FINANCE PORTFOLIO MANAGEMENT EXAM 1

Annual percentage rates can be converted to effective annual rates by means of the following formula: A. [1 + (APR/n)]^n − 1 B. APR × n C. APR/n D. (periodic rate) × (n)

A.[1 + (APR/n)]^n − 1 The effective annual rate incorporates the effects of compounding

Rank the following from highest average historical return to lowest average historical return from 1926 to 2019. 1. Small stocks 2. Long-term bonds 3. Large stocks 4. T-bills A. 1, 2, 3, 4 B. 3, 4, 2, 1 C. 1, 3, 2, 4 D. 3, 1, 2, 4

C. 1, 3, 2, 4

Risk that can be eliminated through diversification is called __________ risk. A. unique B. firm-specific C. diversifiable D. All of these options are correct.

D. All of these options are correct. Explanation Unique risk ≡ firm-specific risk ≡ diversifiable risk ≡ idiosyncratic risk Systematic risk ≡ non-diversifiable risk ≡ market risk

Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are __________ sensitive to changes in the market than are the returns of stock B. A. 20% more B. 120% more C. 20% less D. 83% less

A. 20% more

Which one of the following measures time-weighted returns and allows for compounding? A. Geometric average return B. Arithmetic average return C. Dollar-weighted return D. Historical average return

A. Geometric average return

The formula E(rP) − rf/ σP i i is used to calculate the __________. A. Sharpe ratio B. Treynor measure C. coefficient of variation D. real rate of return

A. Sharpe ratio

Asset A has an expected return of 15% and a reward-to-variability ratio of 0.4. Asset B has an expected return of 20% and a reward-to-variability ratio of 0.3. A risk-averse investor would prefer a portfolio using the risk-free asset and __________. A. asset A B. asset B C. no risky asset D. The answer cannot be determined from the data given.

A. asset A Explanation The reward-to-risk ratio is the important ranking metric. The highest reward-to-risk ratio is preferred.

In the mean standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called the __________. A. capital allocation line B. indifference curve C. investor's utility line D. security market line

A. capital allocation line

A security's beta coefficient will be negative if __________. A. its returns are negatively correlated with market-index returns B. its returns are positively correlated with market-index returns C. Its stock price has historically been very stable D. market demand for the firm's shares is very low

A. its returns are negatively correlated with market-index returns

On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie __________ the current investment opportunity set. A. left and above B. left and below C. right and above D. right and below

A. left and above

The efficient frontier represents a set of portfolios that: A. maximize expected return for a given level of risk. B. minimize expected return for a given level of risk. C. maximize risk for a given level of return. D. None of the options are correct.

A. maximize expected return for a given level of risk.

The normal distribution is completely described by its __________. A. mean and standard deviation B. mean C. mode and standard deviation D. median and variance

A. mean and standard deviation

If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the __________. A. stock's standard deviation B. variance of the market C. stock's beta D. stock's beta

A. stock's standard deviation

Historically, the best asset for the long-term investor wanting to fend off the threats of inflation and taxes while making his money grow has been __________. A. stocks B. bonds C. money market funds D. Treasury bills

A. stocks

The market risk premium is best approximated by __________. A. the difference between the return on an index fund and the return on Treasury bills B. the difference between the return on a small-firm mutual fund and the return on the Standard & Poor's 500 Index C. the difference between the return on the risky asset with the lowest returns and the return on Treasury bills D. the difference between the return on the highest-yielding asset and the return on the lowest-yielding asset

A. the difference between the return on an index fund and the return on Treasury bills

The risk that can be diversified away is __________. A. beta B. firm-specific risk C. market risk D. systematic risk

B. firm-specific risk Explanation Unique risk ≡ firm-specific risk ≡ diversifiable risk ≡ idiosyncratic risk Systematic risk ≡ non-diversifiable risk ≡ market risk

If you believe you have a 60% chance of doubling your money, a 30% chance of gaining 15%, and a 10% chance of losing your entire investment, what is your expected return? A. 5.00% B. 15.00% C. 54.50% D. 114.50%

C. 54.50% (0.60 x 100%) + (0.30 x 15%) + (0.10 x − 100%) = 0.545 = 54.50%

Which of the following arguments supporting passive investment strategies is (are) correct? 1. Active trading strategies may not guarantee higher returns but guarantee higher costs. 2. Passive investors can free-ride on the activity of knowledge investors whose trades force prices to reflect currently available information. 3. Passive investors are guaranteed to earn higher rates of return than active investors over sufficiently long time horizons. A. 1 only B. 1 and 2 only C. 2 and 3 only D. 1, 2, and 3

B. 1 and 2 only

You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual overall average historical performance of the investments you have chosen? Which method provides the best measure of your individual portfolio performance? A. Dollar-weighted return; geometric average return B. Geometric average return; dollar-weighted return C. Arithmetic average return; dollar-weighted return D. Arithmetic average return; geometric average return

B. Geometric average return; dollar-weighted return

The __________ measure of returns ignores compounding. A. geometric average B. arithmetic average C. IRR D. dollar-weighted

B. arithmetic average Arithmetic average is just the sum of returns in each period divided by the number of periods.

The _________ is the covariance divided by the product of the standard deviations of the returns on each fund. A. covariance B. correlation coefficient C. standard deviation D. reward-to-variability ratio

B. correlation coefficient

The excess return is the __________. A. rate of return that can be earned with certainty B. rate of return in excess of the Treasury-bill rate C. rate of return in excess of a predicted model like CAPM D. index return

B. rate of return in excess of the Treasury-bill rate

Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor __________. A. is normally risk neutral B. requires a risk premium to take on the risk C. knows he or she will not lose money D. knows the outcomes at the beginning of the holding period

B. requires a risk premium to take on the risk

The plot of a security's excess return relative to the market's excess return is called the __________. A. efficient frontier B. security characteristic line C. capital allocation line D. capital market line

B. security characteristic line

A measure of the riskiness of an asset held in isolation is __________. A. beta B. standard deviation C. covariance D. alpha

B. standard deviation

Market risk is also called __________ and __________. A. systematic risk; diversifiable risk B. systematic risk; nondiversifiable risk C. unique risk; nondiversifiable risk D. unique risk; diversifiable risk

B. systematic risk; nondiversifiable risk Explanation Unique risk ≡ firm-specific risk ≡ diversifiable risk ≡ idiosyncratic risk Systematic risk ≡ non-diversifiable risk ≡ market risk

The term excess return refers to __________. A. returns earned illegally by means of insider trading B. the difference between the rate of return earned and the risk-free rate C. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk D. the portion of the return on a security that represents tax liability and therefore cannot be reinvested

B. the difference between the rate of return earned and the risk-free rate

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that __________. A. the returns on the stock and bond portfolios tend to move inversely B. the returns on the stock and bond portfolios tend to vary independently of each other C. the returns on the stock and bond portfolios tend to move together D. the covariance of the stock and bond portfolios will be positive

B. the returns on the stock and bond portfolios tend to vary independently of each other

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier __________ and to the __________. A. up; right B. up; left C. down; right D. down; left

B. up; leftThe vertical axis, expected return, is a "good," so higher is better. The horizontal axis, portfolio standard deviation, is a "bad," so further left is better. Thus, as additional securities are added to the portfolio the benefits of diversification shift the efficient frontier up and to the left.

Rank the following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2017. 1. Small stocks 2. Long-term bonds 3. Large stocks 4. T-bills A. 1, 2, 3, 4 B. 3, 4, 2, 1 C. 1, 3, 2, 4 D. 3, 1, 2, 4

C. 1, 3, 2, 4

One method of forecasting the risk premium is to use the __________. A. coefficient of variation of analysts' earnings forecasts B. variations in the risk-free rate over time C. average historical excess returns for the asset under consideration D. average abnormal return on the index portfolio

C. average historical excess returns for the asset under consideration

If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the __________. A. geometric average return B. arithmetic average return C. dollar-weighted return D. index return

C. dollar-weighted return The dollar-weighted return is the internal rate of return of the investment and thus includes the timing and magnitude of purchases and redemptions.

Beta is a measure of security responsiveness to __________. A. firm-specific risk B. diversifiable risk C. market risk D. unique risk

C. market risk

An investor's degree of risk aversion will determine their __________. A. optimal risky portfolio B. risk-free rate C. optimal mix of the risk-free asset and risky asset D. capital allocation line

C. optimal mix of the risk-free asset and risky asset

The complete portfolio refers to the investment in __________. A. the risk-free asset B. the risky portfolio C. the risk-free asset and the risky portfolio combined D. the risky portfolio and the index

C. the risk-free asset and the risky portfolio combined

The expected rate of return of a portfolio of risky securities is __________. A. the sum of the individual securities' covariance B. the sum of the individual securities' variance C. the weighted sum of the individual securities' expected returns D. the weighted sum of the individual securities' variance

C. the weighted sum of the individual securities' expected returns

Another name for the dollar-weighted return is the __________. A. difference between cash inflows and cash outflows B. arithmetic average return C. geometric average return D. Internal rate of return

D. Internal rate of return

Which one of the following would be considered a risk-free asset in real terms as opposed to nominal? A. Money market fund B. U.S. T-bill C. Short-term corporate bonds D. U.S. T-bill whose return was indexed to inflation

D. U.S. T-bill whose return was indexed to inflation

The correlation coefficient between two assets equals __________. A. their covariance divided by the product of their variances B. the product of their variances divided by their covariance C. the sum of their expected returns divided by their covariance D. their covariance divided by the product of their standard deviations

D. their covariance divided by the product of their standard deviations

Firm-specific risk is also called __________ and __________. A. systematic risk; diversifiable risk B. systematic risk; nondiversifiable risk C. unique risk; nondiversifiable risk D. unique risk; diversifiable risk

D. unique risk; diversifiable risk Explanation Unique risk ≡ firm-specific risk ≡ diversifiable risk ≡ idiosyncratic risk Systematic risk ≡ non-diversifiable risk ≡ market risk