Problem Set 1

___ is not a derivative security.

a share of common stock

An investor in a 28% tax bracket is trying to decide whether to invest in a municipal bond or a corporate bond. She looks up municipal bond yields (rm) but wishes to calculate the taxable equivalent yield r. The formula she should use is given by ______.

r = rm /(1 - 28%)

According to the capital asset pricing model, a security with a _________.

positive alpha is considered underpriced

Uninformed traders tend to __________liquidity, while informed traders tend to _____________ liquidity.

provide; consume

A __________ gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date.

put option

When the market is more optimistic about a firm, its share price will ______; as a result, it will need to issue _______ shares to raise funds that are needed.

rise; fewer

One reason that a firm wishes to split it stock is to keep the price of the stock lower to attract more

small investors

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.

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

The term complete portfolio refers to a portfolio consisting of _________________.

the risk-free asset combined with at least one risky asset

In a ___________ index, changes in the value of the stock with the greatest market value will move the index value the most, everything else equal.

value-weighted index

According to the capital asset pricing model, fairly priced securities have _________.

zero betas

The market portfolio has a beta of _________.

1

According to SEC Rule 415 regarding shelf registration, firms can gradually sell securities to the public for __________ following initial registration.

2 years

The stock market typically takes which form?

Auction

The primary market is an example of which type of market?

Brokered Market

Real assets in the economy include all but which one of the following?

Common Stock

Which of the following is not a money market security?

Common Stock

The bond market typically takes which form?

Dealer market

Which of the following are financial assets?

Debt, Equity and Derivative Securities

Which one of the following statements about IPOs is not true?

IPOs generally provide superior long-term performance as compared to other stocks

Which one of the following is a true statement regarding the Dow Jones Industrial Average?

It is a price-weighted average of 30 large industrial stocks.

Which of the following statements are true about the 2010 Flash Crash?

The event is due to the liquidity loss on the buyers' side and the use of a market sell order

The optimal risky portfolio can be identified by finding:

The tangency point of the capital market line and the efficient frontier; The line with the steepest slope that connects the risk-free rate to the efficient frontier

What are the potential risks if the money left on the table is too little?

There will be little profit for the primary market investors and the risk of an IPO failure

_____ is a mechanism for mitigating potential agency problems.

Tying income of managers to success of the firm

Which of the statistics cannot be negative?

Variance

You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ___________ and the line of best fit has a ______________.

all fall on the line of best fit; positive slope

According to the capital asset pricing model, a fairly priced security will plot _________.

along the security market line

Building a zero-investment portfolio will always involve _____________.

equal investments in a short and long position

Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________.

equal to 0

A dollar-denominated deposit at a London bank is called _____.

eurodollars

If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________.

expected returns to fall; risk premiums to fall

The risk that can be diversified away is __________.

firm-specific risk

According to multiple studies by Ritter, initial public offerings tend to exhibit __________ performance initially and __________ performance over the long term.

good; bad

According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________.

identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion

Purchases of new issues of stock take place _________.

in the primary market

Decreasing the number of stocks in a portfolio from 50 to 10 would likely

increase the unsystematic risk of the portfolio

Firms that specialize in helping companies raise capital by selling securities to the public are called _________.

investment banks

Uninformed traders tend to use more __________orders, while informed traders tend to use more _____________ orders.

limit; market

Diversification is most effective when security returns are _________.

negatively correlated

An investor's degree of risk aversion will determine his or her ______.

optimal mix of the risk-free asset and risky asset

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _________.

overpriced

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 ________.

stock's standard deviation

If an investor places a _________ order, the stock will be sold if its price falls to the stipulated level. If an investor places a __________ order, the stock will be bought if its price rises above the stipulated level.

stop-loss; stop buy

According to CAPM, investors require a risk premium as compensation for bearing ______________.

systematic risk

An important characteristic of market equilibrium is _______________.

the absence of arbitrage opportunities

The expected rate of return of a portfolio of risky securities is _________.

the weighted sum of the securities' expected returns

The correlation coefficient between two assets equals _________.

their covariance divided by the product of their standard deviations

Standard deviation of portfolio returns is a measure of ___________.

total risk

Initial public offerings (IPOs) are usually ___________ relative to the levels at which their prices stabilize after they begin trading in the secondary market.

underpriced

The Green Shoe mechanism refers to

underwriters have the right to sell investors more shares than originally planned by the issuer.

Risk that can be eliminated through diversification is called ______ risk.

unique, firm-specific, and diversifiable

In a well-diversified portfolio, __________ risk is negligible.

unsystematic

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______.

up; left

Money market securities are characterized by:

Maturity less than 1 year, Safety of the principal investment, and low rates of return

__________ portfolio management calls for holding diversified portfolios without spending effort or resources attempting to improve investment performance through security analysis.

Passive

The graph of the relationship between expected return and beta in the CAPM context is called the _________.

SML

which one of the following indices is equally weighted?

Wilshire 5000

Arbitrage is based on the idea that _________.

assets with identical risks must have the same expected rate of return

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

beta

The process of polling potential investors regarding their interest in a forthcoming initial public offering (IPO) is called ________.

book building

An adjusted beta will be ______ than the unadjusted beta.

closer to 1

An individual who goes short in a futures position _____.

commits to delivering the underlying commodity at contract maturity

The _________ reward-to-variability ratio is found on the ________ capital market line.

highest; steepest

In the book building mechanism, the underwriters have the right to determine the distribution of the shares. They prefer___________.

long run investors, so that there are less selling pressure and the stock price will remain stable

An order to buy or sell a security at the current price is a ______________.

market order

Beta is a measure of security responsiveness to _________.

market risk

A measure of the riskiness of an asset held in isolation is ____________.

standard deviation

The beta of a security is equal to _________.

the covariance between the security and market returns divided by the variance of the market's returns