unit 20 q
If an investor practices value investing, which of the following stock types is the investor least likely to purchase? A) A stock with an above-average price-to-earnings ratio B) A stock with a low price-to-earnings ratio C) A stock that has exhibited a high dividend yield in the past D) A stock that is presently selling for ⅔ of net tangible assets
*Note LEAST LIKELY TO PURCHASE B) A stock with a low price-to-earnings ratio A growth investor looks for stocks with above average price-to-earnings ratios. Conversely, a value investor focuses on stocks with low P/E ratios, a low price-to-book value, and historically high dividend yields. U20LO5
A securities analyst does not believe that markets are highly efficient. This analyst most likely follows which of the following investing strategies? A) Tactical B) Strategic C) Indexing D) Passive
A) Tactical Those who believe that stock markets are not efficient believe that they can "beat the market." That is the style followed by active or tactical managers. Those who believe in efficient markets would be passive or strategic investors such as those who buy index funds. U20LO10
All of the following are examples of non-diversifiable risks EXCEPT A) liquidity risk B) market risk C) purchasing power risk D) interest rate risk
A) liquidity risk Liquidity risk is a type of unsystematic, or diversifiable, risk. All of the other choices are systematic risk, which is considered to be non-diversifiable. U20LO2
According to the efficient market hypothesis, information found when reading the Wall Street Journal would be considered A) weak-form market efficiency B) strong-form market efficiency C) random walk D) semi-strong form market efficiency
A) weak-form market efficiency The closer to inside information, the stronger the information. Anything published in widely read media would be considered very weak. U20LO10
An investment adviser (IA) explaining modern portfolio theory (MPT) to a client might make all of the following statements EXCEPT A) if one security has a higher return than another, and, at the same time has a higher risk, choose it B) if one security has a higher return than another and, at the same time has a lower risk, choose it C) if two securities offer the same risk, choose the one with the higher return D) if two securities offer the same rate of return, choose the one with the lower
A. if one security has a higher return than another, and, at the same time has a higher risk, choose it *note the word EXCEPT in the question. Higher returns are only justified if they bear a relationship to the added risk. The goal of MPT is to maximize the return for any given amount of risk. U20LO8
Although there is no universal agreement on numbers, the minimum threshold for a stock to be considered large-cap is A) $25 billion B) $10 billion C) $10 million D) $100 billion
B) $10 billion At least for testing purposes, consider any company with a market cap of at least $10 billion to be large-cap. In recent years, the term mega-cap has come into use for those companies with a market cap of $100 billion or more. U20LO6
Which of the following are asset classes? A) Options B) REITs C) Large cap stock funds D) Forward contracts
B) REITs The general consensus is that the major classes, for purposes of an asset allocation program, are equity, debt, cash (or cash equivalents), real estate, and commodities. Large cap stock funds are not an asset class; they are a way to invest in the asset class known as equity. Derivatives, such as options, are not generally considered an asset class, and it is the actual commodity (precious metals, oil, and so forth), not a forward or futures contract, that is the asset class. Most agree that REITs are a proxy for real estate itself. U20LO1
One of the offshoots of the capital asset pricing model (CAPM) is the Capital Market Line (CML). The equation for the CML uses which of the following? A) Correlation coefficient B) Standard deviation C) Alpha D) Beta
B) Standard deviation The CML provides an expected return for a portfolio based on the expected return of the market, the risk-free rate of return, and the standard deviation of the portfolio in relation to the standard deviation of the market. The equation for the CML uses the: expected return of the portfolio; risk-free rate; return on the market; standard deviation of the market; and standard deviation of the portfolio. U20LO8
An investor is long 100 shares of XUZ common stock. If the investor wishes to generate some additional income while also creating a partial hedge, the recommended strategy would be to A) buy additional XUZ stock B) go short an XUZ call C) go long an XUZ call D) go short an XUZ put
B. Go short an xuz call The only way to generate income with options is to sell them (take a short position). Selling the call brings in a premium which creates a partial hedge. U20LO12
As a technique in portfolio management, portfolio diversification reduces A) systematic risk B) unsystematic risk C) returns D) interest rate risk
B. Unsystematic risk, such as business risk, can be almost eliminated with a well-diversified portfolio. Systematic risks, such as interest rate risk, are not helped by diversification. For example, no matter how many bonds you hold in your portfolio, if interest rates go up, they'll all drop in price. On the other hand, holding many bonds limits the overall loss should 1 or 2 issuers default. U20LO2
Your client owns 500 shares of RMBN purchased at $11.94 per share. The stock is now selling for $12.70 per share and the client is concerned that the market may turn downward. You could suggest protecting the profit by A) selling 5 RMBN 12.50 puts B) buying 5 RMBN 12.50 puts C) buying 5 RMBN 12.50 calls D) buy 1 RMBN 12.50 put
B. buying 5 RMBN 12.50 puts The best way to hedge (protect) a profit on a long position is the purchase of puts with a contract value equal to the number of shares held. Because the client owns 500 shares, that would mean buying 5 puts. If the stock should fall, the investor knows that $12.50 per share can be realized by exercising the put. If the stock continues to rise, then the investor can allow the puts to expire and continue to participate in the growth. U20LO12
Your client's child is entering college next year. Which of the following would be the most appropriate recommendation? A) A U.S. Treasury note mutual fund B) A large-cap growth fund C) A 5-year laddered portfolio of U.S. Treasury notes D) A zero-coupon bond maturing in 5 years
C) A 5-year laddered portfolio of U.S. Treasury notes Most would agree that with a regularly scheduled commitment for tuition and other expenses associated with a college education, there is a need for not only income, but also (and perhaps more importantly) assurance that when the bills are due, the principal will not have fluctuated. That would be best accomplished through a laddered portfolio where each year there are T-notes maturing. U20LO7
An investment adviser is doing some research on a company and notices that the current market price is $21 per share. The most recently reported EPS is $3 and the company is paying a $.19 quarterly dividend. On the balance sheet, the company is carrying a significant amount of cash. This company would probably be attractive to this adviser if his investment style was A) growth B) passive C) value D) contrarian
C. Value This is an example of the kind of company appealing to those who follow a value style of portfolio management. The company is selling at a low P/E ratio of 7 to 1 ($21/$3) with a liberal dividend yield of 3.62% (.76/$21). The high cash balance only adds to the value. U20LO5
One of your retired clients aims to maintain a 70%/30% relationship between bonds and equities in her portfolio. At the beginning of the year, the mix was $1.4 million in bonds and $600,000 in equity. At the end of the year, her bonds were worth $1.54 million. Rebalancing the portfolio would NOT be required if the equities were worth A) $513,333 B) $666,000 C) $462,000 D) $660,000
D) $660,000 If the bonds are now worth $1.54 million and the desired percentage is 70%, dividing that value by 70% results in a portfolio value of $2.2 million. That would mean that the 30% in equity would have to be the other $660,000. At the test center, you would plug in $1.54 million; divide by 70% to get the total of $2.2 million. When you subtract the bonds of $1.54 million the remainder is the equity of $660,000. U20LO4
An optimal portfolio is one which A) works well in bull markets, but suffers when there is a market reversal B) is diversified in such manner as to nearly eliminate systematic risk C) offers the greatest reward for the highest risk D) lies on the efficient frontier
D) lies on the efficient frontier In portfolio design, the collection of efficient portfolios is called the efficient set or the efficient frontier. This efficient frontier is plotted as a curve. The objective is for the portfolio to lie on the curve. Then, by being on the efficient frontier, the optimal portfolio has been created; one in which there is the highest return for the least risk. U20LO8
Which of the following describes an investment management style? A) Rebalancing B) Margin C) Large capitalization D) Current income
D. Large capitalization style distinguishes between investing in a small cap company versus a large capitalization company. Current income is an investment objective and not an investment management style. Rebalancing is used to bring asset allocations back to their desired weightings. Margin can be used in a number of investment management styles. U20LO5
An individual who is a proponent of the efficient market hypothesis (EMH) will likely invest in which of the following? A) Balanced mutual fund B) Sector mutual funds C) Growth mutual funds D) Index funds
D. Index funds An individual who believes in the EMH will likely invest in index funds. Inherent in this strategy is a belief that an investor cannot outperform the market with active portfolio management techniques. The remaining choices all incorporate an active portfolio management philosophy. U20LO10
Sector rotation would most likely be employed by an investment adviser using which of the following investment styles? A) Contrarian B) Buy and hold C) Strategic D) Tactical
D. Tactical Sector rotation is the practice of moving portfolio assets from those industries that have reached their peak in the current economic cycle to those that are now on the upswing. Buy and hold, as the name implies, does not involve constant trading and strategic is a passive technique as well. Contrarian investors go opposite the trend which is not the case here. U20LO3
If the expected return on the market is 20% and the risk-free rate is 4%, a stock with a beta coefficient of 0.8 would have an expected rate of return under CAPM of A) 16.0% B) 19.2% C) 12.8% D) 16.8%
The formula is the risk-free rate (.04) plus the product of the stock's beta (.8) and the difference between the expected return on the market and the risk-free rate(.20 - .04). In this case, it would be .04 + .8(.16) or .04 +.128 = .168 U20LO9
An investor does not wish to attempt to time the market, so she invests $300 each month into the GEMCO Growth Fund. Over the past 5 months, her purchase prices have been $10, $12, $15, $20, and $25. On the basis of this information, if she were to stop investing at this point and sell her shares 2 months from now when the NAV is $15 per share and the public offering price is $15.79, it would be CORRECT to state that her A) realized loss would be $1.40 per share B) cost basis for tax purposes was $14.71 C) proceeds were $15.79 per share D) average cost per share was $16.40
This client is taking advantage of dollar cost averaging. Each month, the $300 investment acquires a different number of shares. Take a look at the math below: Month 1: $300 @ $10 per share = 30 shares Month 2: $300 @ $12 per share = 25 shares Month 3: $300 @ $15 per share = 20 shares Month 4: $300 @ $20 per share = 15 shares Month 5: $300 @ $25 per share = 12 shares Total cost is $1,500. Total number of shares is 102. She spent $1,500 and bought a total of 102 shares. Dividing her cost ($1,500) by the number of shares (102) results in a cost per share of $14.71 and that is her cost basis for tax purposes. When redeeming, she would receive the NAV of $15 per share, not the POP. There is no loss here because the proceeds of $15 per share exceed the cost of $14.71. U20LO11
