Fin 411 final test multiple choice

38. Assume you bought an 8% coupon bearing bond with 4 years to maturity at par and then sold it at a premium before maturity. If you were able to reinvest the coupons at the YTM, then: a. HPR = YTM b. HPR is less than YTM c. HPR is greater than YTM d. You cannot tell

c. HPR is greater than YTM

Suppose the CAPM holds which is not true regarding the market portfolio. -It includes all the risky assets in the economy -It lies on the efficient frontier -All securities in the market portfolio are held in proportion to their market values - it is the tendency point between the capital market line and the indifference curve

- it is the tendency point between the capital market line and the indifference curve

21. The duration of a bond normally increases with an increase in _________. I. term-to-maturity II. yield-to-maturity. III. coupon rate A. I only B. I and II only C. II and III only D. I, II and III

A. I only

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

A. always be higher than

21. Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________. A. an abnormal price change immediately following the announcement B. an abnormal price increase before the announcement C. an abnormal price decrease after the announcement D. no abnormal price change before or after the announcement

A. an abnormal price change immediately following the announcement

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

A. expected returns to fall; risk premiums to fall

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

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

19. Small firms have tended to earn abnormal returns primarily in __________. A. the month of January B. the month July C. the trough of the business cycle D. the peak of the business cycle

A. the month of January

12. ABC Internet stock has a volatility of 90% and a beta of 3. The market portfolio has an expected return of 14% and a volatility of 15%. The risk-free rate is 7%. What is the equilibrium expected return on ABC stock? What is the proportion of ABC Internet's variance which is diversified away in the market portfolio?

Answer: Solve for expected return from the CAPM. The proportion diversified away = (beta^2 * market vol^2) / (total vol^2) [(90%)^2-(3)^2(15)^2]/90%^2=75%

9. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________. A. 23.00% B. 19.76% C. 18.45% D. 17.67%

B. 19.76%

Because of convexity, when interest rates change, the actual bond price will always be higher than the bond price predicted by duration 14. The duration of a 5-year zero coupon bond is ____ years. A. 4.5 B. 5.0 C. 5.5 D. 3.5

B. 5.0

18. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should _________. A. buy stock X because it is overpriced B. buy stock X because it is underpriced C. sell short stock X because it is overpriced D. sell short stock X because it is underpriced

B. buy stock X because it is underpriced

23. A firm cuts its dividend payout ratio. As a result you know that the firm's _______. A. return on assets will increase B. earnings retention ratio will increase C. earnings growth rate will fall D. stock price will fall

B. earnings retention ratio will increase

13. Suppose short sales are not allowed. Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________. A. 1 B. less than 1 C. between 0 and 1 D. less than or equal to 0

B. less than 1

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

B. lower when the coupon rate is higher

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

B. lower when the yield to maturity is higher

11. Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum variance portfolio is _________. w A. 10% B. 20% C. 40% D. 60%

C. 40% 30w-(1-w)20=0 30w-20+20w=0 50w=20=40%

15. Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate? A. 2% B. 6% C. 8% D. 12%

C. 8% Risk free rate = expected return -beta ( return on market - risk free rate) 20-1.2(18-risk free rate) 1risk free =20-21.6+1.2risk free -0.2=-1.6rf

22. Which of the following contradicts the proposition that the stock market is weakly efficient? A. Over 25% of mutual funds outperform the market on average. B. Insiders earn abnormal trading profits. C. Every January, the stock market earns above normal returns. D. Applications of technical trading rules fail to earn abnormal returns.

C. Every January, the stock market earns above normal returns.

23. Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis? A. The average rate of return is significantly greater than zero. B. The correlation between the market return one week and the return the following week is zero. C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall. D. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.

C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

8. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be ________________. A. more than 18% but less than 24% B. equal to 18% C. more than 12% but less than 18% D. equal to 12%

C. more than 12% but less than 18%

7. An investor's degree of risk aversion will determine his or her ______. A. tangency portfolio B. risk-free rate C. optimal mix of the risk-free asset and tangency portfolio D. capital allocation line

C. optimal mix of the risk-free asset and tangency portfolio

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

C. positive alpha is considered underpriced

16. An increase in a bond's yield to maturity results in a price decline that is ________ the price increase resulting from a decrease in yield of equal magnitude. A. greater than B. equivalent to C. smaller than D. The answer is indeterminate

C. smaller than

10. Suppose short sales are not allowed. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A. 1.0 B. 0.5 C. 0 D. -1.0

D. -1.0

14. Suppose short sales are not allowed. Which of the following correlations coefficients will produce the least diversification benefit? A. -0.6 B. -0.3 C. 0.0 D. 0.8

D. 0.8 Risk free rate = expected return -beta ( return on market - risk free rate) 20-1.2(18-risk free rate) 1risk free =20-21.6+1.2risk free -0.2=-1.6rf

22. A zero coupon bond is selling at a deep discount price of $430.00. It matures in 13 years. If the yield to maturity of the bond is 6.7%, what is the duration of the bond? A. 6.7 years B. 8.0 years C. 10 years D. 13 years

D. 13 years

20. Important characteristic(s) of market efficiency is that _________________. I. there are no arbitrage opportunities II. security prices react quickly to new information III. active trading strategies will not consistently outperform passive strategies A. I only B. II only C. I and III only D. I, II and III

D. I, II and III

24. The semi-strong form of the efficient market hypothesis implies that ____________ generate abnormal returns and ____________ generate abnormal returns. A. Technical analysis cannot; fundamental analysis can B. Technical analysis can; fundamental analysis can C. Technical analysis can; fundamental analysis cannot D. Technical analysis cannot; fundamental analysis cannot

D. Technical analysis cannot; fundamental analysis cannot

6. You have $500,000 available to invest. The risk-free rate as well as your borrowing rate is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________. A. invest $125,000 in the risk-free asset B. invest $375,000 in the risk-free asset C. borrow $125,000 D. borrow $375,000

D. borrow $375,000

15. Given its time to maturity the duration of a zero coupon bond is _________. A. higher when the discount rate is higher B. higher when the discount rate is lower C. lowest when the discount rate is equal to the risk free rate D. the same regardless of the discount rate

D. the same regardless of the discount rate

10. On the Yahoo Finance website you collect the following data on Intel, Inc.. Intel is currently trading at $26.52 per share. Its earnings per share are $0.97 and its dividends per share are $0.16. Intel's beta is 2.04. The risk-free rate is 1.2% and the expected market return is 9.5%.

The market expect dividends and earnings to grow at an annual rate of 17.42%

11. You are the CFO of a savings & loans institution (a traditional bank). The duration of your deposits is 3.5 years. Your task is to decide on an optimal portfolio of short term and long term loans that will immunize your interest rate risk. More precisely, what fraction of your loan portfolio will be 30-year mortgages and what fraction should be 1-year trade credit? Assume that there are no payments due on either type of loan until they come due.

You should allocate 91.4% of your credit to short term trade loans and 8.6% to long term mortgages

The expected return on the market portfolio is 10%, the standard deviation of the marketreturn is 20%, and the risk-free rate is 4%. Assuming the CAPM holds, what is the standard deviation of an efficient portfolio with a beta of 0.6? a. 12 b 7.6 c 6.0 d 8.6

a. 12

6. Which of the following bonds will have the largest price change if the interest rate changes by 1 ba''is point? a. A 10 year annual pay coupon bond with coupon rate 5% and YTM = 8% b. A 10 year annual pay coupon bond with coupon rate 6% and YTM = 8% c. A 10 year annual pay coupon bond with coupon rate 5% and YTM = 9% d. An 8 year annual pay coupon bond with coupon rate 5% and YTM = 8% 4

a. A 10 year annual pay coupon bond with coupon rate 5% and YTM = 8%

3.Suppose you are picking stocks based on the CAPM benchmark. Under the scenario in Question 2, what is your trading strategy and why? a.Buy the stock, because alpha is positive. b.Buy the stock, because alpha is negative. c.Sell the stock, because alpha is positive. d.Buy the stock, because alpha is negative

a.Buy the stock, because alpha is positive.

Which of the following phenomena would be consistent with the efficient market hypothesis? a.Good News, Inc., just announced an increase in its annual earnings, yet its stock price fell b.Money managers that outperform the market in one year are likely to outperform in the following year c.Stocks that perform well in one week perform poorly in the following week D. Stock prices of companies that announce increased earnings in January tend to outperform the market in February

a.Good News, Inc., just announced an increase in its annual earnings, yet its stock price fell

If a stock is underpriced relative to its value under the CAPM, where does it plot relative to the Security Market Line (SML)? a.It lies above the SML. b.It lies on the SML. c.It lies below the SML. d.Can't tell from the information give

a.It lies above the SML.

if a stock is underpriced relative to its value under the CAPM, where does it plot relative to the Security Market Line (SML)? a.It lies above the SML. b.It lies on the SML. c.It lies below the SML. d.Can't tell from the information given.

a.It lies above the SML.

2. Consider the expectations theory of the term structure of interest rates. If the yield curve is downward sloping, this indicates that investors expect short-term interest rates to __________ in the future. a. increase b. decrease c. not change d. change in an unpredictable manner

b. decrease

5.A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills (risk-free asset) were paying 4.5%. This portfolio had a Sharpe measure of ____. a. 0.22 b. 0.6 c. 0.42 d. 0.25 Sharpe ratio is= average return - risk free / standard deviation

c. 0.42

44. ConEdison's earnings in the current fiscal year are $2 per share, its dividends are $1 per share, and its beta is 0.60. Earnings and dividends are expected to grow at 4% per year forever. The risk- 10 free rate is 3% and the expected market return is 8%. What stock price (price per share) is implied by the Gordon growth model? a. -104 b. 26 c. 52 d. 104

c. 52

5. What is the rate of interest on a 1 year loan starting 3 years from now, implied by the following term structure: (i) A 1-year zero coupon bond has a yield to maturity of 1%, ( ii) A 2-year zero coupon bond has a yield to maturity of 2%, (iii) A 3 year zero coupon bond has a yield to maturity of 3% , (iv) A 4-year zero coupon bond has a yield to maturity of 4% a. 1% b. 5% c. 7% d. 16%

c. 7%

42. If a company's growth rate is high then, all else the same, which of the following must be true: a. the P/E ratio of its stock will be higher b. the stock's beta will be higher c. the price-dividend ratio of the stock will be higher d. both a and c

d. both a and c

1. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pay coupons of $120 annually. Bond A will mature in 5 years while bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, _________. a. both bonds will increase in value but bond B b. both bonds will increase in value but bond B will increase more than bond A c. both bonds will decrease in value but bond A will decrease more than bond B d. both bonds will decrease in value but bond B will decrease more than bond A Decrease is the two bonds change from 12 to 14 percent

d. both bonds will decrease in value but bond B will decrease more than bond A Decrease is the two bonds change from 12 to 14 percent

the correlations between the two assets are positive. what are the correlations between the two portfolios that have the following weights in these assets with the residuals if any invested in the risk free rate assets ? expected return 10, 12 standard deviation 40,50 portfolio 1 = 50%, 30% portfolio 1= -25%, -15% p1,2=0 0<p12<1 p1,2=1 p1,2=-1

p12= -1