Practice Q's

B (overconfidence leads to overtrading)

80.0% complete Question In comparing the performance of two mutual funds over the previous five-year period, you note that the annual returns of the funds are quite similar year-to-year. You also note that one of the funds has a portfolio turnover that averages 12 times the value of the portfolio (i.e., the dollar amount of trades the fund made for the year is 12 times the average dollar value of the portfolio) For one year, turnover was as high as 26. The comparison fund's portfolio turnover never exceeded 0.8 and averaged 0.4 for the five year period. From a behavioral finance point of view, the high turnover fund's management most likely exhibits: A. anchoring. B. overconfidence. C. regret avoidance. D. representativeness.

A (rates are lower so higher risk for inflation)

80.0% complete Question Which of the following best describes the investment characteristics of a high-quality long-term municipal bond? A. High inflation risk; low default risk. B. Low inflation risk; high market risk. C. Low inflation risk; low default risk. D. High inflation risk; high market risk.

B (Another group which insures municipal bonds is the American Municipal Bond Assurance Corporation)

Often, municipal bonds are insured. One group which insures them is the: A. Municipal Insurance Group. B. Municipal Bond Insurance Association. C. Federal Insurance Guarantee Corporation. D. Resolution Trust Corporation.

B (The price changes when interest rates change but if you don't sell the bond aka buy and hold then the price change doesn't really matter. You still get the $1,000 par value at maturity.

Which of the following can be eliminated using a "buy and hold" strategy with regard to fixed income securities? A. Future value risk. B. Interest rate risk. C. Stand alone risk. D. Reinvestment rate risk.

D

Which of the following statements concerning the S&P 500 is incorrect? A. It has less dramatic fluctuations than the Dow Jones Industrial Average. B. It is a reflection of broad sectors of the market. C. It is a value-weighted index. D. It is a broader base measure of the stock market than the Wilshire 5000 Index.

B (Choice "I" (Bonds A and C) have the same coupon, but Bond A has a shorter maturity therefore less volatility. Choice "II" (Bonds D and E) both mature in 15 years, but Bond D's lower coupon makes it more volatile. Choice "III" (Bonds C and B) both have the same maturity, but Bond B's lower coupon means it is more volatile. Choice "IV" (Bonds B and D) is a true statement due to both coupon and maturity.)

Which of the statements below correctly describes the potential price volatility of the following five bonds? I. Bond A: A-rated; 7% coupon; matures in 10 years. II. Bond B: A-rated; 6% coupon; matures in 12 years. III. Bond C: A-rated; 7% coupon; matures in 12 years. IV. Bond D: A-rated; 5% coupon; matures in 15 years. V. Bond E: A-rated; 6% coupon; matures in 15 years. A. Bond A has greater potential for price fluctuations than Bond C. B. Bond D has greater potential for price fluctuations than Bond E. C. Bond C has greater potential for price fluctuations than Bond B. D. Bond D has greater potential for price fluctuations than Bond B.

D

Which of these bonds initially immunizes a bond portfolio if the investors time horizon is 8 years? A. 20 year zero coupon B. Series of Tbills C. Coupon paying bond maturing in 8 years D. Coupon paying bond maturing in 10 years

B (the lower the coupon, the higher the duration. longer duration is greater sensitivity to interest rate risk)

You are faced with several fixed income investment options. Which of these bonds has the greatest interest rate risk? A. A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%. B. A U.S. Treasury strip bond (zero-coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%. C. A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%. D. A U.S. T-bill selling for $950 due in six months. Solution

treasury shares

_____________ are shares that have been repurchased by the corporation

revenue bonds

municipal bonds that are backed by a specific project -NOT backed by the full faith and credit and taxing authority of the entity that issued the bond

confirmation bias

you do not get a second chance at a first impression is an ex of _______________________

C

"Stock prices adjust rapidly to the release of all new public information." This statement is an expression of which one of the following ideas? A. Random walk hypothesis. B. Arbitrage price theory. C. Semi-strong form of the Efficient Market Hypothesis. D. Technical analysis.

C (mutual funds are not tax efficient)

17.4% complete Question A young couple (both age 30) comes to the financial planner with the desire for assistance in improving their family's financial position. They have two healthy children, ages 3 and 6. The husband is a foreman for a manufacturer of auto parts. His current salary is $30,000 per year. The wife is a marketing professor for a state university. Her current salary is $40,000 per year. The couple recently purchased a riverfront home for $100,000 using their entire savings of $20,000 as a down payment. In addition to an $80,000 mortgage, the couple's only debt is an automobile loan having a balance of $12,000. Both husband and wife have very good family health insurance from their employers. The wife has employer-paid life insurance equal to two times her annual salary. When the couple is able to begin an investment program, they want to begin making investments for their retirement and their children's education. Which of the following actions will be the LEAST tax-efficient manner of helping to accomplish the stated goals? A. Investing in individual Roth IRAs. B. Investing through a 403(b) program for the wife. C. Investing in a growth and income mutual fund. D. Investing in Coverdell Education Savings Accounts (CESAs)

A (overconfidence leads to overtrading)

A client invested in a stock recommended by a friend who worked in a bank. The stock provided the client with an 80% return within a year. When the client called his financial planner to discuss investments, the client wanted to add some new stocks to his portfolio. The client explained that he had been so successful in selecting the stock that appreciated by 80% that he wanted to make some additional selections. Which of the behavioral finance biases is most likely present in this client's situation? A. Overconfidence B. Anchoring C. Confirmation bias D. Recency

D (Choice "I" - Treasury securities have interest rate risk if sold prior to maturity. Choice "III" - U.S. government issued securities are said to be free of political or "country" risk.)

A new client owns a U.S. Treasury bond that matures in 26 years. She purchased the bond because she was told that Treasury bonds are risk free. Which of the following statements about Treasury security risks should you communicate to your client? 1. Treasury securities do not have interest rate risk because their coupons are fixed at the time of issue. II. Treasury securities with long maturities have purchasing power risk because their coupon returns are fixed, even if inflation rates rise substantially over the holding period. III. Treasury securities have country risk because they are direct obligations of a national government. IV. Treasury securities do not have default risk because the federal government has the power to tax and create money. A, I and II only. B. I and III only. C. II and III only. D. II and IV only.

D (they do NOT eliminate exchange risks. Its foreign stock held in domestic banks' foreign branch. Trade on US exchange, in US dollars)

American Depository Receipts (ADRs) are for the following purpose(s): I. Finance foreign exports. II. Eliminate currency risk. III. Sell U.S. Securities in overseas markets. IV. Trade foreign securities in U.S. markets. A. I and III only. B. I and IV only. C. II and IV only. D. IV only.

A (Buying a put means the option to sell at a specific price aka they think the price will go down so they want to lock in their sale price now. Rising interest rates cause bond prices to drop so a put option hedges against that)

An investor may use options on debt instruments to protect against: A. Interest rate risk. B. Reinvestment rate risk. C. Default risk. D. Call risk.

C

An old Wall Street saying is, "Cut your losses and let your profits run." However, investors often do the opposite. It seems that people are reluctant to admit they made a mistake in purchasing a stock that subsequently performs poorly. This behavior is most consistent with: A. anchoring. B. herd mentality. C. regret avoidance. D. representativeness.

D

Eddie Bauer bought a tax-exempt Original Issue Discount (OID) bond in November of 1998. Which of the following statements is/are true? I. The bond basis increases at a set rate each year. II. The difference between maturity value and the original issue discount price is known as the OID. III. The bond's earnings are treated as exempt interest income. IV. The bond was issued at a discount to its par value. A. II and III only. B. I and IV only. C. I, II and IV only. D. I, II, III and IV.

A (anchoring results in buying securities that have fallen in value bc it 'must' get back up to that recent high. Hindsight bias is a form of overconfidence related to an investor's belief that they had predicted an event that, in fact, they did not predict. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret. Representativeness is thinking that a good company is a good investment without regard to an analysis of the investment.)

In an after-dinner conversation, your neighbor states that Hot-Flow, Inc. must certainly be a good investment now that the stock has fallen from its recent high of $80 per share. The company currently trades for $65 per share. You ask your neighbor if she has any other information on which to base her buy recommendation. "Not really," she replies, "but if the stock was $80 per share last month, surely it will return to that level in the near future. After all," she continues, "how much can things change in just a few months of time?" Your neighbor's attitude is best described as: A. anchoring. B. hindsight bias. C. regret avoidance. D. representativeness.

D (Interest rate risk does not affect a bond investor if he or she holds the securities to maturity. This is how unit investment trusts are structured. The energy sector will be directly impacted by regulatory influences of a political nature)

Jack Rich has an investment portfolio equally divided among the following funds: Energy sector fund, Bond Unit Investment Trust (25-year average maturity), and a Money Market fund. He is a buy-and-hold investor. Which of the following risks is his portfolio exposed to? I. Business risk. 2. Interest rate risk. 3. Political risk IV. Purchasing power risk. A. I and III only. B. II and IV only. C. I, II and III only. D. III and IV only.

A (The Municipal Bond Insurance Association provides protection against bond default (safe). Munis will provide steady income and they are tax advantaged. Treasury zeroes pay tax on accrued but unrealized income (phantom income.) CMOs, GNMAs, and Mortgage REITs all have volatility of payment and all run the risk of being paid off early if mortgagees decide to refinance their obligations.)

Jocelyn Jane has come to you asking about investments that will produce steady income, provide relative safety of principal, and give her a tax advantage. What will you recommend that she consider adding to her portfolio? A.MBIA-backed municipal bonds. B. Zero-coupon U.S. Treasury bonds. C. Collateralized Mortgage Obligations. D. A mortgage REIT.

C (For dependent children, unearned income over $2,300 is subject to tax at the parent's tax rates. 5,000-2,300 = 2,700)

Junior is 8 years old and has an UGMA account that has been funded with various bonds by Senior. Junior's interest income is $5,000 for the current tax year. How much of the interest will be subject to the parent's tax rate? A. $1,150 B. $2,300 C. $2,700 D. $3,850

A (weak form believes in fundamental analysis aka ratio analysis, economic data, financial performance of the firm)

Kimberly Thurman is a private investor who researches individual stock purchases thoroughly. She studies company annual reports and 10k reports, computes comparative financial ratios from the reports, and compares company financial information to industry statistics to find undervalued stocks. Kim believes in: A. The weak form of the efficient market hypothesis. B. The neglected firm effect. C. The random walk hypothesis. D. The semi-strong form of the efficient market hypothesis.

D (If rates on the mortgage backed securities do not keep up with inflation and rising rates, their purchasing power will be reduced, as will their value (interest rate risk). If interest rates fall, the mortgagees may seek refinancing and prepay their obligations early.)

Mortgage-backed securities may contain which of the following risks: I. Purchasing power risk. II. Interest rate risk. III. Prepayment risk. A. II only. B. I and II only. CI and III only. D. I, II and III.

A (with belief perseverance people are unlikely to change their views given new info)

Over the previous several months, Mathew Arkins, CFP®, has presented senior executives at West-Ark Financial Planning with numerous research reports indicating that several of the recommendations West-Ark has been making to their clients are no longer in favor with the analysts providing the research reports. Despite this apparent change in heart by the analysts, West-Ark has yet to adjust its advice to clients. Which behavioral bias is most evident for West-Ark? A. Belief perseverance. B. Herd mentality. C. Hindsight bias. D. Overconfidence.

C (a person under the age of 19 or under the age of 24 and a full-time student at the end of the tax year, would pay tax at their parent's tax rate if they had more than $2,300 in unearned income. Thus, $100 of Derek's income is taxed at his parent's tax rate. Danny avoids this as $900 is under the standard deduction. Brian's income is earned and the kiddie tax applies only to unearned income and Courtney is 19. If the question stated that Courtney was a full-time college student then "B" would be the correct answer but you can't assume those facts.)

Steven and Julie's children have the following for this year: - Brian, age 12, earns $2,500 in salary mowing lawns. - Courtney, age 19, earns $2,300 in dividends and capital gains. - Derek, age 16, earns $2,400 in dividends and interest. - Danny, age 10, earns $900 in dividends and interest. Whose income is subject to the tax at their parent's tax rate? A. Brian. B. Courtney and Derek. C. Derek. D. Brian, Courtney and Derek.

B (By selling securities the Federal Reserve is taking cash off the market, which increases interest rates. Aka it increases the cost of money so it lessens the funds for investment, which lowers stock prices.

The Federal Reserve Board is expected to sell large quantities of Treasury securities in the near future. What impact will these sales likely have on stock prices? A. Stock prices will decrease because the dividend growth rate of stocks will increase. B. Stock prices will decrease because the required rate of return for investors will increase. C. Stock prices will increase because interest rates will decrease as investors compete to purchase the Treasury securities. D. Stock prices will increase because the growth rate in dividends and earnings will increase.

C (option A is the current ratio, B is the debt ratio, D is a budget)

The client's "Emergency Fund Ratio" reveals: A. How readily a client would be able to meet all current obligations immediately. B. The level of debt that has been used to finance the present lifestyle. C. The client's level of preparedness for job loss or short-term disability. D. The client's savings and spending patterns over a period of time.

D (Preferred stocks are non-voting shares. The description of Option "A" is of common stocks' cumulative voting rights. Option "B" refers to convertibility, while Option "C" addresses participating preferred stocks.)

The cumulative feature on a preferred stock is best described in the following: A. The preferred stock gets to cast its entire total of votes in a grouping for one seat on the board of directors if the shareholders so desire. B. The preferred shareholder has the option of accruing a certain number of shares and then converting them to common stock. C. If there are additional or extra dividends declared, the preferred shareholders have the right to share in the profits. D. If dividends are not paid in a given cycle, they cannot be paid to anyone else until they are paid to preferred shareholders.

B (the lower the coupon the greater the volatility)

The following set of newly issued debt instruments was purchased for a portfolio: - Treasury bond. - Zero-coupon bond. - Corporate bond. - Municipal bond. The respective maturities of these investments are approximately equivalent. Which one of the investments in the proceeding set would be subject to the greatest relative amount of price volatility if interest rates were to change quickly? A. Treasury bond. B. Zero-coupon bond. C. Corporate bond. D. Municipal bond.

B (Baa is the lowest investment grade in moody's while BBB is the lowest investment grade in the S&P)

The lowest bond rating that can still be considered investment grade debt is: A. A B. Baa C. BB D. Caa

D (Financial risk has to do with the amount of leveraging or use of borrowed funds a firm utilizes to structure its investment and finance its assets.)

The type of risk which measures the extent to which a firm uses debt securities and other forms of debt in its capital structure to finance is known as: A. Business risk. B. Systematic risk. C. Default risk. D. Financial risk.

C (Serial bonds are issued in series and mature in series. Registered bonds are paid interest based on to whom the bonds are registered. Bearer bonds pay interest to the holder of the bond. Interest rates can be reset on Reset bonds, and the U.S. government issues Treasury bonds; and both are registered)

These bonds are considered to be owned by whoever possesses them: A. Serial bonds. B. Registered bonds. C. Bearer bonds. D. Reset bonds.

A (the tax swap is meant to offset capital gains and losses not yields)

Which of the following statement(s) regarding bond swaps is/are true? I. A substitution swap is designed to take advantage of anticipated and potential yield differentials between bonds that are similar with regard to coupons, rating, maturities, and industry. II. Rate anticipation swaps utilize forecasts of general interest rate changes. III. The yield pickup swap is designed to alter the cash flow of the portfolio by exchanging similar bonds having different coupon rates. IV. The tax swap is made to substitute current yield in place of capital gains. A. I, II and III only. B. I and III only. C. II and IV only. D. IV only.

A (Option "III" - Dividends are set at issue by the Board as a percent of par value and do not change. Option "IV" - Changes in interest rates directly impact preferred stock, and there is no relief on preferred stock because most cannot be held to maturity (as most are issued without a maturity date). Preferred stock is more risky than bonds because bonds are a legal obligation and have a higher priority in bankruptcy proceedings.)

Which of the following statements about preferred stock are true? I. Its market fluctuations are greater than the long-term bond market fluctuations. II. It is more risky than debt. III. Its dividends are recomputed quarterly. IV. It has no interest rate risk because it is a stock and not a bond. A. I and II only. B. I and IV only. C. II and III only. D. II and IV only.

B (Choice "II" is untrue because systematic risk cannot be diversified away. Choice "V" is untrue because beta measures systematic risk, and not all risk inherent (in this case diversifiable risk) is measured by beta)

Which of the following statements regarding investment risk is correct? I. Beta is a measure of systematic, non-diversifiable risk. II. Rational investors will form portfolios and eliminate systematic risk. III. Rational investors will form portfolios and eliminate unsystematic risk. IV. Systematic risk is the relevant risk for a well-diversified portfolio. V. Beta captures all the risk inherent in an individual security. A. I, II and V only. B. I, III and IV only. C. II and V only. D. II, III and IV only.

C (if corporations own less than or equal to 20%, corporations get 50% of dividends tax free, if corporations own btw 20-80%, they get 65% of the dividends tax free, if the corporation owns more than 80%, they get 100% tax free)

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.

D (Alpha is a stand alone measure, not a comparison. Alpha indicates better than expected returns or worse than expected returns. Since we are dealing with actual return comparison, and not CAPM (expected return), Alpha is not an appropriate measure in this case. So use Treynor and Sharpe ratio comparison here. Sharpe compared to Sharpe and Treynor Compared to Treynor)

Which portfolio manager has out performed the market, if the market had a standard deviation of 18.27%, a return of 10.23%, and the risk-free rate was 2.76% over the period in consideration? A. Manager A, over the period under consideration, had a portfolio which returned 12.12% with a standard deviation of 23.51% B. Manager B, over the period under consideration, had a portfolio which returned 13.3% with a beta of 1.44 C. Manager C, over the period under consideration, had a portfolio which returned 9.23% with a beta of .89 D. Manager D, over the period under consideration, had a portfolio which returned 15.12% with a standard deviation of 29.85%

B (the lower the coupon the more volatile the bond and the longer the duration)

You are faced with several fixed income investments. Which of the following bonds has the longest duration? A. A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%. B> A U.S. Treasury strip bond (zero coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%. C. A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%. D. A U.S. Treasury bill due in 3 months trading for $985.34.

CMO

____________ is when investors are divided into tranches aka short, intermediate and LT. Short term tranches receive principal repayment first. A pool of mortgages; the _________ receives cash flows as borrowers repay mortgages. -

gold

_____________ has a negative correlation to the market and can be used when interest rates are rising as a hedge to inflation

alpha

_____________ is calculated using Jenson's model. It is the difference btw a fund's realized return and its risk adjusted expected return. A positive _____ means the fund manager provided more return than was expected for the risk undertaken.

representativeness

________________ is buying into a company that you think is good without any regard to analysis

anchoring

___________represents the investor's inability to objectively review and analyze new information. it results in buying securities that have fallen in value bc it "must" get back up to that recent high

zero coupon

a _____________ bond is sold at a discount. Holder recognizes income each year even though interest is not received (phantom income). Highest duration

debenture

a ______________ is unsecured corporate debt. Backed by general credit rather than specific assets

hindsight bias

a form of overconfidence where an investor believes they have predicted an event when they have not

longest (longer duration=more price sensitive to interest rates)

choose: longest, shortest bonds with long maturities and low coupons have the ___________ durations

lower, more volatile

choose: lower/higher, less volatile/more volatile the ____________ the coupon, the ___________ the bond

longer, more volatile

choose: shorter/longer, less volatile, more volatile the _________________ the maturity, the ________________ the bond

have, do not have

choose; have, do not have treasury securities __________ interest rate risk if sold prior to maturity. They ______ interest rate risk if held to maturity

recency

giving too much weight to recent observations

overconfidence

hindsight bias and cognitive dissonance are each a form of ____________

belief perseverance

people are unlikely to change their views given new info

EE bonds

sold at face value thru Treasury direct; interest is not federally taxed until redeemed, tax free at the state level. *********** federally tax free if used for education

ladder

the ______________ bond strategy when bonds are bought with varying maturities; reduces interest rate risk

barbell

the bond _________ strategy is when bonds for a portfolio are bought with long and short maturities with few intermediate bonds.

preferred stock

with _________, it has equity and debt features. debt features: stated par value, dividend rate is a % of par equity features: price moves with the price of common stock -no maturity date like a bond and dividend does not fluctuate like common stock. -price of __________ is tied more to interest rates than common stock -if corporations own less than or equal to 20%, corporations get 50% of dividends tax free, if corporations own btw 20-80%, they get 65% of the dividends tax free, if the corporation owns more than 80%, they get 100% tax free