $15.13. C. undervalued by $36.36.
A Dividend / Required Rate of Return The stock is overvalued by $75.00 - $63.64 = $11.36
In assigning credit ratings, the practice of notching by the rating agencies is least likely used to quantify the: A. probability of default. B. priority of payment in the event of default. C. potential severity of loss in the event of default.
A For the rating agencies, the main factor motivating the assignment of a rating is the probability of default. Notching is most likely to be used to address secondary factors such as the priority of payment in the event of default and the potential severity of loss in the event of default. These secondary factors are accounted for via notching the issue's rating up or down relative to the issuer's rating. B is incorrect because this is a secondary factor that rating agencies can account for by notching the issue's rating up or down relative to the issuer's rating. C is incorrect because this is a secondary factor that rating agencies can account for by notching the issue's rating up or down relative to the issuer's rating.
In the context of strategic asset allocation, adding asset classes with low correlation will most likely improve a portfolio's risk-return trade-off as long as the stand-alone risk of the added asset class: A. does not exceed its diversification effect. B. equals its diversification effect. C. exceeds its diversification effect.
A In general, adding assets classes with low correlation improves the risk-return trade-off as long as the stand-alone risk of the added asset class does not exceed its diversification effect. B is incorrect because adding assets classes with low correlation will only improve the risk-return trade-off if the stand-alone risk of the added asset class does not exceed its diversification effect. C is incorrect because adding assets classes with low correlation will only improve the risk-return trade-off if the stand-alone risk of the added asset class does not exceed its diversification effect.
A hedge fund that implements trades based on a top-down analysis of expected movements in economic variables most likely uses a(n): A. macro strategy. B. relative value strategy. C. event-driven strategy.
A Macro strategies emphasize a top-down approach, and trades are made based on expected movements of economic variables. B is incorrect. Relative value strategies focus on pricing discrepancies between related securities. C is incorrect. Event-driven strategies focus on short-term events that are expected to affect individual companies. The approach is thus "bottom up."
The direct capitalization approach to real estate valuation most likely applies a capitalization rate to the annual: A. net operating income. B. net operating income minus income taxes. C. net operating income minus depreciation
A Net operating income is the measure used in the direct capitalization approach. It is a proxy for the property level operating cash flow. B is incorrect. Income taxes are not deducted when using the direct capitalization approach. C is incorrect. Depreciation is not deducted when using the direct capitalization approach.
Which of the following is least likely to be a negative covenant associated with a coupon-paying corporate bond issue? A. A requirement to pay withholding taxes to foreign governments in a timely manner B. A prohibition from investing in long-term projects in emerging market countries C. A requirement to hedge at least 50% of the firm's revenues generated from foreign sales
A Requiring compliance with the existing rules and regulations of foreign governments is administrative in nature and thus an affirmative covenant. B is incorrect because this is a negative covenant that is likely to materially constrain the firm's operational decisions and is likely to be costly to the firm. C is incorrect because this is a negative covenant that is likely to materially constrain the firm's operational decisions and is likely to be costly to the firm.
A pension fund has decided to invest in alternative investments. Which of the following assets is the fund most likely to include in this strategy? A. Securitized debt B. Convertible bonds C. Equity exchange-traded funds
A Securitized debt is an alternative investment, so it could be included in this strategy.
The option-free bonds issued by ALS Corp. are currently priced at 108.50. Based on a portfolio manager's valuation model, a 1 bp increase in interest rates will result in the bond price falling to 108.40, whereas a 1 bp decrease in interest rates will result in the bond price rising to 108.59. The price value of a basis point (PVBP) for the bonds is closest to: A. 0.095. B. 0.088. C. 0.190.
A The bond's PVBP is computed using PVBP=(PV−)−(PV+)2=108.59−108.402=0.095
The Delfain Corporation reported a significant improvement in profitability that was followed by a material upgrade in its credit rating. The market responded by immediately requiring a 100 basis point narrower spread to Gilts on Delfain's 8-year bond. If the bond's modified duration is 6.0 and its convexity is 55.0, the return impact of this change is closest to: A. 6.28%. B. -5.73%. C. 7.10%.
A The return impact of a 60 bps fall in the bond's yield can be computed as: Return impact ≈ -(MDur × ΔSpread) + ½Cvx × (ΔSpread)2 Return impact ≈ -(6.0 × -0.01) + ½(55.0) × (-0.01)2 = 6.28%
Which of the following scenarios can best be described as offering superior protection of shareholder interests? A. When common law is practiced B. When CEO duality is common C. When stakeholder theory prevails
A Unlike civil law systems, common law systems provide judges with the ability to create law by setting precedents that are followed in subsequent cases. Shareholders are viewed as better protected under common law because judges may rule against management actions in situations that are not specifically addressed by statutes.
According to put-call parity, if a fiduciary call expires in the money, the payoff is most likely equal to the: A. difference between the market value of the asset and the face value of the risk-free bond. B. market value of the asset. C. face value of the risk-free bond.
B A fiduciary call, defined as a long position in a call and in a risk-free bond, generates a payoff that is equal to the market value of the asset if it expires in the money. A is incorrect. The difference between the market value of the asset and the face value of the risk-free bond is the payoff of the long call if exercised. This ignores the fact that the face value of the bond needs to be added to the payoff. C is incorrect. The face value of the risk-free bond is the payoff of the fiduciary call if the call expires out of the money,
A trader is able to obtain persistent abnormal returns by adopting an investment strategy that purchases stocks that have recently experienced high returns. This strategy exploits a market-pricing anomaly best described as: A. data mining. B. momentum. C. the overreaction effect.
B A momentum anomaly occurs when securities that have experienced high short-term returns continue to generate higher returns in subsequent periods. Therefore, if a trader can obtain persistent abnormal returns by adopting an investment strategy that purchases stocks that have recently experienced high returns, then he or she is exploiting a momentum anomaly. C is incorrect. The overreaction effect is a pricing anomaly that occurs when investors overreact to the release of unexpected public information, inflating (depressing) stock prices of companies releasing good (bad) information. A is incorrect. Data mining is not a market anomaly but a type of process that could be used to discover statistically significant price patterns.
A portfolio of securities representing a given security market, market segment, or asset class is best described as a: A. benchmark. B. security market index. C. total return index.
B A security market index represents a given security market, market segment, or asset class and is normally constructed as portfolios of marketable securities. A is incorrect. A security market index represents a given security market, market segment, or asset class. A benchmark is a comparison portfolio and is used to evaluate the performance of active portfolio managers. C is incorrect. A total return index reflects not only the prices of the constituent securities but also the reinvestment of all income received since inception.
The three main sources of return for commodities futures contracts most likely are: A. convenience yield, dividend yield, and spot price return. B. collateral yield, roll yield, and spot price return. C. collateral yield, convenience yield, and roll yield.
B The three main sources of return for a commodities futures contract are collateral yield, roll yield, and spot price return. A is incorrect because collateral yield and roll yield are missing. Dividend yield is not a source of return for commodities futures investments. C is incorrect because spot price return is missing. A high convenience yield results in a situation where the futures price will be below the spot price. In this case, the price of the futures contract rolls up to the spot price as the expiry date of the contract approaches.
Which of the following statements describes the most appropriate treatment of cash flows in capital budgeting? A. Interest costs are included in the project's cash flows to reflect financing costs. B. A project is evaluated using its incremental cash flows on an after-tax basis. C. Sunk costs and externalities should not be included in the cash flow estimates.
B All of the incremental cash flows arising from a project should be analyzed on an after-tax basis. C is incorrect. Only sunk costs should be ignored in a project's cash flow estimation, but not any externalities. Sunk costs cannot be recovered once they have been incurred. Externalities (both positive and negative ones) are the effects of an investment decision on other things beside the investment itself; they should therefore be included in the cash flow estimation. A is incorrect. Financing costs like interest costs are excluded from calculations of operating cash flows. The financing costs are reflected in the required rate of return for an investment project. If financing costs are included, we would be double-counting these costs.
Risk management is most likely the process by which an organization: A. minimizes its exposure to potential losses. B. adjusts its risk to a predetermined level. C. maximizes its risk-adjusted return.
B An organization with a strong competitive position can recover from losses more easily than one with a weaker competitive position. Therefore, an organization's risk tolerance should reflect its competitive position. An organization's size does not define the risk sources it faces or the relative losses it can absorb, so it should not be reflected in its risk tolerance. Neither the risk sources affecting an organization nor the size of the losses an organization can absorb are a function of its perception of market stability. A is incorrect because a minimum risk position may not be optimal for the organization. C is incorrect because a high risk-adjusted return may require a level of risk taking that is beyond the organization's capacity to absorb.
The execution step of the portfolio management process includes: A. preparing the investment policy statement. B. finalizing the asset allocation. C. monitoring the portfolio performance.
B Asset allocation occurs in the execution step. A is incorrect. Preparation of the investment policy statement occurs in the planning step. C is incorrect. Portfolio monitoring occurs in the feedback step.
Which of the following is least likely to be directly reflected in the returns on a commodity index? A. Changes in the futures prices of commodities in the index B. Changes in the spot prices of underlying commodities C. Roll yield
B Commodity index returns reflect the changes in future prices and the roll yield. Changes in the underlying commodity spot prices are not reflected in a commodity index. A is incorrect. Changes in the futures prices of commodities in the index are reflected in the index. C is incorrect. The roll yield is reflected in the returns on a commodity index.
An investor who owns a mortgage pass-through security is exposed to contraction risk, which is the risk that when interest rates: A. decline, the security will effectively have a longer maturity than was anticipated at the time of purchase. B. decline, the security will effectively have a shorter maturity than was anticipated at the time of purchase. C. rise, the security will effectively have a shorter maturity than was anticipated at the time of purchase.
B Contraction risk is the risk faced by investors when interest rates fall in that the security will effectively have a shorter maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates. A is incorrect because contraction risk is the risk faced by investors when interest rates fall in that the security will effectively have a shorter, not longer, maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates. C is incorrect because contraction risk is the risk faced by investors when interest rates fall, not rise, in that the security will effectively have a shorter maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates.
The factor least likely to influence the yield spread on an option-free, fixed-rate bond is a change in the: A. credit risk of the issuer. B. expected inflation rate. C. liquidity of the bond.
B For an option-free, fixed-rate bond, changes in the yield spread can arise from changes in the credit risk of the issuer and/or changes in the liquidity of the issue. Changes in the expected inflation rate influence the benchmark rate. C is incorrect because changes in the yield spread an option-free, fixed-rate bond arise from changes in the liquidity of the issue. A is incorrect because changes in the yield spread an option-free, fixed-rate bond arise from changes in the credit risk of the issuer.
The index weighting that results in portfolio weights shifting away from securities that have increased in relative value toward securities that have fallen in relative value whenever the portfolio is rebalanced is most accurately described as: A. float-adjusted market-capitalization weighting. B. fundamental weighting. C. equal weighting.
B Fundamentally weighted indexes generally will have a contrarian "effect" in that the portfolio weights will shift away from securities that have increased in relative value and toward securities that have fallen in relative value whenever the portfolio is rebalanced.
Which of the following statements is most accurate in an efficient market? A. Active strategies will lead to excess risk-adjusted portfolio returns. B. Securities market prices fully reflect their fundamental values. C. Securities market prices respond over time to changes in economic information.
B In an efficient market, market participants will process available information, and those with opposite views will trade among each other until securities market prices fully reflect their fundamental values. An efficient market is thus a market in which asset prices reflect all past and present information.
The process of looking for inflection points in one market that may signal a trend change in a related market is best described as: A. capital market cycle analysis. B. relative strength analysis. C. momentum analysis.
B In intermarket analysis, technicians often use relative strength analysis to look for inflection points in one market as a warning sign to start looking for a change in trend in a related market. A is incorrect. Analysis of capital market cycles is used to find trends that may help predict future price movements based on the reoccurrence of historical cycles. This is typically looked at for a single market, not based on intermarket correlations. C is incorrect. Momentum analysis is focused on identifying changes in market sentiment for a single market, not intermarket correlations.
Which of the following statements best describes a potential concern for clients using robo-advisers? Robo-advisers: A. must be established as registered investment advisers. B. do not seem to incorporate the full range of investment information into their recommendations. C. are likely to be held to a similar code of conduct as other investment professionals in the given region.
B Initial research has shown that robo-advisers do not seem to incorporate the full range of investment information into their recommendations, meaning that important points may be missing in investment decisions. A is incorrect. It is an advantage to clients that robo-advisers must be registered as investment advisers, because they are subject to guidance from the securities regulator of their country. C is incorrect. It is an advantage to clients that robo-advisers must be held to a similar code of conduct as other investment professionals in the given region.
A real estate investor looking for equity exposure in the public market is most likely to invest in: A. real estate limited partnerships. B. shares of real estate investment trusts. C. collateralized mortgage obligations.
B Shares in real estate investment trusts are publicly traded and represent an equity investment in real estate. A is incorrect. Real estate limited partnerships are an example of a private real estate investment. C is incorrect. A collateralized mortgage obligation is an example of debt-based exposure to real estate
A mining company has received government approval for the development of a mining property and has also consulted with members of the local community near the development site throughout the project assessment process. The latter action is best described as an example of: A. principal-agent conflict mitigation. B. stakeholder management. C. regulatory compliance.
B Stakeholder theory broadens a company's focus beyond the interests of only its shareholders to those of its customers, suppliers, employees, and others who have an interest in the company. The local community is likely a stakeholder in the company's development plans. By identifying the community and understanding its interests, the company is engaging in stakeholder management.
Which of the following is least likely a component of the "Four Cs of Credit Analysis" framework? A. Covenants B. Competition C. Collateral
B The "Four Cs of Credit Analysis" framework includes capacity, collateral, covenants, and character. Competition is not one of the components. A is incorrect because covenants are the terms and conditions of lending agreements that the issuer must comply with. It is part of the "Four Cs of Credit Analysis" framework. C is incorrect because collateral refers to the quality and value of the assets supporting the issuer's indebtedness. It is part of the "Four Cs of Credit Analysis" framework.
A company issues new 20-year $1,000 bonds with a coupon rate of 6.2% payable semiannually at an issue price of $1,030.34. Assuming a tax rate of 28%, the firm's annual after-tax cost of debt (%) is closest to: A. 5.94. B. 4.28. C. 4.46.
B The annual after-tax cost of debt is the after tax annual yield to maturity (YTM). Find the YTM by using a financial calculator as follows: PV = -1,030.34, FV = 1,000, N = 40 (20 × 2), PMT = 31 (0.062 × 1,000 × 0.5), compute i. i = 2.97 semiannually Annually, YTM = 2.97 × 2 = 5.94
Two years ago, a homeowner took out a $1 million home mortgage from a bank. The current principal on the loan is $750,000, and the homeowner has defaulted on the loan. Following foreclosure proceedings, the bank sells the property for $600,000 and is only entitled to use these funds to satisfy the loan obligation. The homeowner most likely had a: A. bullet loan. B. non-recourse loan. C. recourse loan.
B The bank does not have a claim against the borrower for the shortfall of $150,000 on the mortgage balance outstanding relative to the proceeds received from the property's sale, indicating that the home mortgage is a non-recourse loan. A is incorrect because a bullet loan is a type of interest-only mortgage loan in which there are no principal payments over the term of the loan. The loan balance outstanding is less than the original mortgage amount, so it is unlikely that this was a bullet loan. C is incorrect because in the case of a recourse loan the bank would have been entitled to make a claim for the shortfall of $150,000 against the borrower.
A trader who owns shares of a stock currently trading at $100 per share places a "GTC, stop $90, limit $85 sell" order (GTC means good till cancelled). Assuming the specified stop condition is satisfied and the order becomes executed, which of the following statements is most accurate? A. The order becomes a market order when the price falls below $85 and remains valid for execution. B. The trader faces a maximum realized loss of $15. C. The order will be executed at either $90 or $85.
B The order becomes valid when the price falls to, or below, $90. The "limit $85 sell" indicates that the trader is unwilling to sell below $85. Thus, the trader faces a maximum loss of $15 ($100 - $85).
The price of a forward contract most likely: A. decreases as the price of the underlying goes up. B. is constant and set as part of the contract specifications. C. increases as market risk increases.
B The price of a forward contract remains constant throughout the life of the contract. It is set as part of the contract specifications. A is incorrect. The price of a forward contract is not affected by market conditions. It is set as part of the contract specifications. C is incorrect. The price of a forward contract is not affected by market conditions. It is set as part of the contract specifications.
Consider a portfolio with two assets. Asset A comprises 25% of the portfolio and has a standard deviation of 17.9%. Asset B comprises 75% of the portfolio and has a standard deviation of 6.2%. If the correlation of these two investments is 0.5, the portfolio standard deviation is closest to: A. 6.45%. B. 7.90%. C. 9.13%.
B The standard deviation of a two-asset portfolio is given by the square root of the portfolio's variance: σp=w21σ21+w22σ22+2w1w2ρ1,2σ1σ2⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√ Using this formula, the existing standard deviation is calculated as follows: 0.252×0.1792+0.752×0.0622+2×0.75×0.25×0.5×0.179×0.062⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√=7.90%
A trader describes her currency contract exposure as "long the euro against the British pound." Which of the following situations best fits her description? She has a: A. contract that allowed her to sell British pounds and acquire euros. B. forward contract to buy euros in exchange for British pounds at a predetermined exchange rate. C. forward contract to buy British pounds, using euros she currently holds.
B The trader has a long forward position in the euro, which means she has committed to purchase euros in exchange for British pounds sometime in the future at an exchange rate determined when the contract was initiated.
A company has 100 million shares outstanding. The share price of a company's stock is £15 just prior to announcing a £100 million expansionary investment in a new plant, and the company estimates that the present value of future after-tax cash flows will be £150 million. Analysts, however, estimate that the new plant's profitability will be lower than the company's expectations. The company's stock price will most likely: A. drop below £15 per share due to the cannibalization of revenue from the new plant. B. increase by less than £0.50 per share. C. increase by the new plant's net present value per share.
B The value of a company is the value of its existing investments plus the net present values of all of its future investments. The NPV of this new plant is £150 million - £100 million = £50 million. The price per share should increase by NPV per share or £50 million/100 million shares = £0.50 per share. As the new plant's profitability is less than expectations, the NPV per share (and hence the increase in the stock price) should therefore be slightly below £0.50 per share.
An informed trader buys a company's stock. His close friends, who lack information or expertise, imitate his action and buy the stock. Which of the following statements concerning this behavioral bias is most accurate? It: A. is identical to representativeness. B. improves market efficiency. C. is inconsistent with rational behavior.
B This behavioral bias is an example of an information cascade wherein the transmission of information is from those participants who act first and whose decisions influence the decisions of others. The behavior of informed traders acting first and uninformed traders imitating the informed traders is consistent with rationality. The imitation trading by the uninformed traders helps the market incorporate relevant information and improves market efficiency.
From the perspective of a CDO manager, an arbitrage collateralized debt obligation most likely differs from a traditional asset-backed security because it involves the: A. pooling of debt obligations. B. active management of the collateral. C. creation of a special purpose entity.
B Unlike a traditional asset-backed security, an arbitrage collateralized debt obligation involves active management because the CDO manager buys and sells debt obligations with the objective of paying off different classes of bondholders as well as generating a high return for the subordinated/equity tranche and the manager. A is incorrect because both arbitrage collateralized debt obligations and traditional asset-backed securities involve the pooling of debt obligations. C is incorrect because both arbitrage collateralized debt obligations and traditional asset-backed securities involve the creation of a special purpose entity.
The value at risk of an alternative investment is best described as the: A. probability of losing a fixed amount of money over a given time period. B. minimum amount of loss expected over a given time period at a given probability level. C. time period during which a fixed amount is lost at a given probability level.
B Value at risk is defined as the minimum amount of loss expected over a given time period at a given probability level. A is incorrect. Value at risk is defined as the minimum amount of loss expected over a given time period at a given probability level. C is incorrect. Value at risk is defined as the minimum amount of loss expected over a given time period at a given probability level.
Compared with the occurrence of fundamental developments related to a company, when do technical analysts believe that related security price movements are most likely to arise? A. After B. Before C. Simultaneously
B Technicians believe that security price movements occur before fundamental developments of a company unfold and before they are reported to the public. A is incorrect. Technicians believe that security price movements occur before, not after, fundamental developments unfold—certainly before they are reported. C is incorrect. Technicians believe that security price movements occur before, not at the same time as, fundamental developments unfold—certainly before they are reported.
If dividends paid by the underlying increase, the value of a European call option will most likely: A. not change. B. increase. C. decrease.
C A European call option is worth less the more dividends are paid by the underlying. A is incorrect. A European call option is worth less the more dividends are paid by the underlying. B is incorrect. A European call option is worth less the more dividends are paid by the underlying.
Which of the following bonds is most likely to trade at a lower price relative to an otherwise identical option-free bond? A. Convertible bond B. Putable bond C. Callable bond
C A callable bond benefits the issuer because it gives the issuer the right to redeem all (or part) of the bonds before the maturity date. Thus, the price of a callable bond will typically be lower than the price of an otherwise identical non-callable bond. A is incorrect because a convertible bond also benefits bondholders as it gives them the right to convert the bonds into the issuer's common stock. All else being equal, the price of a convertible bond will typically be higher than the price of an otherwise identical non-convertible bond. B is incorrect because a putable bond benefits bondholders as it gives them the right to sell the bonds back to the issuer before the maturity date. All else being equal, the price of a putable bond will typically be higher than the price of an otherwise identical non-putable bond.
The option-free bonds of Argus Corporation have a duration of eight years. When interest rates rise by 100 bps, the bond's price declines by 7.9%. When interest rates fall by 100 bps, however, the price rises by 8.2%. The asymmetrical price change is most likely caused by the: A. coupon effect. B. maturity effect. C. convexity effect.
C A fall in interest rates will result in a higher percentage rise in the bond's price compared with the percentage fall in the bond's price when interest rates rise by the same amount. A is incorrect because the coupon effect relates to the sensitivity of bond price changes to changes in the coupon rate. B is incorrect because the maturity effect relates to the sensitivity of bond price changes to the time to maturity.
Compared to traditional investments, alternative investments least likely demonstrate which of the following characteristics? A. Narrow manager specialization B. Underlying investments that are illiquid C. A high degree of regulation
C Alternative investments are less regulated and transparent than traditional investments such as equity and debt securities. A is incorrect because narrow manager specialization is a characteristic of alternative investments. B is incorrect because a characteristic of alternative investments is that the underlying investments are illiquid
An asset with a current market price of $15.50 and an estimated intrinsic value of $12.50 is best described as being: A. undervalued. B. fairly valued. C. overvalued.
C An asset with an estimated intrinsic value less than the market price is considered overvalued. A is incorrect because an asset with a current market price above its estimated intrinsic value would be considered overvalued (not undervalued). An asset is undervalued when its estimated intrinsic value is higher than its market price. B is incorrect because an asset with a current market price above its estimated intrinsic value would be considered overvalued (not fairly valued). An asset is fairly valued when its estimated intrinsic value equals its market price.
Using the "Four Cs of Credit Analysis" framework, which of the following is the least likely factor to be considered under the category of "capacity"? A. Level of competition B. Industry fundamentals C. History of fraud or malfeasance
C Any history of fraud or malfeasance is a major warning flag to credit analysts under the category of "Character." A is incorrect because level of competition is part of the "Capacity" analysis for industry structure. B is incorrect because company fundamentals is under the category of "Capacity" for credit analysis.
Stock X and Stock Y have the same level of total risk. Stock X has twice the systematic risk of Stock Y and half its non-systematic risk. Stock X's expected return will most likely be: A. the same as the expected return of Stock Y. B. lower than the expected return of Stock Y. C. higher than the expected return of Stock Y.
C Because Stock X has a higher systematic risk level compared with Stock Y, its expected return will be higher than that of Stock Y. A is incorrect because Stock X has a higher systematic risk level compared to Stock Y, implying a higher (not the same) expected return compared to Stock Y. B is incorrect because Stock X has a higher systematic risk level compared to Stock Y, implying a higher (not lower) expected return compared to Stock Y.
Collectibles are least likely to provide: A. long-term capital appreciation. B. portfolio diversification. C. current income.
C Collectibles do not provide current income, but they can potentially provide long-term capital appreciation and help further diversify a portfolio. A is incorrect. Collectibles can potentially provide long-term capital appreciation. B is incorrect. Collectibles can potentially provide portfolio diversification.
Given the following information about a firm: debt-to-equity ratio (D/E) of 50% tax rate of 40% cost of debt of 8% cost of equity of 13% the firm's weighted average cost of capital (WACC) is closest to: A. 8.9%. B. 7.5%. C. 10.3%.
C Convert D/E to the weight for debt: The weight for equity is one minus the weight of debt: 2/3 = 1 - (1/3). WACC = weight of debt × cost of debt × (1 - tax rate) + weight of equity × cost of equity = (1/3) × 0.08 × (1 - 0.40) = (2/3) × 0.13 = 0.1026 = 10.3%
The least likely reason investors incorporate environmental and societal factors into their investment analysis is to: A. improve investment performance. B. have a more comprehensive understanding of a company's risks. C. limit investments to those equities that are consistent with their moral or ethical values.
C Environmental, social, and governance investment analysis can be implemented across all asset classes and is not limited to equity investments. It is done to provide a more comprehensive understanding of a company's risks and improve investment performance. A is incorrect. ESG is done to provide a more comprehensive understanding of a company's risks. B is incorrect. ESG is done to improve investment performance.
In the semi-strong-form of market efficiency, fundamental analysis most likely requires the analyst to: A. extrapolate historical data to estimate future values and make investment decisions. B. use trading rules for detecting the price movements that lead to new equilibrium prices. C. do a superior job of estimating the relevant variables and predicting earnings surprises.
C Fundamental analysis facilitates a semi-strong-form efficient market by disseminating value-relevant information. Fundamental analysis can be profitable in terms of generating abnormal returns if the analyst creates a comparative advantage with respect to this information. Such an advantage can be achieved by doing a superior job of estimating the relevant variables and predicting earnings surprises. A is incorrect. Simply extrapolating historical data may not produce superior returns in an efficient market. B is incorrect. The use of technical rules for detecting the price movements and gradual price adjustments comprises technical analysis, not fundamental analysis.
For a forward contract with a value of zero, a situation where the spot price is above the forward price is best explained by high: A. interest rates. B. storage costs. C. convenience yield.
C If the convenience yield is high, holding the underlying confers large benefits, thus the spot price can exceed the forward price for a forward contract with a value of zero. Based on the formulaVt(T) = St - (γ - θ)(1 + r)t - F0(T)(1 + r)-(T-t)and an initial value Vt(0) of zero, large benefits γ explain why the spot price can exceed the forward price.
When estimating the NPV for a project with a risk level higher than the company's average risk level, an analyst will most likely discount the project's cash flows by a rate that is: A. determined by the firm's target capital structure. B. below the WACC. C. above the WACC.
C If the systematic risk of the project is above average relative to the company's current portfolio of projects, an upward adjustment is made to the company's MCC or WACC.
In a currency swap, the underlying principal amount is exchanged: A. only at the start of the swap. B. only at the end of the swap. C. both at the start and at the end of the swap.
C In a currency swap, the underlying principal is denominated in different currencies and is typically exchanged at the start and end of the swap. A is incorrect. In a currency swap, the underlying principal is denominated in different currencies and would typically be exchanged not only at the start of the swap but also at the end of the swap. B is incorrect. In a currency swap, the underlying principal is denominated in different currencies and would typically be exchanged not just at the end of the swap but at the start of the swap as well.
In efficient financial markets, risk-free arbitrage opportunities: A. will not exist. B. may persist in the long run. C. may exist temporarily.
C In efficient financial markets, risk-free arbitrage opportunities may exist temporarily, but their continuous exploitation will eliminate these arbitrage opportunities in the long run. A is incorrect. Financial markets being efficient does not mean that risk-free arbitrage opportunities cannot exist. B is incorrect. In efficient financial markets, any risk-free arbitrage opportunities will exist only temporarily because their continuous exploitation will result in these arbitrage opportunities being eliminated in the long run.
Which of the following characteristics of a target company is likely the least attractive for a leveraged buyout? A. Substantial amount of physical assets B. Strong and sustainable cash flow C. High leverage
C Low leverage is an attractive feature of a target company in a leveraged buyout. This characteristic makes it easier for an acquirer to use debt to finance a large portion of the purchase price. A is incorrect. A substantial amount of physical assets is a desirable feature of a target company in a leveraged buyout. B is incorrect. A strong and sustainable cash flow is a desirable feature of a target company in a leveraged buyout.
Which of the following bonds are most likely to be bearer bonds? A. Foreign bonds B. Domestic bonds C. Eurobonds
C Most Eurobonds are bearer bonds, meaning that the trustee does not keep records of who owns the bonds; only the clearing system knows who the bond owners are. A is incorrect because most domestic bonds are registered bonds. B is incorrect because most foreign bonds are registered bonds for which ownership is recorded by either name or serial number.
Which statement best describes the early exercise of non-dividend paying American options? Early exercise may be advantageous for: A. both deep-in-the-money calls and deep-in-the-money puts. B. deep-in-the-money calls. C. deep-in-the-money puts
C Only deep-in-the-money put options may be exercised early. The price cannot fall below zero, so the additional upside of such an option is limited. A is incorrect. Being deep in the money is no reason for an early exercise of call options because there are no theoretical limits to further price increases. B is incorrect. Being deep in the money is no reason for an early exercise of call options because there are no theoretical limits to further price increases.
The most likely impact of adding commodities to a portfolio of equities and bonds is to: A. increase risk. B. provide higher current income. C. reduce exposure to inflation.
C Over the long term, commodity prices are closely related to inflation, so including commodities in a portfolio of equities and bonds will reduce its exposure to inflation. A is incorrect because commodities have low correlations with traditional securities and therefore reduce overall risk. B is incorrect because commodity investments tend to produce no current income.
Management fees for a private equity fund are most likely based on the: A. fair value of assets under management. B. drawdown of committed capital plus any undistributed capital gains. C. total committed capital minus capital returned from investments that are exited.
C Private equity management fees are based on the full amount of committed capital, whether drawn down or not, minus capital that has been returned to investors from investments that have been exited. A is incorrect because it is hedge funds, not private equity funds, which base their management fees on the fair value of assets under management. B is incorrect because private equity funds charge management fees on all committed capital, not just drawdowns, and do not charge management fees on capital gains.
The Macaulay duration of a non-callable perpetual bond with a yield in perpetuity of 8% is closest to: A. 7.4. B. 8.0. C. 13.5.
C The Macaulay duration of a non-callable perpetual bond is: MacDur = (1 + r)/r = 1.08/0.08 = 13.5
If the yield to maturity on an annual-pay bond is 7.75%, the bond-equivalent yield is closest to: A. 8.05%. B. 7.90%. C. 7.61%.
C The bond-equivalent yield = 2 × (1.0775^0.5 - 1) = 0.07605 or 7.61%.
Which of the following statements concerning different valuation approaches is most accurate? A. One advantage of the three-stage dividend discount model (DDM) model is that it is equally appropriate to young companies entering the growth phase and those entering the maturity phase. B. It is advantageous to use asset-based valuation approaches rather than forward-looking cash flow models in the case of companies that have significant intangibles. C. The justified forward price-to-earnings ratio (P/E) approach offers the advantage of incorporating fundamentals and presenting intrinsic value estimations.
C The justified forward P/E approach offers the advantage of incorporating fundamentals and presenting intrinsic value estimations. A is incorrect. The three-stage DDM model is appropriate to young companies entering the growth phase but not those entering the maturity phase. For such companies, the two-stage DDM model is appropriate. B is incorrect. In the case of companies that carry significant intangibles, the use of forward looking cash flow models is more advantageous than the asset-based valuation models.
Compared with public equity markets, which of the following statements is most accurate about private equity markets? Operating in the private market: A. offers stronger incentives to improve corporate governance. B. allows more opportunities to raise capital. C. allows management to better adopt a long-term focus.
C The management of a public firm is under pressures to meet shorter-term demands, such as meeting quarterly sales and earnings projections from analysts. Private owners are thus better able to focus on longer-term value creation opportunities. A is incorrect. By operating under public scrutiny, companies are incentivized to be more open in terms of corporate governance and executive compensation to ensure that they are acting for the benefit of shareholders. B is incorrect because public equity markets are much larger than private ones.
A forward rate agreement most likely differs from most other forward contracts because: A. positions cannot be closed out prior to maturity. B. it involves an option component. C. its underlying is not an asset
C Forward rate agreements, unlike most other forward contracts, do not have an asset as an underlying. Instead, the underlying is an interest rate. A is incorrect. Forward rate agreements can also be closed out prior to maturity. B is incorrect. Forward rate agreements do not involve an option component.
Unlike commercial industry classification systems, industry classification systems developed by governments most likely: A. are updated more frequently. B. are more transparent. C. include private companies.
C Industry classification systems developed by governments do not distinguish between public and private companies, whereas commercial classification systems include only publicly traded organizations. A is incorrect. Commercial industry classification systems are updated more frequently than government classification systems. B is incorrect. Unlike commercial industry classification systems, most government classification systems do not disclose information about specific businesses.
Valuation of a swap during its life will least likely involve the: A. application of the principle of no arbitrage. B. use of replication. C. investor's risk aversion.
C Risk neutrality, not risk aversion, is a key element of derivatives pricing, including swaps. A is incorrect. The statement is true because the principle of no arbitrage is applied in pricing swaps. B is incorrect. The statement is true because replication is used in pricing swaps.
The market value of an 18-year zero-coupon bond with a maturity value of $1,000 discounted at a 12% annual interest rate with semi-annual compounding is closest to: A. $130.04. B. $192.86. C. $122.74.
C The value of a zero-coupon bond is Face value(1+r)N where r is the market discount rate per period, and N is the number of evenly spaced periods to maturity. The value of the zero-coupon bond is $1,000(1+0.12/2)18×2=$122.74
