Fin 421 Multiple choice practice

11. Proponents of the EMH typically advocate __________. A. a conservative investment strategy B. a liberal investment strategy C. a passive investment strategy D. an aggressive investment strategy

C. a passive investment strategy

13. If you believe in the __________ form of the EMH, you believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest. A. semi-strong B. strong C. weak D. any of the above

D. any of the above

2. The arithmetic average of 12%, 15% and 25% is _________. A. 17.3% B. 15% C. 17.2% D. 20%

A. 17.3% Explanation: Arithmetic avg = (12+15+25)/3=17.3

17. You are considering investing $1,000 in a complete portfolio. The complete portfolio is comprised of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest __________ of your complete portfolio in treasury bills. A. 19% B. 25% C. 50% D. 65%

A. 19% Explanation: .11 = wf(.05) + (1-wf)[(.6)(.14) + (.4)(.10) wf = .19

17. In a recent study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher. A. higher B. lower C. unaffected D. more skewed

A. Higher

24. According to a study by French (1980), the mean return on the S&P 500 portfolio on __________ between July 1962 and December 1978 was negative. A. Mondays B. Tuesdays C. Wednesdays D. Fridays

A. Mondays

20. When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns. A. positive; positive B. positive ; negative C. negative; positive D. None of the above

A. Postive, postive

10. Consider a treasury bill with a rate of return of 5% and the following risky securities: Security A : E(r) = .15; Variance= .0400 Security B : E(r) = .10; Variance = .0225 Security C : E(r) = .12; Variance = .1000 Security D: E(r) = .13; Variance = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor would choose as part of his complete portfolio would be __________. A. security A B. security B C. security C D. security D

A. Security A Explanation: Slope = [(.15-.05)/(.04)^.5]= .5000

7. Historical records regarding returns on stocks, Treasury bonds, and Treasury bills between 1926 and 1995 show that __________. A. stocks offered investors greater rates of return than bonds and bills B. stock returns were less volatile than those of bonds and bills C. bonds offered investors greater rates of return than stocks and bills D. bills outperformed stocks and bond

A. Stocks offered investors greater rates of return than bonds and bills

21. When testing mutual fund performance over time one must be careful of ___________, which means that a certain percentage of poorer performing funds fail over time which makes the performance of remaining funds seem more consistent over time. A. Survivorship bias B. Lucky event bias C. Magnitude bias D. Mean reversion bias

A. Survivorship bias

15. A rule for buying or selling stocks according to recent price movements is called __________. A. a filter rule B. a market anomaly C. an enigma D. none of the above

A. a filter rule

26. Portfolios that lie on the portion of the efficient frontier below the minimum-variance portfolio ___________________. A. add nothing to the investment opportunity set B. are sometimes useful in implementing sophisticated hedging techniques C. represent opportunities for arbitrage D. None of the above answers is correct

A. add nothing to the investment opportunity set

5. The beta, of a security is equal to __________. A. the covariance between the security and market returns divided by the variance of the market's returns B. the covariance between the security and market returns divided by the standard deviation of the market's returns C. the variance of the security's returns divided by the covariance between the security and market returns D. the variance of the security's returns divided by the variance of the market's return

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

5. The market risk premium is defined as ___________. A. the difference between the return on an index fund and the return on Treasury bills B. the difference between the return on a small firm mutual fund and the return on the Standard and Poor's 500 index C. the difference between the return on the risky asset with the lowest returns and the return on Treasury bills D. the difference between the return on the highest yielding asset and the lowest yielding asset

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

6. The reward/variability ratio is given by __________. A. the slope of the capital allocation line B. the second derivative of the capital allocation line C. the point at which the second derivative of the investor's indifference curve reaches zero D. none of the above

A. the slope of the capital allocation line

12. The holding period return on a stock was 37.50%. Its ending price was $26 and its cash dividend was $1.50. Its beginning price must have been __________. A. $18.50 B. $20.00 C. $21.50 D. $23.00

B. $20.00 Explanation: P=(26+1.50)/(1+.375) = $20

18. You are considering investing $1,000 in a complete portfolio. The complete portfolio is comprised of treasury bills that pay 5% and a risky portfolio, P, constructed with 2 risky securities X and Y. The weight of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and treasury bills respectively would be __________, __________ and __________ if you decide to hold a complete portfolio that has an expected return of 8%. A. $162, $595, $243 B. $243, $162, $595 C. $595, $162, $243 D. $595, $243, $162

B. $243, $162, $595 Explanation: .08(1,000) = F(.05) + (1000-F)[.6(.14) + .4(.10) F= 595 X = (1,000 - 595)(.6) = 243 Y = (1,000 - 595)(.4) = 162

14. You invest $100 in a complete portfolio. The complete portfolio is comprised of a risky asset with an expected rate of return of 12% and a standard deviation of 15% and a treasury bill with a rate of return of 5%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is __________. A. .40 B. .47 C. .57 D. .80

B. .47 Explanation: Slope = (.12-.05)/.15 = .4667

25. Given the results of Jensen's study (1969), you would expect approximately __________ of 1,000 funds to have positive alphas for 10 straight years. A. 0 B. 1 C. 2 D. 10

B. 1 Explanation: Number with ten straight alpha'a = 1000*(.5)*10 = 1

3. The geometric average of 10%, 20% and 30% is __________. A. 15% B. 19.7% C. 20% D. 23%

B. 19.7% Explanation: Geometric Average = ((1.10)(1.20)(1.30))(1/3)-1= 19.7

22. Consider a no-load mutual fund with $200 million in assets and 10 million shares at the start of the year, and $250 million in assets and 11 million shares at the end of the year. During the year investors have received income distributions of $1 per share, and capital gains distributions of $0.25 per share. Assuming that the fund carries no debt, and that the total expense ratio is 1%, what is the rate of return on the fund? A. 31.25% B. 19.85% C. 18.85% D. There is not sufficient information to answer this question

B. 19.85% Explanation: 70 * [(1 - .5) / (1 - .3)] = $50

11. An investor invests 40% of his wealth in a risky asset with an expected rate of return of 15% and a variance of 4% and 60% in a treasury bill that pays 6%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively. A. 8.0%, 12% B. 9.6%, 8% C. 9.6%, 10% D. 11.4%, 12%

B. 9.6%, 8% Explanation: E(rp) = .4(.15) + .6(.06) = .0960 Stdev = .4(.04).5 =.0800

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

B. Firm Specific Risk

18. Fama and French (1991) and Reinganum (1988) found that firms with __________ market/book ratios had higher stock returns. A. high B. low C. medium D. both a and b

B. Low

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

B. Systematic risk, nondiversifiable risk

4. The risk-free rate is usually approximated by ___________. A. the return on bank savings accounts B. the return on Treasury bills C. the return on money market mutual funds D. None of the above

B. The return on treasury bills

1. In the context of the capital asset pricing model, the systematic measure of risk is __________. A. unique risk B. beta C. standard deviation of returns D. variance of returns

B. beta

19. Diversification is most effective when security returns are __________. A. high B. negatively correlated C. positively correlated D. uncorrelated

B. negatively Correlated

29. The standard deviation of return on investment A is .20 while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is __________. A. .12 B. .28 C. .30 D. .75

C. .30 Explanation: Correlation = .0030/[.20(.05)] = .3

8. You invest $600 in security A with a beta of 1.2 and $400 in security B with a beta of .90. The beta of this formed portfolio is __________. A. 1.02 B. 1.05 C. 1.08 D. 1.10

C. 1.08 Explanation: .6(1.2) + .4(.9) = 1.08

6. Consider the multi-factor APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factors 1 and 2 portfolios are 1% and 7% respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist. A. 13.5% B. 15.0% C. 16.5% D. 23.0%

C. 16.5% Explanation: E('r) = .07 + .75(.01) + 1.25(.07) = .165

25. The term efficient frontier refers to the set of portfolios which _________________. A. yield the greatest return for a given level of risk B. involve the least risk for a given level of return C. Both a and b above D. None of the above answers are correct

C. Both a and b are true

12. Which of the following is not a method employed by followers of technical analysis? A. charting B. relative strength analysis C. earnings forecasting D. All of the above are methods employed by technical analysts

C. Earnings Forecast

22. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always __________. A. equal to the sum of the securities standard deviations B. equal to -1 C. equal to 0 D. greater than 0

C. Equal to 0

22. Which of the following contradicts the proposition that the stock market is weakly efficient. A. Over 25% of mutual funds outperform the market on average B. Insiders earn abnormal trading profits C. Every January, the stock market earns above normal returns D. Applications of technical trading rules fail to earn abnormal return

C. Every January, the stock market earns above normal returns

8. Historical returns have generally been __________ for stocks of small firms as/than for stocks of large firms. A. the same B. lower C. higher D. There is no evidence of a systematic relationship between returns on small firm stocks and returns on small firm stock

C. Higher

16. Jaffee found that stock prices __________ after insiders intensively bought shares and__________ after insiders intensively sold shares. A. decreased, decreased B. decreased, increased C. increased, decreased D. increased, increased

C. Increased, decreased

14. Evidence supporting semi-strong form market efficiency suggests that investors should make their investment choices according to ____________ A. technical analysis B. fundamental analysis C. indexing D. the recommendation of a broke

C. Indexing

19. Jegadeesh and Titman (1993) found that __________ exhibiting recent superior performance tend to continue to do well, while the performance of ___________ is highly unpredictable. A. individual stocks; portfolios of stocks B. individual stocks; portfolios of options C. portfolios of stocks; individual stocks D. portfolios of bonds; portfolios of stock

C. Portfolios of stocks, individual stocks

9. Historically small firm stocks have earned higher returns than large firm stocks. When viewed in the context of an efficient market, this suggests that ____________. A. small firms are better run than large firms B. government subsidies available to small firms produce effects that are discernible in stock market statistics C. small firms are riskier than large firms D. small firms are not being accurately represented in the data

C. Smaller firms are riskier than larger firms

21. __________ is a true statement regarding the variance of risky portfolios. A. The higher the coefficient of correlation between securities, the greater will be the reduction in the portfolio variance B. There is a direct relationship between the securities coefficient of correlation and the portfolio variance C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities D. none of the above

C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities

4. According to the capital asset pricing model, a security with a __________. A. negative alpha is considered a good buy B. positive alpha is considered overpriced C. positive alpha is considered underpriced D. zero alpha is considered a good buy

C. positive alpha is considered underpriced

Of the alternatives available, __________ typically have the highest standard deviation of returns. A. commercial paper B. corporate bonds C. stocks D. treasury bills

C. stocks

27. The optimal risky portfolio can be identified by finding _____________. A. the minimum variance point on the efficient frontier B. the maximum return point on the efficient frontier C. the tangency point of the capital market line and the efficient frontier D. None of the above answers is correct

C. the tangency point of the capital market line and the efficient frontier

30. A portfolio is comprised of two stocks, A and B. Stock A has a standard deviation of return of 5% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .2778. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The variance of return on the portfolio is __________. A. .0035 B. .0055 C. .0075 D. .0095

D. .0095 Explanation: Variance = =(.4)2(.05)2 + (.6)2(.15)2 + 2(.4)(.6)(.05)(.15)(.2778) Variance = .0095

7. Consider the one-factor APT. The variance of return on the factor portfolio is .06. The beta of a well-diversified portfolio on the factor is 1.3. The variance of return on the well-diversified portfolio is approximately __________. A. .0360 B. .0600 C. .0780 D. .1014

D. .1014 Explanation: Portfolio Variance = .06 * (1.3)^2

28. A portfolio is comprised of two stocks, A and B. Stock A has a standard deviation of return of 25% while stock B has a standard deviation of return of 5%. Stock A comprises 20% of the portfolio while stock B comprises 80% of the portfolio. If the variance of return on the portfolio is .0080, the correlation coefficient between the returns on A and B is __________. A. -.975 B. -.025 C. .025 D. .975

D. .975 Explanation: .0080=(.2)2(.25)2+(.8)2(.05)2 + 2(.2)(.8)(.25)(.05)Corr corr = .975

3. The market portfolio has a beta of __________. A. -1.0 B. 0 C. 0.5 D. 1.0

D. 1.0

16. The return on the risky portfolio is 18%. The risk-free rate as well as the investor's borrowing rate is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is __________. A. 16.00% B. 16.40% C. 19.20% D. 20.00%

D. 20.00% Explanation: y = .25/.20 = 1.25 E(rc) = 10 + 1.25(.18 - .10) = .20

13. You invest $100 in a complete portfolio. The complete portfolio is comprised of a risky asset with an expected rate of return of 12% and a standard deviation of 15% and a treasury bill with a rate of return of 5%. __________ of your money should be invested in the risky asset to form a portfolio with an expected rate of return of 9% A. 87% B. 77% C. 67% D. 57%

D. 57% Explanation: .09 = wp(.12) + (1-wp)(.05) wp=.57

15. You have $500,000 available to invest. The risk-free rate as well as your borrowing rate is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should __________. A. invest $125,000 in the risk-free asset B. invest $375,000 in the risk-free asset C. borrow $125,000 D. borrow $375,000

D. Borrow $375,00 Explanation: y = (.22-.08)/ (.16-.08) = 1.75 500,000*(1.75-1)= 375,000

23. Researchers have found that most of the small firm effect occurs __________. A. during the spring months B. during the summer months C. in December D. in January

D. In january

9. Fama and French claim that after controlling for firm size, and the ratio of book value to market value, beta is _____________ in explaining stock returns. A. more significant B. just as significant as before C. less significant D. insignificant

D. Insignificant

2. __________ is a true statement regarding the multi-factor arbitrage pricing theory. A. Only the stock beta affects the stock price B. Only the stock unique risk affects the stock price C. Only the stock variance and beta affect the stock price D. Several systematic factors affect the stock price

D. Several systematic factors affect the stock price

10. The expected return of the risky asset portfolio with minimum variance is __________. A. the market rate of return B. zero C. the risk-free rate D. There is not enough information to answer this question

D. There is not enough Information to answer this question

24. Firm specific risk is also called __________ and ___________. A. systematic risk, diversifiable risk B. systematic risk, non-diversifiable risk C. unique risk, non-diversifiable risk D. unique risk, diversifiable risk

D. Unique risk, diversifiable risk