CFP - Investment Planning

What is beta?

A measure of the systematic risk that investors should be compensated for

Coefficient of Variation (CV)

A standardized measure of the risk per unit of return. It is calculated by dividing the standard deviation by the expected return. CV = Standard Deviation/x-bar

unsystematic risk

ABCDEFG Accounting risk Business risk Country risk Default risk Executive risk Financial risk Government/regulation risk

Jensen's Alpha

Measures investment performance as the raw portfolio return less the return predicted by the capital asset pricing model. alpha = Rp - [Rf + Beta(Rm-Rf)]

Systematic Risk

PRIME Purchasing power Reinvestment rate risk Interest rate risk Market risk Exchange rate risk

A twenty year zero coupon bond is more volatile in response to interest rate changes than a similar bond paying a 5% coupon. A. True B. False

Solution: The correct answer is A.

A portfolio has a total return of 10.5%, a beta of 0.72 and a standard deviation of 6.3%. The risk free rate is 3.8%, the market return is 12.4%. Jensen's measure of this portfolio's performance is A. 0.5% B. 4.3% C. 7.9% D. 9.3%

Solution: The correct answer is A. A = Actual Return - Er = .105 − .0999 = .005 ER = Rf + B (Rm − Rf) ER = .038 + .72 (.124 − .038) = .0999

EE Savings Bonds are issued at face value, but may be worth more than the face value at maturity. A. True B. False

Solution: The correct answer is A. EE savings bonds are sold at face value and earn accrued interest.

Which of the following forms of the efficient market hypothesis supports fundamental analysis? A. Weak Form B. Semi-Strong Form C. Strong Form D. None of the choices

Solution: The correct answer is A. Only the weak form accepts Fundamental Analysis as a viable investment approach.

Which of the following performance measures is a stand-alone metric? A. Jensen's Alpha B. Sharpe Ratio C. Treynor Ratio D. Standard Deviation

Solution: The correct answer is A. Sharpe and Treynor are performance measures that are used in comparison to each other. Standard Deviation is a measure of absolute risk. Jensen's Alpha is an absolute measure of performance and is widely interpreted as a measure of excess returns.

The weak form of the efficient market theory contends that A. past performance is useless in predicting future price movements. B. past performance can help determine the general direction of future price movements. C. any publicly available information is useless in predicting future price movements. D. price movements are not random but follow a general trend over a period of time.

Solution: The correct answer is A. The weak form only rejects technical analysis. Essentially it supports fundamental analysis and insider information.

A fixed income security whose price has fallen as a result of an increase in interest rates in the market place is said to be subject to: A. Interest rate risk. B. Reinvestment rate risk. C. Purchasing power risk. D. Exchange rate risk.

Solution: The correct answer is A. A fixed income security whose price has fallen as a result of an increase in interest rates in the market place is said to be subject to interest rate risk.

Michael has an investment with the following annual returns for four years: Year 1: 12% Year 2: -5% Year 3: 8% Year 4: 18% What is the arithmetic mean (AM) and what is the geometric mean (GM)? A. AM = 8.25%, GM = 7.91% B. AM = 8.25%, GM = 10.64% C. AM = 10.75%, GM = 7.91% D. AM = 10.75%, GM = 10.64%

Solution: The correct answer is A. AM = (.12 -.05 + .08 + .18) / 4 = .0825 = 8.25% GM = (1.12 × .95 × 1.08 × 1.18) ^ (1/4) - 1 × 100 GM = (1.356) ^ (1/4) - 1 × 100 GM = 7.91% Also, the AM is always more than the GM unless the returns are the same every year, it which case AM = GM.

Assume Mike's stock that he bought at $40 per share falls to $20. How much equity would he be required to contribute per share, if the maintenance margin is 35% and the initial margin was 60%? A. $3 B. $4 C. $5 D. $6

Solution: The correct answer is A. Actual Equity: $20 − 16* = 4 Required Equity: $20 × .35 = $7.00 Margin Call= 7 − 4 = 3 * The stock was purchased for $40 on margin. They needed to pay for 60% of that amount, or $24. $40 - $24 paid, leaves $16 of debt.The current equity is $20 per share, minus the debt of $16.

The Real Rate of Return component of a bond's yield includes the effect of the term-to-maturity. A. True B. False

Solution: The correct answer is B.

The primary objective of an equity-income fund is A. capital gains. B. current income with less capital risk. C. potentially high capital gains with limited income. D. high risk-return trade-offs.

Solution: The correct answer is B.

This approach to security analysis starts with economic analysis, moves to industry analysis and then fundamental analysis. A. The Dow theory analysis. B. Top-down analysis. C. Bottom-up analysis. D. Random Walk analysis.

Solution: The correct answer is B.

Which of the following statements is (are) correct concerning exchange-traded funds (ETFs)? I. You can buy and sell ETFs any time during trading hours. II. ETFs are actively managed. III. ETFs have high portfolio turnover rates. IV. ETFs rarely distribute any capital gains. A. I, II and IV only B. I and IV only C. II and III only D. I only

Solution: The correct answer is B.

A firm has earnings before taxes of $128 million and taxes of $39 million. The company pays $12 million in preferred dividends and $31 million in common dividends. There are 24 million shares of common stock outstanding. What is the amount of the earnings per share? A. $1.92 B. $3.21 C. $3.71 D. $3.83

Solution: The correct answer is B. (128 - 39 - 12) ÷ 24 = $3.21 EPS is always after taxes and after preferred stock dividends.

ADRs A. represent ownership in unlisted domestic stocks. B. pay dividends in U.S. dollars. C.receive company dividends only in U.S. dollars. D. are subject to taxation only by the U.S. government.

Solution: The correct answer is B. ADR's represent shares of foreign stock held in a domestic bank's foreign branch. They trade in USD, but do not eliminate exchange rate risk.

When an investor feels that some segments of the markets are efficient and some segments are inefficient, what asset allocation strategy would best fit their beliefs? A. Market Timing B. Core-Satellite Allocation C. Strategic Asset Allocation D. Tactical Asset Allocation

Solution: The correct answer is B. Market timing is an attempt to anticipate the movements in Equities, suggesting the markets are inefficient. Strategic, Asset Allocation uses a buy and hold strategy across a broad set of asset classes, suggesting the markets are efficient. Tactical Asset Allocation believes markets are inefficient and they seek to outperform market returns based on short term performance. Core-Satellite seeks to hold a core portfolio in index funds or ETFs with smaller portfolio (satellite) to have an active investment strategy to take advantage of market inefficiencies.

Which of the following would not be an investment holding in a Money Market Mutual Fund? A. Treasury Bills B. Bank Certificates of Deposit C. Bankers' Acceptances D. Repurchase Agreements

Solution: The correct answer is B. Money Market Mutual Funds will invest in jumbo CDs (aka Negotiable Certificates of Deposit), but not Bank CDs. Jumbo CDs are typically offered through a brokerage firm and are in amounts of $100,000 or greater. Bank CDs are non-negotiable and are in smaller amounts.

Joe purchased 1 share of XO for $80. One year later the stock paid a dividend of $2 and Joe purchased an additional share for $95. Joe sold the stock 1 year later for $110. What is the dollar weighted return? A. 35.6% B. 17.60% C. 18.50% D. 53.0%

Solution: The correct answer is B. CF0 = <80> CF1 = <93> (2 - 95) CF2 = 220 (110 x 2) IRR = 17.60%

A company has 2 million shares of common stock outstanding. Annual sales are $26 million. The net profit margin is 8% and the dividend payout ratio is 40%. Currently the stock trades at $17.68 per share. Given this information, the company has a P/E ratio of A. 17 and a dividend yield of 3.20%. B. 17 and a dividend yield of 2.35%. C. 16 and a dividend yield of 3.20%. D. 16 and a dividend yield of 2.35%.

Solution: The correct answer is B. Salesx Profit MarginNet income $26Mx .08$2.08M EPS = Net income = 2.08 = 1.04 EPSShares outstanding 2 Stock Price = P/E x EPS17.68 = P/E x 1.0417.68 = P/E1.04 17 = P/E Dividend Yield= Dividend = EPS x Payout Ratio = 1.04 x .40 = .4160 = .0235 = 2.35%Stock Price 17.68 17.68 17.68

Joe purchased 1 share of XO for $80. One year later the stock paid a dividend of $2 and Joe purchased an additional share for $95. Joe sold the stock 1 year later for $110. What is the time-weighted return? A. 35.6% B. 18.5% C. 17.6% D. 53.0%

Solution: The correct answer is B. There are two methods to solve this problem. Cashflow and Geometric mean. 1. Cashflow: CF = -80 CF = 2 CF = 110 IRR 18.51 2. Time-weighted return is a holding period return linked for the two periods. Sale price - purchase price + or - cash flow divided by purchase price, then take the geometric return 1. (95 - 80 + 2)/80 = .2125 2. (110 - 95)/95 = .1579 3. Use the geometric mean formula. Take the Nth root (2 occurrences, in this case) take the square root of: ((1+.2125) x (1+.1579)) - 1 (1.2125 x 1.1579) = 1.4040, take the square root = 1.1849 then subtract 1 = .1849 or 18.49% You will see a difference in time-weighted versus dollar weighted. One relies on annual returns and the other on cash flows.

Since T-bills are issued at a discount, the accrued income is taxable in the year in which it is earned. A. True B. False

Solution: The correct answer is B. T- Bills are sold at a discount with the longest maturity of 52 weeks. No coupon payments are made.

Private Activity Revenue bonds are not Federally tax exempt because they benefit private projects. A. rue B. False

Solution: The correct answer is B. (FALSE)

One common method of estimating the growth rate of dividends is to A. randomly assign an annual growth rate of 4% to the latest dividend amount. B. multiply the return on assets by the dividend payout ratio. C. multiply the return on equity by the firm's retention rate. D. multiply the return on equity by the dividend payout ratio.

Solution: The correct answer is C.

Which of the following is not a diversifiable risk? A. Business Risk B. Financial Risk C. Interest Rate Risk D. Default Risk

Solution: The correct answer is C. Diversifiable risks are unsystematic risks which include: A, B, C, D, E, F, G. Accounting, Business, Country, Default, Executive, Financial, and Government.

The following data has been gathered concerning a particular investment and conditions in the market. Risk-free rate 3.0% Market return 10% Beta of investment 1.5 According to the Capital Asset Pricing Model, the required return for this investment is A. 8.8% B. 12.9% C. 13.5% D. 14.9%

Solution: The correct answer is C. ER = Rf + B (Rm - Rf) = .03 + 1.5 (.10 - .03) = 13.5

Given the following diversified mutual fund performance data, which fund had the best risk-adjusted performance if the risk-free rate of return is 5.7%? Fund A: Average rate of return = .0782, Standard deviation of annual return = .0760 and Beta = 0.950 Fund B: Average annual return = .1287, Standard deviation of annual return = .1575 and Beta = 1.250 Fund C: Average annual return = .1034, Standard deviation of annual return = .1874 and Beta=0.857 Fund D: Average annual return = .0750, Standard deviation of annual return = .0810 and Beta = 0.300 A. Fund B, because the annual return is highest. B. Fund C, because the Sharpe ratio is lowest. C. Fund D because the Treynor ratio is highest. D. Fund A, because the Treynor ratio is lowest.

Solution: The correct answer is C. If a fund is diversified, use the Treynor model and the result there is arrived at by dividing the return by the beta. In this case, fund D has the highest risk adjusted rate of return. Treynor = [(rp-rf)/(Bp)]. In this case, the result is .06.

Asset selection can be achieved through one of four fundamental means. Which of the following is not one of the four means? A. Discounted cash flow techniques B. Relative valuation with multipliers C. Fundamental Analysis D. Indexing

Solution: The correct answer is C. Choices A, B, and D are 3 of the four fundamental means to achieve asset allocation. The fourth option is technical analysis (not listed as an answer choice). Technical analysis uses the historical pricing and volume data to make asset decisions. Both discount cash flow and relative valuation methods are part of fundamental analysis.

Which one of the following types of investor benefits most from the tax advantage of preferred stocks? A. Government. B. Individual. C. Corporate. D. Mutual funds.

Solution: The correct answer is C. There is a 70% exclusion from taxation on the dividends of preferred stock of one corporation held by another corporation. Actually, if 20% or more of the corporation paying the dividend is owned by the company receiving the dividends, then up to 100% of the dividend is tax free. Non-profit institutional stocks generally pay no federal taxes and therefore, the corporate dividend received deduction of 70% is of no value.

Exempt from state & local income tax. A. Treasury Notes B. TIPS C. I Bonds D. All Treasuries

Solution: The correct answer is D.

Treasury stock can be used to do which of the following? pay for an acquisition pay the company employees pay stock dividends cover employee stock option plan contributions A. I and III only B. II and IV only C. III and IV only D. I, III and IV only

Solution: The correct answer is D.

On December 31, the Gold Standard Company reported the following information on its financial statements: Total current assets $680,000 Total long-term assets $1,850,000 Total current liabilities $490,000 Total long-term debt $975,000 According to this information, the company's current ratio is approximately A. 1.9 B. 1.73 C. 1.68 D. 1.39

Solution: The correct answer is D. Current Ratio = Current Assets/Current Liabilities = 680,000/490,000 = 1.3878

Which of the following forms of the efficient market hypothesis supports technical analysis? A. Weak Form B. Semi-Strong Form C. Strong Form D. None of the choices

Solution: The correct answer is D. None of the above. Even the weak form holds that technical analysis is of no particular value.

In the absence of a true risk-free rate, which of the following serve as substitution? A. Prime Rate B. Treasury Bond Rate C. Government Money Market Rate D. Treasury Bill Rate

Solution: The correct answer is D. Prime rate is the rate banks offer their best customers. Treasury Bonds are long term rates and would not reflect short term changes in rates. Money Market rates are a function of the underlying investment options. T-Bill rates serve as the risk-free rate.

In computing portfolio performance, the Sharpe index uses ______________, while the Treynor index uses ________________ for the risk measure. A. beta, standard deviation B. standard deviation; correlation coefficient C. standard deviation; coefficient of variation D. standard deviation; beta

Solution: The correct answer is D. Sharpe may be remembered as beginning with the letter "'S" as does standard deviation. This mnemonic device may be helpful.

Portfolio A has a total return of 14.5%, a beta of 1.54, and a standard deviation of 17.6%. Portfolio B has a total return of 16.4%, a standard deviation of 14.5%, and a beta of 1.63. If the risk free rate is 4.5% and the market return is 10.2%, using Treynor's measure, which portfolio performed better on a risk adjusted basis? A. A because it had a lower Treynor. B. B because it had a lower Treynor. C. A because it had a higher Treynor. D. B because it had a higher Treynor.

Solution: The correct answer is D. Treynor A 14.5 − 4.5 = 6.49% 1.54 Treynor B 16.4 − 4.5 = 7.30% 1.63

Winifred, Inc. paid $1.64 as an annual dividend per share last year. The company is expected to increase their annual dividends by 3% each year. How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment? A. $18.22 B. $18.77 C. $27.33 D. $28.15

Solution: The correct answer is D. Value = D1 ÷ ( r - g) = 1.64(1.03) ÷ (.09 - .03) = 28.15

Mutual fund XYZ has a correlation coefficient of .89 with the S&P 500. Mutual fund XYZ also has a beta of 1.15, standard deviation of 17% and an expected return of 14%. The risk free rate of return is 3% and the market return is 12%. Which of the following is the most appropriate risk adjusted performance measure(s) to use? A. Sharpe. B. Treynor. C. Sharpe and Alpha. D. Treynor and Alpha.

Solution: The correct answer is D. When the r-squared is greater than .70, then Beta is an appropriate measure of risk. If Beta is an appropriate measure of risk, then both Treynor and Alpha are appropriate to use. If r-squared is less than .70, standard deviation is the appropriate measure of risk and sharpe would be the right ANS. R-squared is .7921 in this example (.89 × .89 = .7921)