CFP 513: Investment Planning Practice Exam

A call option with an exercise price of $105 is selling in the open market for $4.25 when the market price of the underlying stock is $102. What is the intrinsic value of this option?

The answer is $0. This call option is out-of-the-money; thus, its intrinsic value is zero.

Kelly's bond portfolio has a duration of 5.8 years and is currently valued at $20,000. If interest rates drop by 0.5%, what is the approximate value of her portfolio?

The answer is $20,532. Because interest rates have dropped, Kelly's portfolio will increase in value. No calculation is required.

Last year, Patrice began investing in the Apex Fund. She is investing $500 every quarter and wants to know what her average cost per share (basis) has been. These are the prices of the Apex Fund at the end of each quarter when she made her purchases: $35.50, $38.90, $65.70, $72.50, and $89.00. What is her average cost per share?

The answer is $53.12. Calculated as follows: $ AmountShare Price# of Shares Purchased $500 ÷$35.50 =14.0845 $500 ÷$38.90 =12.8535 $500 ÷$65.70 =7.6104 $500 ÷$72.50 =6.8966 $500 ÷$89.00 =5.6180 TOTAL 47.063 shares $2,500 ÷ 47.063 shares = $53.12

Sam owns a Stellar Infrastructure mutual fund. Last year, Stellar Infrastructure had a return of 12%, the S&P 500 had a return of 11%, and six-month Treasury bills averaged a return of 3%. The standard deviation of the Stellar Infrastructure fund is 9, and the S&P 500 Index had a standard deviation of 12. The beta of Stellar was 1.10. Which of the following is the Sharpe ratio for the Stellar Infrastructure mutual fund?

The answer is 1.00. The Sharpe ratio is calculated as follows: (.12% - .03%) ÷ .09 = 1.00

Juan has an investment portfolio consisting of 30% MIJ stock with a beta of 1.76, 40% ABC stock with a beta of 0.98, and 30% LFM stock with a beta of 2.09. What is the weighted beta for Juan's portfolio?

The answer is 1.547. The portfolio's weighted beta is calculated as follows: (0.30 × 1.76) + (0.40 × 0.98) + (0.30 × 2.09) = (0.528 + 0.392 + 0.627) = 1.547 With a beta higher than 1.0, the portfolio is much more volatile than the overall market.

Which of the following is Allison's expected rate of return on MIJ stock, assuming that the risk-free rate of return is 4.5%, the forecasted rate of return of the market portfolio is 11%, and the stock's beta is 1.15?

The answer is 11.98%. Allison's expected rate of return is 11.98% [4.5% + (11% - 4.5%)1.15]. LO 8.2.1

Assume an investor has purchased a bond with these characteristics: Seven years to maturity $1,000 face value 6% annual coupon (paid semiannually) 8.43% current yield $711.74 current market price Which of the following is the bond's yield to maturity?

The answer is 12.25%. The bond's yield to maturity is calculated using the following inputs: PV = -$711.74 FV = $1,000 PMT = 6% × 1,000 ÷ 2 = $30 N = 14 (7 x 2 periods per year) I/YR = 12.2508, or 12.25% LO 7.4.1

Based on the following information, which of the following is the expected rate of return for Softco Corporation? Stock's beta 0.80 Forecasted market rate of return 15% Risk-free rate of return 6.5%

The answer is 13.30%. Using the capital asset pricing model, the expected rate of return is 13.30% [6.5% + (15% - 6.5%)0.80].

Rex, Ltd., has assets of $400 million and liabilities of $200 million. Last year, the company earned $45 million and paid out $15 million in dividends. Using the formula g = return on equity × retention rate, what is the growth rate for Rex, Ltd.?

The answer is 15.0%. $400,000,000 - $200,000,000 = $200,000,000 of equity; $45,000,000 earnings ÷ $200,000,000 equity = 0.225, or 22.50% ROE $45,000,000 earnings - $15,000,000 paid out in dividends = $30,000,000 of retained earnings; $30,000,000 ÷ $45,000,000 = 0.6667 retention rate g = ROE × RR g = 0.2250 × 0.6667 = 0.15, or 15% LO 4.2.2

What is the duration of a zero-coupon bond maturing in 17 years, yielding 3.50%, and trading for $356.98 in the secondary market?

The answer is 17 years. A zero-coupon bond's duration is equal to its term to maturity. LO 4.1.2

Charlie owns a bond with a 5.25% annual coupon rate. Over the past year, the inflation rate was 2.4%. What is Charlie's real rate of return on the bond?

The answer is 2.78%. Charlie's real rate of return was 2.78% [(1.0525 ÷ 1.024) - 1]. LO 7.1.1

Hiromoto purchased 100 shares of Sony stock last year. At the time of his purchase, Sony's stock was trading on the Tokyo exchange at 4,600 yen per share, and the exchange rate was 120 yen to the U.S. dollar. Hiromoto has just checked on the price of Sony, which is currently trading at 4,700 yen per share on the Tokyo stock exchange. The exchange rate is now 130 yen to the U.S. dollar. Which of the following statements about Hiromoto's capital gain (loss) is CORRECT?

The answer is Hiromoto's capital gain was offset by the fall in the value of the yen relative to the U.S. dollar. LO 5.5.2

Mysterious Company stock has a mean return of 9% and a standard deviation of 3%. Based on this information, which of the following statements is CORRECT? A) Mysterious Company is unlikely to experience a negative return. B) Approximately 68% of Mysterious Company's returns will fall between 3% and 15%. C) Half of Mysterious Company's returns will fall below 6%. D) Five percent of Mysterious Company's returns will be greater than 15%.

The answer is Mysterious Company is unlikely to experience a negative return. With a normal probability distribution, 68% of the returns fall within one standard deviation of the mean, 95% within two standard deviations, and 99% within three standard deviations. Therefore, Mysterious Company has less than a 0.5% chance of experiencing a negative return.

Sergei is deciding whether to invest in either corporate bonds, which yield 9%, or municipal bonds (with equal risk), which yield 7%. Assuming Sergei's personal income tax rate is 35%, which investment should he choose?

The answer is Sergei should choose municipal bonds. The taxable equivalent yield (TEY) of the municipal issue is 10.77% [TEY = 7% ÷ (1 - 0.35)]. Based on this calculation, Sergei should invest in municipal bonds since the corporate bond yield is lower at 9%. LO 7.4.1

Brian and Kellie purchased savings bonds for their children's future college education expenses. What series of bonds did they choose if the savings bonds are inflation-indexed and may be used to pay for higher education costs on a tax-favored basis?

The answer is Series I. Series I savings bonds are an inflation-indexed debt security issued by the U.S. government. The accrued interest on Series I bonds may be completely excluded from income tax if the bond proceeds are used to pay for qualified higher education costs.

Your client has just experienced an unanticipated financial emergency resulting in an immediate need of $25,000. Which of your client's assets would you advise be sold to cover this expense?

The answer is Short-Term U.S. Treasury ETF. The other three choices may exhibit either liquidity risk or marketability risk or both. The U.S. Treasury ETF would be the least susceptible to these risks and highly liquid and accessible.

The duration of a bond is inversely related to its

The answer is coupon rate. Duration is directly related to term to maturity and inversely related to coupon rate and yield to maturity.

FLY Company is a publicly owned airline. The company has a capital structure consisting of 85% stock and 15% bonds. Investors in the common stock of FLY are subject to all of the following risks except

The answer is default risk. Common stockholders of FLY are not subject to default risk because the company is not obligated to make dividend payments. LO 6.1.2

Which of the following may a common stockholder vote on? A) Declaration of dividends B) Changing material suppliers C) Authorization of debt financing to fund expansion D) Election of the board of directors

The answer is election of the board of directors. Common stockholders cannot vote on either the size or the payment of a dividend. Changing material suppliers and authorizing the use of debt financing are decisions for management. LO 3.1.1

Yadira owns 20 stocks across several sectors of the economy that are part of the S&P 500 index, typically known as "blue chip" stocks. Her investments are exposed to which of the following risks?

The answer is market risk. Market risk is the risk inherent in the overall securities marketplace and is sometimes simply referred to as volatility.

Which of the following is NOT considered an anomaly to the efficient market hypothesis? A) The small or neglected firm effect B) The P/E ratio effect C) The January effect D) The Morningstar enigma

The answer is the Morningstar enigma. The Value Line enigma relates to stocks that are rated 1 on Value Line's scale of 1-5 ratings. Historically, these stocks have had a tendency to outperform lower-rated stocks by Value Line. LO 8.3.2

The segment of the security trading marketplace that allows for institutional investors to trade with other institutional investors outside of normal trading hours is known as

The answer is the fourth market. The segment of the security trading marketplace that allows for institutional investors to trade with other institutional investors outside of normal trading hours is known as the fourth market.

Francis and William would like to place $5,000 into an account that would be used primarily for emergencies. Which of the following investment choices should be recommended for an emergency fund?

A) Money market mutual funds B) U.S. Treasury bonds C) Series I savings bonds D) Guaranteed investment contracts

Last year, Wanda purchased the following shares of Calendars, Inc., stock. DateSharesBasisJanuary 10100$3,000May 5100$4,000July 27200$10,000 On November 22 of the same year, Wanda sold 150 shares for $9,000. To minimize the tax consequences of the sale, Wanda used the specific identification method to identify the shares sold. Which of the following is her gain or loss using this method?

Last year, Wanda purchased the following shares of Calendars, Inc., stock. DateSharesBasisJanuary 10100$3,000May 5100$4,000July 27200$10,000 On November 22 of the same year, Wanda sold 150 shares for $9,000. To minimize the tax consequences of the sale, Wanda used the specific identification method to identify the shares sold. Which of the following is her gain or loss using this method?

Connie, 45, has an extensive amount of assets in a separately managed account. The account is mostly compromised of small-cap growth companies. What is the best benchmark to analyze the performance of her account?

Russell 2000. Connie should use the Russell 2000 Index to compare her investment portfolio's performance to a benchmark. This index is used to benchmark small-capitalization companies.

JKL stock is trading at $75. Janet owns a put option on JKL stock with an exercise price of $72. What is the intrinsic value of Janet's option?

The answer is $0. The intrinsic value of a put option is the greater of zero or the exercise price less the market price of the underlying stock. Therefore, the intrinsic value of Janet's option is $0. An option never has a negative intrinsic value. LO 5.2.1

ABC Corporation issued bonds with a 10-year maturity, $1,000 par value, and 7% coupon rate (paid semiannually). Two years after issue, interest rates on similar bonds fell to 5.75%. What price should ABC Corporation bonds sell for in the secondary market?

The answer is $1,079.26. This answer is calculated using the following factors: FV = $1,000 PMT = 7% x 1000 ÷ 2 = $35 N = 16 semiannual periods (8 years x 2 periods per year) I/YR = 5.75% Solve for PV = -1,079.26, or $1,079.26

Ronald owns a Hydro Industries 7% convertible bond. The bond is convertible into 30 shares of Hydro Industries, which is currently trading at $43 per share. The investment value of the bond is $980, and the current market price of the bond is $1,433. What is the conversion value of Larry's bond?

The answer is $1,290. Conversion value = conversion ratio × market price of common stock, or 30 × $43 = $1,290.

Tim began purchasing BLT, Inc., mutual fund shares several years ago. He has followed a dollar-cost averaging approach by investing $1,000 each year for five years. The following data depicts Tim's purchases: Year Investment Share Price 1 $1,000 $120 2 $1,000 $100 3 $1,000 $118 4 $1,000 $97 5 $1,000 $130 What is Tim's average cost per share?

The answer is $111.58. Calculate the number of shares purchased each year, then total the shares purchased. The total investment is then divided by the total number of shares purchased ($5,000 ÷ 44.809 = $111.58).

Case Study Question ABC stock has a current market price of $130 and has paid a steady annual dividend of $3.50 per share. The dividend is expected to grow at a constant rate of 5% per year for the foreseeable future. If the Pratts have a required rate of return of 8%, what is the intrinsic value of the stock using the constant growth dividend discount model, and was the stock overpriced or underpriced in the secondary market?

The answer is $122.50, overpriced. Using the constant growth dividend discount model, the intrinsic value of ABC stock is $122.50, calculated as follows: ($3.50 × 1.05%) ÷ (8% - 5%) = 3.6750 ÷ 0.03 = $122.50. When the intrinsic value of the stock is less than the current market price, the stock is deemed to be overpriced in the secondary market. LO 9.2.1

Peter asks his broker to purchase 500 shares of ABC stock at market, using a 50% initial margin. The broker has a 30% maintenance margin. The broker contacts Peter to inform him that the stock was purchased for $60 per share. If the stock falls to $35 per share, what is the amount of cash that must be placed into the account to achieve the maintenance margin?

The answer is $2,750. Peter must deposit $2,750 to achieve the maintenance margin, calculated as follows: Value: $35 × 500 shares = $17,500 Loan amount: $30,000 × 0.50 = ($15,000) Actual equity: $2,500 Required equity: $17,500 × 0.30 = $5,250 Cash needed: $2,750 ($5,250 - $2,500) LO 1.2.1

LJM stock has a current annual dividend of $2.50 per share that is expected to remain constant. Using the perpetuity dividend discount model, what is LJM's market price if an investor's required rate of return is 10%?

The answer is $25.00. Using the no-growth (perpetuity) dividend discount model, V = D ÷ r, the intrinsic value of the stock is $25.00 ($2.50 ÷ 0.10). LO 4.3.1

XYZ stock is trading at $50. Joe owns a call option on XYZ stock with an exercise price of $47. What is the intrinsic value of Joe's option?

The answer is $3. The intrinsic value of a call option is the greater of zero or the market price, less the exercise price. Therefore, the intrinsic value of Joe's option is $3 ($50 - $47). LO 5.2.1

Pierre is interested in purchasing LFM stock. LFM has an estimated free cash flow to equity (FCFE) for the next year of $2.75 per share, which is expected to grow at a constant rate of 3.5% per year. Pierre's required rate of return is 12%. Using the FCFE valuation model, what is the intrinsic value of LFM stock?

The answer is $32.35. Using the model V = FCFE1 ÷ (r - g), the intrinsic value of the stock is $32.35 [$2.75 ÷ (0.12 - 0.035)]. LO 4.3.2

CCC stock paid a dividend this year of $3, and this dividend is expected to grow at a rate of 10% for the next two years and at a rate of 5% thereafter. Assuming Jackie expects to sell the stock in three years, and her required rate of return is 12%, what is the price she should be willing to pay for CCC stock?

The answer is $49.25. Use the multistage growth dividend discount model to calculate the stock's intrinsic value. Step 1: Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $3.00 × 1.10 = $3.30 D2 = $3.30 × 1.10 = $3.63 Step 2: Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $3.63 × 1.05 = $3.81 V = $3.81 ÷ (0.12 - 0.05) = $54.45 Step 3: Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $3.30 CF2 = $3.63 + $54.45 = $58.08 I/YR = 12% Solve for NPV = $49.25 The intrinsic value of the stock is $49.25. LO 4.3.1

Rudy is reviewing a preferred stock that pays a constant dividend of $5.50 per share. If his required rate of return is 10%, what is the maximum price he should be willing to pay for this stock in the secondary market?

The answer is $55.00. The intrinsic value of this preferred stock is calculated as follows: $5.50 ÷ 0.10 = $55.00. Rudy would be willing to pay a maximum of $55.00 per share for the preferred stock. LO 4.3.1

ABC Corporation pays a current annual dividend of $0.75 per share. This dividend is expected to grow at a 30% rate per year during Years 1 and 2. After Year 2, the company's dividend is expected to grow at a constant rate of 8%. What is the value of the stock today, assuming a required rate of return of 10%?

The answer is $58.50. Using the multistage growth dividend discount model, the value of the stock equals $58.50. Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $0.75 × 1.30 = $0.9750 D2 = $0.9750 × 1.30 = $1.2675 Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $1.2675 × 1.08 = $1.3689 V = $1.3689 ÷ (0.10 - 0.08) = $68.4450 Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $0.9750 CF2 = $1.2675 + $68.4450 = $69.7125 I/YR = 10% Solve for NPV = $58.50

Case Study Question The Pratts are considering purchasing JKL stock based on a stock tip from their neighbor, Alicia. Alicia has provided them with the following information: Current dividend: $2.50 Expected dividend growth rate for years 1 and 2: 8% Expected dividend growth rate for years 3+: 10% Based on this information, what is the intrinsic value of JKL stock if the Pratts have a required rate of return for this investment of 14%?

The answer is $66.37. Using the multistage growth dividend discount model, calculate JKL stock's intrinsic value: Step 1: Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $2.50 × 1.08 = $2.70 D2 = $2.70 × 1.08 = $2.92 Step 2: Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $2.92 × 1.10 = $3.21 V = $3.21 ÷ (0.14 - 0.10) = $80.25 Step 3: Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0= $0 CF1= $2.70 CF2 = $2.92 + $80.25 I/YR= 14% Solve for NPV = $66.37

JEM Corporation always pays a dividend of $5.50 per share. What of the following is the intrinsic value of the stock, assuming a required rate of return of 8% and a risk-free rate of return of 4%?

The answer is $68.75. The intrinsic value of the stock is $68.75 ($5.50 ÷ 0.08) using the no-growth (perpetuity) dividend discount model.

HAR stock has a current annual dividend of $3 per share that is expected to grow at a constant rate of 5% annually. Using the constant growth dividend discount model, what is HAR's market price if an investor's required rate of return is 9%?

The answer is $78.75. Using the constant growth dividend discount model [V = D1 ÷ (r - g)], an investor should not pay more than $78.75 for HAR stock [$3.15 ÷ (0.09 - 0.05)]. LO 4.3.1

Norma Smith owns ABC Corporation bonds of AA rated quality that mature in seven years, pay semiannual interest, and have a coupon of 8%. Similar bonds (AA rated, seven years to maturity) yield 9%. The ABC Corporation bonds are convertible into common stock at $26 per share, and the current market price of ABC common stock is $23. What is the conversion value of an ABC Corporation bond?

The answer is $884.61. Conversion value = conversion ratio × market price of common stock, or ($1,000 ÷ $26) × $23 = $884.61. LO 2.2.1

DDD stock paid a dividend this year of $6, and this dividend is expected to grow at a rate of 10% for the next two years and at a rate of 5% thereafter. Assuming David's required rate of return is 12%, which of the following is DDD's intrinsic value?

The answer is $98.46. Use the multistage growth dividend discount model to calculate the stock's intrinsic value. Step 1: Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $6.00 × 1.10 = $6.60 D2 = $6.60 × 1.10 = $7.26 Step 2: Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $7.26 × 1.05 = $7.62 V = $7.62 ÷ (0.12 - 0.05) = $108.86 Step 3: Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $6.60 CF2 = $7.26 + $108.86 = $116.12 I/YR = 12% Solve for NPV = $98.46 The intrinsic value of the stock is $98.46. LO 4.3.1

Wayne owns shares in the Big Value mutual fund. Last year, Big Value had a return of 18%, the S&P 500 Index had a return of 21%, and six-month Treasury bills averaged a return of 5%. Big Value's standard deviation was 14, the standard deviation of the S&P 500 index was 12, and Big Value's beta was 0.9. Which of the following is the Treynor ratio for Big Value last year?

The answer is +14.44. The Treynor ratio for Big Value: (18 - 5) ÷ 0.9 = 14.44

Given the following information: Portfolio actual return: 9% Market actual return: 12% Portfolio standard deviation: 4% Market standard deviation: 7% Portfolio beta: 0.65 Risk-free rate of return: 3% What is the portfolio's alpha?

The answer is 0.15%. Calculated as follows: Alpha = 9% - [3% + (12% - 3%)0.65] = 0.15%. LO 7.2.1

Which of the following is the coefficient of variation (CV) for an investment with a standard deviation of 8.65%, an expected return of 11.5%, and a beta of 1.25?

The answer is 0.7522. It is calculated as follows: CV = standard deviation of asset ÷ expected or mean return of asset = 0.0865 ÷ 0.1150 = 0.7522 The CV is a computation of the relative measure of total risk per unit of expected return and is used to compare investments with varying rates of return and standard deviations. LO 6.2.3

An analysis of the monthly returns for the past year of a mutual fund portfolio consisting of two funds revealed the following statistics: Fund A Fund B Total return 18% 11% Standard deviation 24% 17% Percentage of portfolio 35% 65% Correlation coefficient (R).27 What is the standard deviation of the portfolio?

The answer is 15.58%. This requires using the standard deviation of a portfolio formula: σP=√W2iσ2i+W2jσ2j+2WiWj[COVij]σP=Wi2σi2+Wj2σj2+2WiWj[COVij] Break this formula down into three sections: Fund A: (0.35)2(24)2 = (0.1225)(576) = 70.56 Fund B: (0.65)2(17)2 = (0.4225)(289) = 122.1025 Covariance: 2(0.35)(0.65)(24)(17)(0.27) = 50.1228 σp = (70.56 + 122.1025 + 50.1228)0.5 σp = (242.7853)0.5 = 15.5816, or 15.58% LO 6.2.4

Stock TTY has a mean return of 11% and a standard deviation of 5%. What is the probability of a return of less than 6%, assuming a normal distribution of returns?

The answer is 16%. The probability of Stock TTY returning more than 11% is 50%. Additionally, the probability that the stock's return lies within one standard deviation of the mean is 68%. Because the distribution is symmetric, there is a 34% chance that returns will be between 6% and 11%. Therefore, the probability of a return less than 6% is 16% (100% − 50% − 34%). LO 6.2.2

Case Study Question Given the following historical return information for ABC stock: Year Annual Rate of Return 1 12% 2 18% 3 -10% 4 -14% 5 23% Which of these is the standard deviation for this series of returns?

The answer is 16.77%. The standard deviation for this historical series of return for ABC stock is 16.77%. Using the HP 10bII+ the steps are listed below, however for the TI BAII Plus, please see the supplemental calculator document: Keystrokes Display [SHIFT] [C ALL] 0.000012 [Ʃ+]1.000018 [Ʃ+] 2.000010 [+/-][Ʃ+] 3.000014 [+/-][Ʃ+] 4.000023 [Ʃ+] 5.0000 [SHIFT] [Sx,Sy]16.7690, or 16.77% LO 9.1.2

Saturn, Inc., has assets of $750 million and liabilities of $250 million. Last year, the company earned $120 million and paid out $30 million in dividends. Using the formula g = return on equity × retention rate, what is the growth rate for Saturn, Inc.?

The answer is 18%. $750,000,000 - $250,000,000 = $500,000,000 of equity; $120,000,000 earnings ÷ $500,000,000 equity = 0.24, or 24% ROE $120,000,000 earnings - $30,000,000 paid out in dividends = $90,000,000 of retained earnings; $90,000,000 ÷ $120,000,000 = 0.75 retention rate g = ROE × RR g = 0.24 × 0.75 = 0.18, or 18% LO 4.2.2

Luigi is considering purchasing KAB stock. He has been investing time in calculating financial ratios in order to compare various investment choices. Given KAB has a profit margin of 26.5%, a dividend payout ratio of 35%, a market price per share of $62.50, and sales per share of $3.15, what is the company's price-to-sales (P/S) ratio?

The answer is 19.84. The P/S ratio is an indication of how much an investor is paying for a specific revenue stream—in this case, the company's annual sales. The P/S ratio of KAB equals 19.84 ($62.50 ÷ $3.15). As with other ratios, the P/S ratio of KAB is then compared to its peers to determine whether the stock appears to be undervalued or overvalued. LO 4.3.2

Nancy bought 50 shares of ABC stock for $50 per share. She made additional purchases at the end of each of the following years: Year 1: 10 shares at $52 per share Year 2: 10 shares at $53 per share Year 3: 10 shares at $45 per share ABC stock has not paid any dividends during her holding period. At the end of Year 4, the stock is trading for $55 per share. Which of the following is Nancy's return over the past four years on ABC stock (assume she sells the stock for the current trading price)?

The answer is 2.95%. The dollar-weighted return is calculated as follows: CF0 (2,500) [50 × $50] CF1 (520) [10 × $52] CF2 (530) [10 × $53] CF3 (450) [10 × $45] CF4 4,400 [80 × $55] Solve for IRR/YR = 2.95%

CPM stock is currently trading for $30 per share and has earnings of $1.50 per share. What is CPM's price-to-earnings (P/E) ratio?

The answer is 20. CPM stock has a P/E ratio of 20 ($30 ÷ $1.50). LO 4.3.2

Case Study Question Assume the Pratts' 100 shares of ABC stock with a current market price of $130 per share undergoes a 2-for-1 stock split. How many shares of ABC stock will they own at what new market price per share?

The answer is 200 shares at $65 per share. In a 2-for-1 stock split, the number of shares doubles; therefore, the Pratts will own 200 (100 × 2) shares of ABC stock. The total value of their stock holding will not change; however, the stock price will be reduced by half. Therefore, the new market price of ABC stock will be $65 ($130 ÷ 2) per share. LO 9.2.2

Javier has just been informed that his XYZ stock will be incurring a 2-for-1 stock split. How many additional shares will Javier acquire if he already owns 200 shares of XYZ?

The answer is 200. Javier will acquire 200 additional shares, and therefore, will own a total of 400 shares of XYZ stock. In a stock split, the par value of each share of stock is reduced, and the number of shares is increased proportionately. LO 3.2.1

During the past year, the stock market had a return of 8%, while the risk-free rate of return was 3%. Fund B had a realized return of 12%, a standard deviation of 15, and a beta of 1.20. Jensen's alpha for the fund is

The answer is 3.00%. Alpha = 12% - [3% + (8% - 3%)1.20] = 12% - 9% = 3%

Greg holds two stocks in his investment portfolio. Stock HGF has a mean return of 4.75% and a standard deviation of 1.57%. Stock POI has a mean return of 15.56% and a standard deviation of 9.82%. The portfolio is weighted in the proportions of 75% for HGF stock and 25% for POI stock. These stocks exhibit a covariance of 12.86. Based on the information provided, what is the standard deviation of this two-asset portfolio?

The answer is 3.50%. Calculated as follows: σp = [(0.75)2(1.57)2 + (0.25)2(9.822)2 + 2(0.75)(0.25)(12.86)]0.5 = [1.387 + 6.029 + 4.823]0.5 = [12.2390]0.5 = 3.4984, or 3.50% By combining these two stocks in their given proportions, Greg has created a portfolio with a standard deviation of 3.50%, significantly lowering the risk exposure associated with POI stock. LO 6.2.4

A wash sale for tax purposes occurs when a person sells a security and repurchases it within ___ days before or after the sale.

The answer is 30. A wash sale occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities. If this event occurs, the basis of the new stock or securities will include the unrecovered portion of the basis of the formerly held stock or securities.

Assume the nominal return on 30-year U.S. T-bonds is 6.5%, and the inflation rate is 1.75%. Which of the following is the real rate of return on the T-bonds?

The answer is 4.67%. The real rate of return is 4.67%, calculated as follows: {[(1 + 0.065) ÷ (1 + 0.0175)] -1} × 100 = 0.0467, or 4.67%.

Phil is considering adding a tax-free municipal bond to his extensive investment portfolio. He is in the 37% federal marginal income tax bracket and lives in a state that does not impose a state income tax. His broker has offered him the opportunity to purchase a AAA-rated general obligation bond. Assuming the bond has a coupon rate of 3.35%, what is its taxable equivalent yield?

The answer is 5.32%. This bond's taxable equivalent yield is calculated as follows: 3.35% ÷ (1 - 0.37). LO 7.1.1

RAP mutual fund had these returns over the past three years: Year 1: 15% Year 2: -5% Year 3: 7% What is the arithmetic and geometric mean returns for RAP? Arithmetic Geometric

The answer is 5.67% and 5.34%. The arithmetic mean is 5.67%, calculated as follows: (15% - 5% + 7%) ÷ 3. The geometric mean is 5.34%, calculated with the following time value of money (TVM) inputs: PV = -1, FV = (1.15)(0.95)(1.07), PMT = 0, N = 3, solve for I/YR = 5.34%. LO 7.1.1

Kate has a corporate bond with an annual coupon rate of 5.85% and a current market price of $1,035. The bond may be called in five years for a price of $1,050. Which of these is the bond's yield to call (YTC)?

The answer is 5.91%. The bond's YTC is 5.91%. It is calculated using the following inputs: PV = -$1,035 FV = $1,050 PMT = 1,000 × 5.85% ÷ 2 = $29.25 N = 10 (5 x 2 periods per year) Solve for I/YR = 5.91% LO 7.1.1

The returns for Mutual Fund P exhibit a normal probability distribution with a mean of 11% and a standard deviation of 8.75%. What is the probability that Mutual Fund P's return next year will be greater than 11%?

The answer is 50%. With a normal probability distribution, half the returns fall above the mean return, and half the returns fall below the mean return. LO 6.2.2

RST stock has a mean return of 12.21% and a standard deviation of 4.11%. Based on this information, 68% of RST's returns should fall between what rates of return, assuming a normal probability distribution?

The answer is 8.10% to 16.32%. An investor who purchases RST stock should expect to achieve an annual return between 8.10% and 16.32% approximately 68% of the time (one standard deviation of 4.11% in both directions from the mean return of 12.21%). LO 6.2.2

Angela purchased a corporate bond currently selling for $925 in the secondary market. The bond has a coupon rate of 7.75% and matures in 12 years. Which of these is the yield to maturity on this bond?

The answer is 8.77%. The yield to maturity on this bond is calculated using the following inputs: PV = -$925 PMT = 7.75% × 1,000 ÷ 2 = $38.75 FV = $1,000 N = 24 (12 x 2 periods per year) Solve for I/YR = 8.77%

Bob owns an 8% coupon bond with 13 years to maturity, which is currently selling for $975. The bond is callable in five years at a 3% premium. What is the yield to call on Bob's bond?

The answer is 9.12%. The yield to call is calculated using the following inputs: PV = -$975 FV = $1,030 PMT = 8% × 1,000 ÷ 2 = $40 N = 10 (5 x 2 periods per year) Solve for I/YR = 9.12% LO 7.4.1

Case Study Question The Pratts are considering purchasing an AAA rated 10-year bond with a coupon rate of 7.75% paid semiannually. The bond is currently trading for $987.50 in the secondary market. What are both the current yield (CY) and the yield to maturity (YTM) of this bond?

The answer is CY = 7.85%, YTM = 7.93%. The CY for the bond is 7.85%, calculated as follows: CY = ($1,000 × 7.75%) ÷ $987.50 = 7.85%. The YTM is calculated using the following inputs: PV = -$987.50 FV = $1,000 PMT = 7.75% x 1,000 ÷ 2 = $38.75 N = 20 (10 x 2 periods per year) Solve for I/YR = 7.9334, or 7.93%. LO 9.1.1

DIV Corporation's current market value is $50 million, with 2 million shares outstanding. The board of directors votes to pay a stock dividend of 10%. Which of the following statements is correct? A) DIV Corporation's per-share stock price will be adjusted upward following the stock dividend. B) DIV Corporation's overall market value will be $55 million following the stock dividend. C) DIV Corporation will have 2 million shares outstanding following the stock dividend. D) DIV Corporation's per-share stock price will be $22.73 following the stock dividend.

The answer is DIV Corporation's per-share stock price will be $22.73 following the stock dividend. DIV Corporation's overall market value will remain unchanged at $50 million, with 2.2 million shares outstanding. The stock price per share will be adjusted downward to $22.73 ($50,000,000 ÷ 2,200,000).

An investor is deciding whether to make an investment in LKJ stock, which has a standard deviation of 4.3% and an expected return of 13%, or FDS stock, which has a standard deviation of 5.6% and an expected return of 10.5%. Using the coefficient of variation (CV), which of the following is the preferable investment choice?

The answer is LKJ, with a CV of 0.3308. The CV is calculated by dividing the standard deviation of an asset by its expected return. For LKJ, the CV is 0.3308 (0.043 ÷ 0.13). For FDS, the CV is 0.5333 (0.056 ÷ 0.105). Using only this information, the investor may choose to select the asset with the lower CV, which in this case, is the LKJ stock. LO 6.2.3

Jacob is interested in purchasing several corporate bonds for his portfolio. If the following investments have similar yields, which of the following should be recommended for his investment portfolio?

The answer is Moody's, Aaa rated. Moody's, S&P, and Fitch rate the quality of bond issues. Aaa rated bonds are of a higher quality than S&P AA rated bonds or S&P BBB bonds. A.M. Best rates insurance companies. LO 2.3.2

Sinowe purchased a Treasury-issued security for its par value of $1,000. The security has a coupon rate of 6%, and the last semiannual interest payment he received was $36. The security recently matured, and Sinowe received $1,200. What type of Treasury security did he own?

The answer is Treasury Inflation-Protected Securities (TIPS). Sinowe owned a TIPS. The security was issued at par with a 6% coupon. The principal value is inflation-adjusted every six months, and one-half of the stated coupon rate is paid semiannually on the inflation-adjusted principal. The last interest payment of $36 and the paid maturity value of $1,200 reflect the inflation-adjusted principal.

Greg and Elizabeth are discussing their retirement plan with Jack, a financial advisor with an investment advisory firm. They would like Jack to reposition a portion of their assets into an investment that would provide them a monthly income with minimal risk. Which of the following choices would be the best for Jack to recommend to his clients?

The answer is U.S. government bond fund. Of the available choices, only the U.S. government bond fund would offer the client monthly income. LO 3.6.1

Reham Corporation has declared a record date of Friday, August 1, for its next quarterly dividend. Which of the following is the last day an investor can purchase the stock and still qualify for the dividend?

The answer is Wednesday, July 30. The record date is the first business day after the ex-dividend date. On the record date, trades are settled and reflected on the corporation's books. Accordingly, to be listed as a shareholder of record, the investor must purchase the stock before the ex-dividend date of Thursday, July 31.

For a given change in yields, the difference between the actual change in a bond's price and that which is predicted using duration alone will be greater for

The answer is a bond with greater convexity. Duration is a linear measure of the relationship between a bond's price and yield. The true relationship is not linear as measured by the convexity. When convexity is higher, duration will be less accurate in predicting a bond's price for a given change in interest rates. Short-term bonds generally have low convexity. LO 4.1.2

Which of the following statements regarding futures contracts is correct? A) A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. B) To complete a futures contract, delivery of the asset or commodity must be made. C) Futures contracts do not trade on an exchange. D) Hedging involves purchasing a futures contract in the same position of that which is currently held.

The answer is a futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. To complete a futures contract, delivery of the commodity or asset may be made. But more often, the buyer (or holder) simply purchases an offsetting contract and cancels the original position. Hedging involves purchasing a futures contract in the opposite position of that which is currently held. Futures contracts are traded on an exchange such as the Chicago Mercantile Exchange.

Which of the following statements regarding modern portfolio theory is correct? A) A portfolio that lies at the point where the indifference curve is tangent to the efficient frontier is the optimal portfolio. B) A portfolio that lies below the efficient frontier is superior to the one that has the same risk but lies on the efficient frontier. C) A portfolio that lies below the security market line (SML) is undervalued. D) A portfolio that lies below the efficient frontier is unattainable.

The answer is a portfolio that lies at the point where the indifference curve is tangent to the efficient frontier is the optimal portfolio. Statements III and IV are not correct. A portfolio that lies below the SML is overvalued because its expected return is lower than the required return plotted on the SML. A portfolio that lies below the efficient frontier is inferior to one that lies on the efficient frontier. Each portfolio on the efficient frontier offers the highest possible return for a particular level of risk.

The top 10 shareholders of publicly held Emax, Inc., are selling 10 million shares they personally own through a public offering. The investment banker will offer these shares as part of which of the following offerings?

The answer is a secondary offering. If a company has already issued shares but wants to raise additional capital through the sale of more stock, it does so by what is called a secondary or seasoned offering.

Smith Farms Corporation is a large producer of soybeans. The company's management would like to hedge this season's crop in the commodity futures market. What is the best type of hedge position for Smith Farms Corporation to take and why? A) A short hedge to protect against lower soybean prices B) A long hedge to protect against lower soybean prices C) A short hedge to protect against higher soybean prices D) A long hedge to protect against higher soybean prices

The answer is a short hedge to protect against lower soybean prices. With a short hedge, you are hedging against prices going down. If they do go down, you will make money on the short position, and this would offset any losses on having to sell the long position at lower prices. LO 5.3.1

Which type of hedge should a wheat farmer select? A) A short hedge—sell wheat futures contracts as a hedge against a decline in the price of wheat. B) A long hedge—buy wheat futures contracts as a hedge against a decline in the price of wheat. C) A long hedge—buy wheat futures contracts as a hedge against an increase in the price of wheat. D) A short hedge—sell wheat futures contracts as a hedge against an increase in the price of wheat.

The answer is a short hedge—sell wheat futures contracts as a hedge against a decline in the price of wheat. Because the wheat farmer is long wheat, he would be interested in a short hedge to protect against a decline in the price of wheat.

When a taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities, this transaction is classified as

The answer is a wash sale. The wash sale rule is intended to prevent a claim of a tax loss on specific security transactions. This rule will postpone the capital loss if a substantially identical security is purchased within 30 days before or after the sale. If this event occurs, the basis of the new stock or securities will include the unrecovered portion of the basis of the formerly held stock or securities.

Which of these is a risk associated with corporate bonds? A) Interest rate risk B) Reinvestment rate risk C) Default risk D) All of these

The answer is all of these. All bonds are subject to systematic risks. However, government bonds are not subject to default risk.

Which of the following is a risk involved in an investment in undeveloped land? A) The investor may not be able to obtain permits to build on the land. B) Access to the investor's land may be restricted by adjacent landowners. C) The land may be adversely rezoned. D) All of these.

The answer is all of these. An investment in undeveloped land may be subject to all of these risks.

Case Study Question ABC stock is subject to which of the following risks? A) Market risk B) Business risk C) Financial risk D) All of these

The answer is all of these. Common stock is subject to a variety of risks, including, but not limited to, business risk, financial risk, and market risk.

Which of the following statements are the basic assumptions of technical analysis? A) Supply and demand is driven by both rational and irrational factors. B) All of these. C) Stock prices move in trends. D) Supply and demand determine the market prices of securities.

The answer is all of these. For technical analysis to work, prices must react slowly to new information. Technical analysts believe security prices move in trends, and these trends persist over an appreciable period of time. LO 4.2.1

Which of these statements describing the primary market is correct? A) A syndicate is a group of investment banks that collectively underwrite an issue. B) One goal of underwriting is to evaluate a firm's financial needs. C) The purpose of the primary market is to facilitate the initial sale of securities to the public. D) All of these.

The answer is all of these. In the primary market, underwriters assist with the sale of the issue, evaluate the firm's financial needs, and determine the best investment vehicle to achieve the capital goal.

Which of the following statements describing the primary market is correct? A) All of these. B) The purpose of the primary market is to facilitate the initial sale of securities to the public. C) A syndicate is a group of investment banks that collectively underwrite an issue. D) One of the goals of underwriting is to evaluate a firm's financial needs.

The answer is all of these. In the primary market, underwriters assist with the sale of the issue, evaluate the firm's financial needs, and determine the best investment vehicle to achieve the capital goal. LO 1.2.1

Case Study Question Based on the desire for Larry to retire at age 62, the Pratts should consider preparing a comprehensive investment strategy. Which of the following steps should be included in the financial planning process? A) Prepare a complete and thorough investment policy statement detailing their financial goals and objectives. B) Match the appropriate investment vehicles to meet their needs and objectives. C) All of these. D) Review and examine their tax situation and personal financial statements.

The answer is all of these. The Pratts' financial plan should include all of these steps. Investment planning requires examining the client's financial situation to determine if the client's goals and objectives can be met while simultaneously meeting any investment needs and requirements. In order to do an effective job of investment counseling, the planner should examine and review the client's financial goals and time horizon, risk tolerance and risk exposure, tax situation, liquidity and marketability needs, and personal financial statements.

If the coefficient of determination (R2) between MNB stock and the market is 0.86, which of the following statements are correct? A) With an R2 of 0.86, the overall market may be an appropriate benchmark for the measurement of investment risk inherent in MNB stock. B) The Treynor performance measure may be used for analysis when the R2 of the stock is 0.86. C) 86% of the movement of MNB stock may be explained by changes affecting the overall market. D) All of these.

The answer is all of these. The higher the R2 of the stock, the more the overall market is an appropriate benchmark for the measurement of investment risk. The use of Treynor's performance measure is indicated only when the R2 of the stock is approximately 0.70 or greater. LO 6.2.5

Which of the following is a disadvantage of investing in convertible bonds? A) The yield is less than that of a nonconvertible bond with similar risk and maturity. B) All of these. C) They are doubly cursed in times of high interest rates and low stock prices. D) The holder may be forced into conversion if the bond is callable.

The answer is all of these. These bonds are doubly cursed during times of high interest rates and low stock prices because convertibles typically have lower coupon rates than comparable nonconvertibles. Thus, they experience greater price volatility.

Case Study Question Larry is considering repositioning his 401(k) plan assets into the asset allocation portfolio. Over the past year, the portfolio produced a 14.50% return with a beta of 1.15. The risk-free rate is 3.25%, and the overall market returned 12.65%. Based on this information, what is Jensen's alpha, and has the fund manager added any value to the portfolio?

The answer is alpha = 0.44%, the fund manager outperformed the market by 0.44%. Jensen's alpha for this portfolio is 0.44%, calculated as follows: 14.50% - [3.25% + (12.65% - 3.25%)1.15] = 0.44%. A positive alpha indicates the portfolio manager outperformed the market on a risk-adjusted basis. LO 9.1.2

Your client has learned of a private placement offering. Which of the following is NOT a characteristic of a private placement? A) An investor with a net worth of $1 million, including the value of their primary residence, can participate in a private placement offering. B) A major advantage of a private placement is that the selling costs associated with a public offering are eliminated. C) Private offerings can be tailored more to the needs of investors and issuers than public offerings. D) Frequent investors in private placements include insurance companies and pension funds.

The answer is an investor with a net worth of $1 million, including the value of their primary residence, can participate in a private placement offering.

Case Study Question Larry's 401(k) plan has experienced returns over the past five years of -10%, 15.55%, -5.87%, 12.75%, and 14.85%. What are both the arithmetic and geometric means for this series of returns?

The answer is arithmetic mean = 5.45%; geometric mean = 4.85%. Arithmetic mean: [(-0.10 + 0.155 - 0.0587 + 0.1275 + 0.1485) ÷ 5] = 0.0545, or 5.45%. Geometric mean: PV = -1; FV = (1 - 0.10)(1 + 0.155)(1 - 0.0587)(1 + 0.1275)(1 + 0.1485) = 1.2671; N = 5; solve for I/YR = 4.8485, or 4.85%.

Which of the following statements correctly identify the factor relationships of the Black-Scholes option valuation model? A) as the amount of time until expiration increases, the price of the call option increases. B) the price of a call option will decrese when the risk-free rate increases. C) the lower the volatility of the underlying stock, the greater the price of the call option. D) if the market price of the underlying stock increases, the price of the call option decreases.

The answer is as the amount of time until expiration increases, the price of the call option increases. As the volatility of the underlying stock increases, the price of the call option will increase. The price of a call option will increase when the risk-free rate increases. If the market price of the underlying stock increases, the price of the call option increases. LO 5.2.1

Which of these statements regarding unit investment trusts (UITs) is CORRECT? A) The majority of UIT offerings are listed on the major stock exchanges. B) Units in a UIT are priced in the secondary market at a premium or discount to NAV. C) At the maturity date of the portfolio, the securities are generally liquidated, and the proceeds are distributed to the investors or trust beneficiaries. D) UITs are actively managed, as portfolio managers typically attempt to match the return of a stated index.

The answer is at the maturity date of the portfolio, the securities are generally liquidated, and the proceeds are distributed to the investors or trust beneficiaries. UITs are considered unmanaged or passively managed because the initial securities (usually bonds) included in the portfolio are typically held until maturity. UIT units are sold at NAV plus a commission. Units are sold in the secondary market but not on the major exchanges.

Jack has $50,000 to invest in a portfolio of bonds. He decides to invest $25,000 into bonds with a two-year maturity and $25,000 into bonds with a 10-year maturity. His portfolio illustrates what type of bond strategy?

The answer is bond barbells. Bond barbells is a strategy for investing in both short-term and long-term bond issues. LO 2.3.1

Case Study Question Which of the following statements regarding the financial planning engagement you have with the Pratts is CORRECT? You must communicate to the client any limitations on the scope of the engagement. Your recommendations must be written and prepared in a clear, understandable manner.

The answer is both I and II. In this financial planning engagement, you must communicate to the client any limitations on the scope of the engagement, and your recommendations must be written and prepared in a clear, understandable manner. LO 9.3.2

Which of the following statements regarding indifference curves is correct? It is a graphical expression of the utility function in the dimensions of expected return and risk. It depicts the amount of risk an investor is willing to take on (as measured by standard deviation) to achieve a certain return.

The answer is both I and II. These statements are correct. LO 8.1.1

Which of the following technical indicators measures the strength of the market by comparing the number of advancing stocks to the number of declining stocks?

The answer is breadth of the market. Breadth of the market is the technical indicator that attempts to measure the overall strength of the market by comparing the number of advancing stocks to the number of declining stocks. LO 4.2.1

You currently own 100 shares of a stock that has increased in value from $15 to $35 per share. You do not want to sell the stock but want to protect yourself against a large downturn in the market. Which of the following is an effective action on your part?

The answer is buy a $30 put option on the stock. The purchase of a put option on the stock will provide downside protection without limiting the investor's upside.

Owen owns XYZ stock, which has recently increased in value by 50%. Owen would like to preserve as much of this gain as possible and retain the potential for additional price increases. Which of the following strategies best meets Owen's goal?

The answer is buy a put. This would allow Owen to hold the stock for additional gain but reserve the right to sell at or near the current value if the stock price plummets. Shorting the stock would lock in Owen's gain but not allow him to take advantage of additional price increases. Additional price increases would be offset by the cost of replacing the shorted stock. Writing a call would provide some offset to a drop in price but would not allow for potential gain in value. Buying a call would not provide any downside protection. LO 5.2.2

Warren is a strong proponent of the buy-and-hold strategy. Which of the following is NOT an advantage of this strategy?

The answer is buy and hold is an active management strategy requiring constant monitoring. Buy and hold is a passive management strategy and is supported by the efficient market hypothesis. LO 8.5.2

Case Study Question The Pratts are concerned that ABC stock may substantially decline in price in the near future. Which of the following option strategies would best protect the Pratts' position in ABC stock? (Assume they own 100 shares currently valued at $130 per share, and all options will expire within 60 days.)

The answer is buy one put option with an exercise price of $120 for $3.00 per share. If the Pratts are bearish, they will either sell a call or buy a put. In this particular case, the Pratts should purchase one put option with an exercise price of $120 for $3.00 per share. The total cost of the put option, excluding transaction costs, is $300 ($3 × 100). Each put option contract gives the holder the right to sell 100 shares of the underlying stock at the exercise price within a specified time frame.

Which of the following statements concerning portfolio diversification is CORRECT? A) Diversification reduces the portfolio's expected return because diversification reduces a portfolio's total risk. B) The benefits of diversification are not realized until at least 25 individual securities are included in the portfolio. C) Only systematic risk is reduced as diversification is increased. D) By increasing the number of securities in a portfolio, total risk would be expected to fall at a decreasing rate.

The answer is by increasing the number of securities in a portfolio, total risk would be expected to fall at a decreasing rate. As more securities are added to a portfolio, diversification benefits begin to diminish. The main attraction of diversification is the reduction of risk without an accompanying loss of return. LO 6.1.1

Which of the following statements regarding closed-end investment companies is correct? A) Shares of a closed-end fund always trade at NAV. B) After the initial public offering, a closed-end fund will continue to issue additional shares. C) A major advantage to a closed-end investment company manager after the initial public offering is the unlimited nature of the company's capitalization. D) Closed-end investment company shares trade in the same manner as publicly traded stocks in the secondary market.

The answer is closed-end investment company shares trade in the same manner as publicly traded stocks in the secondary market. Shares of a closed-end fund are priced daily at NAV, but generally trade at a premium or discount to NAV. A closed-end fund's capitalization is relatively fixed (not unlimited) after the initial public offering. LO 3.3.1

Which of the following are attributes of an economy that is coming out of recession? A) Interest rates are falling. B) Personal incomes are in decline. C) Unemployment is increasing. D) Cyclical stocks will begin to move up in price.

The answer is cyclical stocks will begin to move up in price. Once the economy starts to recover, the unemployment rate will decline, interest rates will fall, and personal income will grow. Then cyclical stocks will begin to move up in price.

Advantages of investing in exchange-traded funds (ETFs) include all of the following except A) tax efficiency. B) daily pricing. C) low expense ratios. D) ability to sell short.

The answer is daily pricing. ETFs are continually priced during a trading day, just like stocks.

Case Study Question ABC stock is subject to all of the following risks except

The answer is default risk. Common stock is subject to a variety of risks, including, but not limited to, business risk, financial risk, and market risk. However, common stock is not subject to default risk. Default risk is the potential inability of a debt issuer to make timely interest and principal repayments. LO 9.2.2

The basic purposes of the investment policy statement include all of the following except A) determining the specific assets to include. B) setting objectives. C) determining communication procedures. D) establishing investment management procedures.

The answer is determining the specific assets to include. This is not one of the basic purposes of the investment policy statement.

All of the following statements describing diversification are correct except A) diversification is not enhanced by the addition of foreign securities to a portfolio because they are always highly correlated with domestic equity. B) to reduce liquidity risk, one would keep a sufficient portion of assets in cash or cash equivalent assets. C) to minimize interest rate risk, one could diversify within the fixed-income asset category by staggering bond maturity dates. D) to minimize business risk, one could allocate among a number of asset categories and purchase mutual funds.

The answer is diversification is not enhanced by the addition of foreign securities to a portfolio because they are always highly correlated with domestic equity. Diversification is enhanced by the addition of foreign securities to a portfolio because they are usually not highly correlated with domestic equity. Each of these asset classes, as a whole, responds differently to different types of risk; therefore, diversifying or allocating investment resources among these classes is a proven way to reduce risk overall, dampen volatility, and improve the performance of one's portfolio. LO 6.1.1

Which of the following acts involves acquiring assets with different risk characteristics? A) Diversification B) Correlation C) Determination D) Differentiation

The answer is diversification. Correlation exists when two investments have rates of return that move in concert. LO 6.1.1

Ronaldo and Juanita are interested in adding real estate to their investment portfolio. Their portfolio currently consists of GNMAs and equity mutual funds. They are only considering assets that may be traded on the exchanges in the secondary market and are interested in returns that are comprised mostly of current income. Which of the following investments would you recommend to them to diversify their portfolio? A) Mortgage REITs B) Equity REITs C) RELPs D) REMICs

The answer is equity REITs. Because their portfolio consists of mortgage-backed securities and equities, Ronaldo and Juanita should avoid mortgage REITs and REMICs if they are looking to diversify. RELPs are not publicly traded. Equity REITs invest in income-producing property and are usually publicly traded. LO 5.1.1

Debt-to-equity ratios are used to analyze what type of risk?

The answer is financial. Business risk is the uncertainty of income caused by the nature of a firm's business. As the certainty of income to the company decreases, the likelihood of cash flows to the investor decreases as well. Market risk is a type of systematic risk. LO 6.1.2

Which of the following is NOT an assumption of Harry Markowitz's modern portfolio theory? A) For a given level of risk, investors prefer lower returns to higher returns. B) Investors consider each investment opportunity as being represented by a probability distribution of expected returns over a specific holding period. C) Investors estimate the risk of the portfolio based on the variability of returns. D) Investors base investment decisions solely on expected return and risk.

The answer is for a given level of risk, investors prefer lower returns to higher returns. For a given level of risk, investors prefer higher returns to lower returns. In addition, investors base their indifference to alternative investments on the maximization of wealth over a specified period, and this indifference diminishes as they get beyond this period. LO 8.1.1

Which of the following is a characteristic of investing internationally? A) High correlations of foreign stocks with U.S. stocks lower portfolio risk. B) Foreign investments can be purchased in the United States through American depositary receipts (ADRs). C) Accounting practices abroad are similar to those in the United States, which simplifies comparison and evaluation of foreign investments. D) Foreign investments are not subject to currency exchange rate fluctuations.

The answer is foreign investments can be purchased in the United States through American depositary receipts (ADRs). Foreign investments are subject to currency exchange rate fluctuations. LO 5.5.1

Which of the following statements correctly explain fundamental analysis in an efficient market? A) Fundamental analysis allows investors to accurately calculate the future price of a security. B) Fundamental analysis can offer trading strategies that consistently beat the market. C) Fundamental analysis does not allow discovery of profitable market anomalies. D) Fundamental analysis allows investors to create portfolios that are consistent with their risk tolerances.

The answer is fundamental analysis allows investors to create portfolios that are consistent with their risk tolerances. Fundamental analysis may allow discovery of profitable market anomalies. Fundamental analysis does not offer trading strategies that consistently beat the market. LO 4.2.1

Which of the following correctly describe characteristics of a money market mutual fund? A) funds may be withdrawn from the account at any time without penalty by writing a check on the account. B) the rate of return on the fund is highly sensitive to changes in long-term market rates. C) the fund typically invests in high-quality, long-term investments such as Treasury bonds, REITs, and promissory notes. D) the investments within the fund usually mature within one year and have an average maturity of less than 90 days.

The answer is funds may be withdrawn from the account at any time without penalty by writing a check on the account. Money market mutual funds typically invest in high-quality, short-term investments such as Treasury bills, commercial paper, and negotiable CDs. The investments within the fund usually mature within one year and have an average maturity of less than 60 days. The rate of return is highly sensitive to changes in short-term market rates. LO 1.3.1

Elayne recently purchased a municipal bond through her stockbroker. The broker told her that the bond is backed by the full faith and credit of the issuer. What type of bond did Elayne buy for her portfolio?

The answer is general obligation bond (GO). GOs are municipal bonds that are issued to finance capital improvements for the benefit of the entire community. Because taxes back most GOs, municipalities may require a taxpayer vote to approve new issues.

Which of the following statements describing tangible assets and natural resources is CORRECT? A) The share value of a mutual fund that invests primarily in companies that develop natural resources is positively correlated with the value of the bond market. B) Oil and gas investments are typically offered to the public as general partnerships. C) Collectibles offer the investor personal enjoyment and a highly liquid investment. D) Gold prices and stock prices have traditionally had an inverse relationship.

The answer is gold prices and stock prices have traditionally had an inverse relationship. Because gold prices move inversely with stock prices, gold has been used as a hedge against falling stock values. Collectibles offer the investor personal enjoyment at the expense of an efficient and liquid market. Oil and gas partnership interests are typically offered as limited partnerships. Both the bond market and the stock market are negatively correlated with the value of natural resources.

Which of these is an example of a defensive stock? A) Restaurant stock B) Grocery store stock C) Computer stock D) Airline stock

The answer is grocery store stock. Companies that provide non-cyclical consumer products (i.e., food, consumer staples, pharmaceuticals, and tobacco) typically do well despite general economic downturns. A computer stock, an airline stock, and a restaurant stock are types of companies that sell luxury products and services, purchases of which may be reduced during an economic downturn.

Which of the following statements regarding hedge funds is CORRECT? A) Hedge funds are typically favored by inexperienced investors to hedge against losses they may experience as they gain investment savvy. B) Hedge funds are usually structured as a partnership. C) Hedge fund managers, like mutual fund managers, are compensated largely based on assets under management. D) Hedge funds are passively managed in an attempt to provide predictable returns for investors.

The answer is hedge funds are usually structured as a partnership. The partnership is with the general partner as the investment manager and the investors as limited partners. Hedge funds are actively and aggressively managed, seek superior returns, and are best suited for wealthy, sophisticated investors. Hedge fund managers are largely compensated for performance, not assets under management.

According to Markowitz, an investor's optimal portfolio is determined when the investor's A) indifference curve meets the efficient frontier. B) indifference curve crosses the efficient frontier. C) lowest indifference curve is tangent to the efficient frontier. D) highest indifference curve is tangent to the efficient frontier.

The answer is highest indifference curve is tangent to the efficient frontier. The optimal portfolio for an investor is determined as the point when the investor's highest indifference curve is tangent to the efficient frontier.

Which of the following would least likely be included as a constraint in an investment policy statement (IPS)? A) How funds are spent after being withdrawn from the portfolio B) Any unique needs or preferences an investor may have C) Constraints put on investment activities by regulatory agencies D) The global issue of taxation

The answer is how funds are spent after withdrawal from the portfolio. This would not be a constraint of an IPS.

Which of the following statements regarding common stock is CORRECT? A) If Jacob sells his XYZ stock to Darlene the day before the record date, Jacob will receive the dividend for that period. B) During recessions, cyclical stocks typically perform better than defensive stocks. C) An investor who owns common stock in street name is issued a certificate of ownership by the corporation. D) Growth stocks are so named because they pay dividends that grow at a constant rate.

The answer is if Jacob sells his XYZ stock to Darlene the day before the record date, Jacob will receive the dividend for that period. The person who is the owner of the stock on the second business day before the record date is issued the dividend for that period. Jacob sold the stock to Darlene after the ex-dividend date; therefore, he is still the owner of record because the trade will not settle for two business days following the sale. Darlene purchased the stock after the ex-dividend date. Stock owned in street name is held by the brokerage firm; the corporation does not issue a certificate to the investor. Growth stocks typically do not pay dividends. The value of the stock is expected to grow—or appreciate—with the reinvestment of earnings. Defensive stocks typically perform better than cyclical stocks in a recessionary economy.

Which of the following is a characteristic of American depositary receipts (ADRs)? A) Dividends are declared in the foreign currency, so exchange-rate risk is completely eliminated. B) They are not relatively liquid and marketable investments. C) ADRs are denominated and pay dividends in foreign currencies. D) Information regarding the foreign company is often more easily attainable with ADRs because the entity holding the security generally has access to that information.

The answer is information regarding the foreign company is often more easily attainable with ADRs because the entity holding the security generally has access to that information. ADRs are trust receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank. They are an alternative to investing directly in foreign companies or foreign mutual funds. Dividends are declared in the local currency, so exchange-rate risk is not completely eliminated.

Which of the following is a benefit of investing in municipal bonds? A) Revenue bonds are backed by the taxing power of the municipality. B) Gains from the sale of municipal bonds are not subject to federal tax. C) Nominal yields on municipal bonds are higher than corporate securities with similar maturities and credit ratings. D) Interest earned on general obligation bonds is not subject to federal income tax.

The answer is interest earned on general obligation bonds is not subject to federal income tax. Generally, municipal bond interest is not subject to federal income taxation. General obligation bonds are backed by the taxing power of the municipality; revenue bonds are backed by the revenues generated by the facility they finance. Gains from the sale of municipal bonds are subject to federal taxation. Nominal yields on municipals are typically lower than comparable corporate securities because of the tax advantages. LO 2.1.1

Portfolio immunization is designed to mitigate which type of risk?

The answer is interest rate risk. A bond portfolio is immunized when the duration of the portfolio is equal to the time horizon of the investor, thereby mitigating both interest rate risk and reinvestment rate risk.

Which of the following financial intermediaries would a business look to for startup capital? A) Unit investment trusts B) Credit unions C) Mutual funds D) Investment bankers

The answer is investment bankers. Startup capital is typically available at commercial banks and from investment bankers.

Asante stipulated that certain assumptions must be present for the capital asset pricing model (CAPM) to be used. Which of the following statements is NOT one of these assumptions? A) Investment expenses, such as taxes and transaction costs, are relevant in investment decision making. B) At all times, capital markets are in equilibrium. C) All investors have the same expectations for a given investment. D) Investors can always borrow and lend money at the risk-free rate of return.

The answer is investment expenses, such as taxes and transaction costs, are relevant in investment decision making. The CAPM does not consider taxes or transaction costs. LO 8.2.1

Which of the following correctly describes a disadvantage of cash and cash equivalents? A) the rate of return on passbook savings accounts is relatively high when compared to higher risk alternatives such as government bonds. B) an investor may quickly convert a money market deposit account to cash to meet short-term needs. C) investments in money market mutual funds are insured or guaranteed by the U.S. government. D) investors choosing to redeem their CDs prior to maturity may be subject to a substantial penalty.

The answer is investors choosing to redeem their CDs prior to maturity may be subject to a substantial penalty. One of the advantages of money market deposit accounts is their liquidity. They may be used by investors as a source of funds to meet emergencies and other short-term obligations. Investments in money market mutual funds are not insured or guaranteed by the U.S. government. The rate of return on passbook savings accounts is relatively low when compared to higher risk alternatives such as government bonds.

Which of the following is NOT an advantage of the buy-and-hold strategy? A) The strategy ensures that the investor will not be out of the market during an upturn in prices or its most profitable trading days. B) Investors or managers time their security purchases while staying fully or predominantly invested in the market, thereby maximizing profit potential. C) The investor's income tax obligations may be managed more effectively. D) The investor can minimize the transaction costs in the acquisition and trading of securities.

The answer is investors or managers time their security purchases while staying fully or predominantly invested in the market, thereby maximizing profit potential. Market timing is an attempt to predict the overall direction of the securities market and take advantage of changes in the prices of those securities, whether those prices go up or down. Studies have shown that, by and large, market timing techniques do not work over the long term. LO 8.5.2

Paulo believes in the weak form of the efficient market hypothesis. This means he believes

The answer is it may be possible to outperform the market by taking advantage of anomalies such as the small firm effect and the neglected firm effect. The weak form holds that current stock prices have already incorporated all historical market data and that historical price trends are, therefore, of no value in predicting future price changes. Although fundamental analysis and insider information may produce above-market returns under the weak form, technical analysis is of no value. LO 8.3.1

Assume that the economy has been in a recession for the past nine months. Inflation has started to decline, consumer confidence is low, and the yield curve has shifted from inverted to flat. Which of the following types of investments would be most appropriate for the coming year? A) Large-cap stocks B) Tangible assets C) IPOs D) U.S. Treasury bills

The answer is large-cap stocks. Large-cap stocks would be the most appropriate type of investment in this situation. LO 8.5.1

Which of the following combinations of risks is associated with art and other collectibles? A) Regulation risk and interest rate risk B) Market risk and business risk C) Reinvestment rate risk and purchasing power risk D) Liquidity risk and market risk

The answer is liquidity risk and market risk. The collectibles market is usually characterized by an inefficient market and inherent lack of liquidity.

Your clients, Ralph and Louise, have contacted you regarding withdrawing some funds to pay for future uncovered medical expenses. Louise had a recent diagnosis that will require surgery and recovery time, causing her to miss work for a number of months. The couple has arrived at your office for a meeting. How should you proceed?

The answer is listen to your clients' concerns and offer financial advice, as warranted. This would be the prudent first step and the other choices may be part of an overall strategy to deal with the health issue and financial burden this may cause to your clients. LO 8.6.1

Which of the following combinations will result in a bond with the greatest price volatility? A) High coupon and long maturity B) High coupon and short maturity C) Low coupon and short maturity D) Low coupon and long maturity

The answer is low coupon and long maturity. Price volatility is measured by duration. Duration is inversely related to the bond's coupon rate and directly related to the bond's term to maturity.

Which of the following is NOT a key element that separates hedge funds from mutual funds? A) Leverage is often used in hedge funds. B) Derivatives are used extensively by hedge funds. C) Illiquid securities are often used in hedge funds. D) Many hedge funds are broadly diversified.

The answer is many hedge funds are broadly diversified. Hedge funds are private investment vehicles that tend to be more heavily concentrated than mutual funds. They often use leverage and derivatives, employ narrow investment strategies, and invest in nonpublic and illiquid securities. LO 3.4.1

Rossalyn is researching GFD stock to determine if she should add it to her extensive equity portfolio. This stock has a beta of 1.40 and a standard deviation of 6.85%. Assuming the market rate of return is 10%, and the current 90-day T-bill rate is 2%, what is the market and stock risk premiums for GFD stock?

The answer is market = 8.00%; stock = 11.20%. The market risk premium is calculated as follows: rm - rf = (10% - 2%). The stock risk premium is 11.20%, calculated as follows: (rm - rf)βi = (10% - 2%)1.40.

An investor would consider converting a convertible bond into common stock if the bond's A) duration exceeds 10 years. B) market price is less than the conversion value. C) yield to maturity is less than its conversion premium. D) yield to call is the same as a comparable municipal bond.

The answer is market price is less than the conversion value. An investor would consider converting a convertible bond into common stock if the bond's conversion value exceeds its market price.

Which of the following would an investor choose to immunize a bond portfolio over a specific investment time horizon? A) Increase the coupon rate of each bond in the portfolio over the investment time horizon. B) Match the average weighted duration of the portfolio to the investment time horizon. C) Attempt to eliminate the default risk of the portfolio over the investment time horizon. D) Match the maturity of each bond in the portfolio to the investment time horizon.

The answer is match the average weighted duration of the portfolio to the investment time horizon. Bond portfolio immunization balances reinvestment rate risk with interest rate risk and occurs when the investment time horizon matches the average weighted duration of the portfolio. LO 2.3.1

Jim, 32, and Caren, 30, have been married for seven years. Both Jim and Caren work and have no children, so they have a large amount of disposable income. They live in the suburbs and are planning to purchase a condominium downtown as a weekend getaway. They would like to invest their money in a safe place for the down payment during the six months they spend searching for the perfect location and amenities. Which of the following investments would you recommend to Jim and Caren to accomplish this goal? A) Stock index fund B) U.S. government income fund C) Money market fund D) Investment-grade bond fund

The answer is money market fund. Jim and Caren are preparing to make a significant purchase within a relatively short period of time. They will require a highly liquid investment to keep their money safe. Therefore, the money market fund best matches their investment objective.

Which of the following correctly explains a disadvantage of investing in money market instruments? A) certificates of deposit (CDs) generally pay a higher rate of interest than long-term corporate bonds and are FDIC insured. B) money market mutual funds pay a low rate of interest. C) certificates of deposit are not subject to penalties for withdrawals made prior to maturity. D) money market instruments are not subject to purchasing power (inflation) risk.

The answer is money market mutual funds pay a low rate of interest. An investor in CDs is willing to accept a lower return to maintain a high degree of safety. Certificates of deposit are subject to penalties for withdrawals made prior to maturity. However, by accepting a low rate of return, the investor is subject to purchasing power (inflation) risk. Money market instruments are subject to purchasing power (inflation) risk.

Which of the following stock market anomaly descriptions is CORRECT? A) January effect: buy stocks in January B) BVMV: buy stocks with high market value relative to book value C) Size effect: big-company stocks outperform small-company stocks over time D) Neglected firm effect: buy stocks followed by few analysts

The answer is neglected firm effect: buy stocks followed by few analysts. Buying stocks in December and selling them in January is the January effect. Buying stocks with high book value to market value is BVMV. Small-company stocks outperforming large-company stocks over time is the size effect.

Vince is considering an investment in PLM international growth fund with a beta of 1.85. He needs to achieve a 16% rate of return to meet his financial goals. If the market has averaged a rate of return over the past five years of 10%, and the risk-free rate of return is 3.5%, should Vince invest in this fund? A) No, Vince's required rate of return is less than the fund's expected rate of return. B) No, the fund's expected rate of return is less than Vince's required rate of return. C) Yes, the fund's expected rate of return is less than Vince's required rate of return. D) Yes, Vince's required rate of return is less than the fund's expected rate of return.

The answer is no, the fund's expected rate of return is less than Vince's required rate of return. The expected rate of return for this fund is 15.53% (rounded) using the CAPM: 3.5% + (10% - 3.5%)1.85. Because the expected rate of return is less than Vince's required rate of return, he should not invest in the fund. LO 8.2.1

Which of the following is a characteristic of preferred stock? A) offers guaranteed income B) pays interest based on current market interest rates C) represents equity ownership D) is issued for a fixed period of time

The answer is offers guaranteed income. Preferred stocks possess features of both stocks and bonds. However, they represent equity ownership with no maturity date and pay dividends, though payment may be suspended if earnings are poor. Preferred stocks trade on the exchanges.

As a result of a market correction, your client's portfolio mix has changed substantially from the desired allocation. What portfolio management technique could be used to bring the allocation back to the desired mix?

The answer is portfolio rebalancing. Rebalancing refers to adjusting the weights of securities in a portfolio to their target weights after price changes have affected the weights.

Which of the following statements concerning preferred stock is correct? A) Preferred stockholders are paid before bondholders in terms of priority of payment of income and in case of corporate liquidation. B) Preferred stock resembles bonds, in that dividend income continues forever unless the stock issue is called or otherwise retired. C) Preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directors. D) If the issuer of a cumulative preferred stock fails to pay the dividend in any year, the unpaid dividend(s) will not have to be paid in the future.

The answer is preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directors. Preferred stockholders are paid after bondholders in terms of priority of payment of income and in case of corporate liquidation. If the issuer of a cumulative preferred stock fails to pay the dividend in any year, the unpaid dividend(s) will have to be paid in the future before common stock dividends can be paid.

Xavier is concerned that his investment portfolio is too concentrated in only a few stocks. He meets with his financial advisor for advice. The advisor recommends that Xavier diversify his portfolio among many different types of issues. Which of the following is the primary goal of this strategy?

The answer is reduce portfolio risk. Diversification aims to reduce unsystematic risk, not necessarily increase portfolio returns.

Dealer A purchases 26-week T-bills from Dealer B. Concurrently, Dealer A agrees to sell the T-bills back to Dealer B for delivery five weeks later at a specified higher price. What type of transaction is taking place between Dealer A and Dealer B?

The answer is reverse repurchase agreement. In a reverse repurchase agreement, the dealer buys government securities from another dealer and then sells them back later at a higher price. LO 1.3.1

Which of the following actions is consistent with a belief in the efficient market hypothesis (EMH)? A) Selecting a random set of stocks for a portfolio B) Waiting to purchase a stock until its price increases above the 40-day moving average C) Comparing the intrinsic value of a security with its market value D) Searching for undervalued securities

The answer is selecting a random set of stocks for a portfolio. The fundamental assumption of the EMH is that current stock prices reflect all available information and that prices rapidly (or immediately) adjust to reflect any new information. In addition, any new information must be unexpected; therefore, any changes in stock prices resulting from this new information will be random (i.e., the random walk theory). LO 8.3.2

Assume that the yield curve currently is shaped as shown in YC1, [Inverted Yield Curve] and you anticipate it will be shaped as shown in YC2 [Normal Yield Curve] one year from now. Assuming you want to maximize the opportunity for capital appreciation, which of the following investment strategies would you recommend for clients, based on the current and anticipated shapes of the yield curves?Y

The answer is sell short-term bonds and buy long-term bonds. When a yield curve is inverted, a financial planner should consider purchasing long-term securities to lock in rates for a long period of time—in anticipation of lower yields in the future. Such a move might also result in a capital gain on the investment as bond prices rise.

Which of the following forms of the efficient market hypothesis does an investor follow if she believes that current stock prices not only reflect all historical price data, but also reflect data from analyzing financial statements, industry, or current economic outlook?

The answer is semistrong form. Thus, even credible fundamental analysis is of no value in this form, and only insider information may produce above-market returns. LO 8.3.1

Which of the following statements correctly explains separately managed accounts and their relation to mutual funds? A) the key difference between mutual funds and separate accounts is that in a separate account, the money manager is purchasing the securities in the portfolio on behalf of the fund, not on behalf of the investor. B) they are similar to mutual funds, in that a money manager develops a model index specializing in a particular aspect of the market. C) separately managed accounts are individual investment accounts offered by financial consultants who provide advisory services and are managed by independent money managers using an asset-based fee structure. D) in a mutual fund, the investor owns the underlying securities directly, while in a separately managed account, the investor owns shares of the fund.

The answer is separately managed accounts are individual investment accounts offered by financial consultants who provide advisory services and are managed by independent money managers using an asset-based fee structure.

Which of the following forms of the efficient market hypothesis does an investor follow if he believes that current stock prices reflect all public and private information?

The answer is strong form. Even insider traders are unlikely to consistently outperform the market under the strong form. In addition, neither technical analysis nor fundamental analysis is of any value under this form. LO 8.3.1

All of the following correctly explain advantages of investing in real estate investment trusts (REITs) except A) professional management. B) liquidity. C) tax deferral. D) diversification.

The answer is tax deferral. Tax deferral is not an advantage of investing in REITs. REITs are professionally managed assets investing in a diversified portfolio of real estate holdings. Many REITs trade on the exchanges and over the counter, thereby providing investors with liquidity.

Which of the following statements regarding fundamental and technical analysis is CORRECT? A) Investors looking for excellent companies to invest in may use bottom-up analysis, which is a form of technical analysis. B) Technical analysis is not considered valid under the efficient market hypothesis because this type of analysis is attempting to predict future prices based on past price movement. C) In top-down analysis, an investor would start by researching various industries, then choosing stocks within that industry. D) Fundamental analysis may result in better returns than the overall market under both the weak and semistrong forms of the efficient market hypothesis.

The answer is technical analysis is not considered valid under the efficient market hypothesis because this type of analysis is attempting to predict future prices based on past price movement.

Which of the following is the primary difference between the underlying assumptions of technical analysis and those of fundamental analysis? A) Technical analysts argue that the market only weighs irrational factors, and therefore, the psychology of investors will produce a herd effect. B) Technical analysts hold that the price of a security is established by the expected investor return and a combination of risk factors. C) Technical analysts maintain that stock prices adjust quickly to the dissemination of public information. D) Technical analysts believe the trend in security prices is determined solely by the interaction of economic supply and demand.

The answer is technical analysts believe the trend in security prices is determined solely by the interaction of economic supply and demand. Stock prices move in trends, and therefore, market price adjustments occur gradually over time (e.g., company financial statements play a much less important role).

Distributions of dividend and capital gains in cash to mutual fund investors A) are added to the tax basis of the shares once taxes on the distributions are paid. B) decrease the cost basis of the shares, whether taxes are paid or not. C) decrease the taxable gain or increase the loss on sale of the shares after taxes are paid. D) are fully taxable to the investor.

The answer is that distributions of dividend and capital gains in cash to mutual fund investors are fully taxable to the investor. If the dividends and capital gains are reinvested, the individual receives an increased tax basis. If the distributions are made in cash, there is no increase in the tax basis of the underlying securities. LO 3.3.1

According to the arbitrage pricing theory (APT), the return on a stock represents which of the following?

The answer is the APT depends on the stock's responsiveness to unexpected changes. The APT examines a stock's responsiveness to a series of unexpected events. The APT is related to the expected return on the stock. The APT is not reduced by the construction of diversified portfolios. The APT does not take into consideration the market return if the expected rate of inflation is realized. LO 8.3.2

Which of the following correctly identifies an issue with the Dow Jones Industrial Average (DJIA)? A) the DJIA fails to account for the number of shares outstanding. B) the DJIA considers stock dividends of less than 10%. C) the DJIA reflects the payment of cash dividends. D) the S&P 500 Index and the DJIA have a correlation coefficient of only 95%, indicating that the DJIA is not a fair representation of the overall market.

The answer is the DJIA fails to account for the number of shares outstanding. Although the DJIA has fundamental problems, it is highly correlated with other broader market indexes such as the S&P 500 Index. A high correlation indicates that the DJIA is an adequate representation of the market in spite of its fundamental weaknesses. The DJIA ignores stock dividends of less than 10% and fails to reflect the payment of cash dividends.

If an investment has a correlation coefficient of 0.80 with the market, which of the following performance measures is the best measure of risk?

The answer is the Sharpe ratio. Because the correlation coefficient is 0.80, the coefficient of determination (R squared) is 0.64. Therefore, only 64% of the returns from the investment can be explained by the market (i.e., systematic risk represents 64%). Beta only measures systematic risk, which means that 36% of outcomes will not be captured by beta. Thus, Treynor and Jensen are not appropriate because they use beta. Sharpe is always an appropriate performance measure because the ratio is calculated using standard deviation. LO 6.2.5

Wendy traveled to France and converted U.S. dollars into euros when the exchange rate was USD 1.42 for each euro. When Wendy returned from France, she had some euros left over and converted them back into U.S. dollars. At that time, one dollar was worth .77 euros. Wendy wants to know if she made or lost money on the euros she exchanged back into U.S. dollars. You inform her that

The answer is the dollar has strengthened, and she lost money. When she returned, she would have preferred the euro to strengthen against the dollar; that way, she could have received more dollars.

Which of the following statements regarding market efficiency is correct? A) The efficient market hypothesis (EMH) is the proposition that the securities markets are efficient, with the prices of securities reflecting their current economic value. B) Any new information must be expected; therefore, any changes in the stock price resulting from this new information will be anticipated. C) The fundamental assumption of the theory is that prices will not rapidly adjust to reflect any new information. D) Investors who accept the EMH usually adopt an active investment strategy.

The answer is the efficient market hypothesis (EMH) is the proposition that the securities markets are efficient, with the prices of securities reflecting their current economic value. Investors who accept the EMH usually adopt a passive investment strategy. Investors who do not accept the EMH pursue an active investment strategy. The fundamental assumption of the theory is that current stock prices reflect all available information for a company, and prices rapidly adjust to reflect any new information. Any new information must be unexpected; therefore, any changes in the stock price resulting from this new information will be random. LO 8.3.1

Which of the following statements concerning technical analysis as an approach to selecting securities is correct? A) The emphasis of technical analysis is on internal factors that help to detect supply and demand conditions in the market. B) Technical analysis may only be applied to the aggregate market, not to individual stocks. C) Company financial statements are the primary tools of the technical analyst. D) The rationale for technical analysis is that stock prices immediately adjust to changes in the market.

The answer is the emphasis of technical analysis is on internal factors that help to detect supply and demand conditions in the market.Technical analysis can be applied to the aggregate market as well as individual stocks. The rationale for technical analysis is that stock prices require time to adjust to changes in supply and demand. Company financial statements are used by fundamental analysts. LO 4.2.1

Gabriela is considering the purchase of a mortgage REIT or an equity REIT. The current economic environment includes slowly increasing interest rates and moderately increasing inflation. Vacancy rates for real estate properties are relatively low compared to historical averages. Which of the REITs is the best for Gabriela to purchase and why?

The answer is the equity REIT, because low vacancy rates and increasing inflation will help raise rental rates for the properties. Equity REITs acquire real estate for the purpose of renting the space to other companies. Income is generated from the rents and sales of the real estate properties. LO 5.1.1

Adding investments with a negative beta to a well-diversified portfolio that currently has a beta of one will cause

The answer is the expected performance of the portfolio to improve in bear markets. A negative beta means that the investment will move in the opposite direction from the market. Therefore, if the market is declining, then the security should increase in value, thereby increasing the value of the portfolio in a bear market. LO 6.2.1

Which of the following correctly identifies an advantage of the buy-and-hold strategy? A) the investor is guaranteed a profit. B) the investor will miss out on an upturn in stock prices. C) the investor is not able to effectively manage any investment tax obligations. D) the investor can minimize transaction costs.

The answer is the investor can minimize transaction costs. The buy-and-hold strategy, among other investment strategies, does not guarantee a profit to the investor. The investor may effectively manage any investment tax obligations. The investor will not be out of the market during an upturn in stock prices. LO 8.5.2

What is the role of an underwriting syndicate?

The answer is to sell the new issue to the public. The underwriting syndicate participates in selling the new issue to the public. This is the function of venture capital. This applies to an underwriter in a firm commitment underwriting. The issuer of the new security registers the issue with the SEC. LO 1.1.1

Which of the following is NOT considered when calculating a mutual fund operating expense? A) Shareholder recordkeeping B) Management fees C) Transaction costs related to the portfolio securities D) 12b-1 fees

The answer is transaction costs related to the portfolio securities. A fund's operating expenses include management fees, 12b-1 fees, and administrative fees. Funds do incur transaction costs and those costs do impact performance but transaction costs are not captured in the expense calculation.

Which of the following forms of the efficient market hypothesis suggests that fundamental analysis and insider information may produce above-market returns?

The answer is weak. The weak form holds that current stock prices reflect all historical market data and that historical price trends are, therefore, of no value in predicting future prices. However, this form holds that credible fundamental analysis and insider information may produce above-market returns.

CAL stock has a current annual dividend of $1.25 that has been growing at a constant rate of 4.5% per year. Assuming the stock is currently selling for $40, and your required rate of return is 7.5%, should you buy the stock at today's price? A)

The answer is yes, because the stock is undervalued. On the basis of the constant growth dividend discount model, the intrinsic value of CAL stock is $43.54, calculated as follows: V = [$1.25 × (1 + 0.045)] ÷ (0.075 - 0.045) V = $1.30625 ÷ 0.03 V = $43.54 Because CAL stock is currently selling for $40 per share, it is undervalued in the secondary market and worthy of a purchase.

Mimi, a client of Osborne Capital, Inc., believes her portfolio should be adjusted. She supports her claim by stating that she just won the lottery and wants to retire 10 years earlier than originally planned. Does she have a valid claim?

The answer is yes, her wealth and time horizon have changed. Changes in wealth, time horizon, and liquidity requirements all dictate the need to rebalance. Taxes, laws, regulations, and unique circumstances also play into this decision.