Chapter 12 Fin 407

Business risk can be thought of as the uncertainty of operating income.

True

From the standpoint of volatility, the two common measures of risk are beta and standard deviation.

True

Holding period return measures the total return an investor receives over the life of the investment.

True

If the beta of ABC Company is 1.2 and the market

True

Investing is based on the concept that False- Beta measures onforgoing immediate consumption provides for greater future consumption.

True

Liquidity is the ability to sell an investment quickly and at a competitive price, with no loss of principal and little price concession.

True

Market timing is an investment strategy that investors use to be fully invested in periods of increasing stock prices and be out of the market during periods of declining stock prices.

True

Modern portfolio theory is based on the diversification process.

True

Preferred stocks are similar to bonds because their fixed income payments are also determined as a percentage of par value.

True

Reinvestment rate risk is the risk that earnings (cash flows) distributed from current investments will not be reinvested in a rate of return equal to the expected yield of the current investment.

True

Selecting the single best portfolio along the efficient frontier for a particular investor depends on being able to accurately assess the investor's personal preferences for expected return and risk.

True

Some common investment goals include purchasing a home, funding children's education, and saving for retirement.

True

Standard deviation measures the total volatility and total risk (systematic and unsystematic) or a portfolio.

True

The capital asset pricing model (CAPM{) is an asset-pricing model that developed from the Markowitz efficient frontier and the introduction of a risk-free asset.

True

The coefficient of determination describes the percentage of variability of returns of an asset that can be explained by changes in the returns of another asset.

True

The correlation coefficient is a statistical measure generated from a regression analysis that provides insight into the relationship between two securities, two portfolios, or two indexes.

True

The efficient market hypothesis is a theory that suggest securities are priced fairly and efficiently by the market and investors are unable to consistently outperform the market on a risk-adjusted basis.

True

The purpose of budgeting is to manage the amount of income and expenses on a monthly basis.

True

The three ways to invest in natural resources are through direct investing in limited partnerships, investing in stocks of natural resource companies, and investing in natural resource mutual funds.

True

Three advantages of real estate investments are cash flow, depreciation deductions, and low correlation with other asset classes.

True

Which of the following statements regarding derivatives is(are) CORRECT? I. Derivatives are securities that derive their value in whole or in part by having a claim on certain underlying securities. II. Gains or losses on the sale of derivatives will depend on their difference between the purchase price and the sales price. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding capital market theory is(are) CORRECT? I. The capital market line (CML) is the graphical depiction of the capital asset pricing model (CAPM). II. The capital market line (CML) depicts the trade-off between risk and expected return for all assets, especially individual securities. A. I only B. II only C. Both I and II D. Neither I nor II

A. I only

Which of the following statements regarding futures contracts is(are) CORRECT? I. A futures contract is an agreement that provides for the future exchange of a particular asset or commodity between a buyer and a seller. II. Most participants in futures are either hedgers or speculators- hedgers seek to profit form the uncertainty of the future; speculators seek to reduce price uncertainty over some future period. A. I only B. II only C. Both I and II D. Neither I nor II

A. I only

Which of the following statements regarding market efficiency is(arE) CORRECT? I. The efficient market hypothesis (EMH) is the proposition that securities markets are efficient and that the prices of securities reflect their current economic value. II. Investors who believe the EMH usually adopt an active investment strategy. A. I only B. II only C. Both I and II D. Neither I nor II

A. I only

Which of the following statements regarding the use of a passive investment strategy in common stock valuation is(are) CORRECT? I. If the securities market is totally efficient, no active investment strategy should be able to beat the market in a risk-adjusted basis; therefore, a passive investment strategy may be superior. II. Passive investment strategies include stock selection, sector rotation, and market timing A. I only B. II only C. Both I and II D. Neither I nor II

A. I only

Which of the following statements regarding the use of an active investment strategy in common stock evaluation is(are) CORRECT? I. Pursuit of an active investment strategy assumes that investors possess some advantage relative to other market participants, such as superior analytical skills. II. Active investment strategies include buy-and-hold and using index funds. A. I only B. II only C. Both I and II D. Neither I nor II

A. I only

All of the following are investments available through direct investing EXCEPT A. Savings deposits, certificate of deposit, and U.S. savings bonds B. Money market and hybrid mutual funds C. Treasury bills, commercial paper, and eurodollars D. Option and futures contracts

B. Money market and hybrid mutual funds

Which of the following statements regarding market efficiency is(are) CORRECT? I. An efficient market is one in which security prices quickly and fully reflect all available information. II. The efficient market hypothesis states that securities markets are efficient and security prices reflect their true economic value. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding risk and return on investments are correct EXCEPT A. Market risk includes a wide range of factors originating outside of securities, including recessions, wars, structural changes in the economy, and changes in consumer preferences B. Exchange rate risk is the variability in returns on securities caused by currency fluctuations C. A Treasury bill may have substantial liquidity risk, where as a small over-the-counter (OTC) stock has little or no liquidity risk D. Inflation risk, or purchasing power risk, is the variability in security returns caused by the changes in the purchasing power of invested dollars

C. A Treasury bill may have substantial liquidity risk, where as a small over-the-counter (OTC) stock has little or no liquidity risk

Which of the follow statements regarding the machine of futures trading is(are) CORRECT? I. Short position is an agreement to sell an asset at a specified future date at a specified time. II. Long position is an agreement to purchase an asset at a specified future date at a specified price. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding building an efficient portfolio is(are) CORRECT? I. An efficient portfolio is one with the highest level of expected return for a given level of risk or one with the lowest risk for a given level of expected return. II. The efficient frontier is the set of efficient portfolios generated by the Markowitz portfolio model. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding market efficiency is(are) CORRECT? I. To assess market efficiency, three cumulative forms of efficiency are discussed: the weak form, the semi-strong form, and the strong form II. The weak for of market efficiency involves market data, whereas the semi-strong and strong forms involve the assimilation of all public and private information, respectively. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding option is(are) CORRECT? I. Buyers of calls are betting that the price of the underlying common stock will risk, making the call option more valuable. II. Put buyers are betting that the price of the underlying common stock will decline, making the put option more valuable. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding options is(are) CORRECT? I. The call option buyer expects the price of the stock to move up and relatively soon. II. The put option buy expects the price of the stock to move down and relatively soon. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding risk is(are) CORRECT? I. Interest rate risk is the variability of a security's returns resulting from changes in interest rates. II. Inflation risk, or purchasing power risk, is the variability of security returns caused by the decline in the purchasing power of invested dollars. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding systematic and unsystematic risk is(are) CORRECT? I. Systematic risk represents the portion in the variability of a stock's total return that is directly associated with overall movements in the general economy of stock market. II. Unsystematic risk represents the portion in the variability of a stock's total return that is not related to the variability in general economic activity. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding the measuring of rate of return on investment is(are) CORRECT? I. Arithmetic mean is a better measure of average (typical) performance over single period. II. Geometric mean is a better measure of the change in wealth over time (multiple periods) A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding the total risk of an asset is(are) CORRECT? I. Systematic risk is the risk attributable to broad macroeconomic factors affecting all securities such as interest rate risk, market risk, and inflation risk. II. Unsystematic risk is the risk attributable to factors unique to an individual security, such as business risk, financial risk, and liquidity risk. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding the use of passive investment strategies as a way to select and manage common stock is(are) CORRECT? I. Passive investment strategies emphasize minimizing transaction costs and time spent in managing the stock portfolio because expected benefits from active trading or analysis are likely to be less than the costs. I. Passive investors act as if the market is efficient and accept the consensus estimates of return and risk, regarding current market price as the best estimate of a security's value. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II

Which of the following statements regarding portfolio management (is)are CORRECT? I. Portfolio management consists of building a portfolio, revising the portfolio on a regular basis, and measuring the portfolio's performance. II. If an investor pursues an active investment strategy, the issue of market efficiency must be considered when revising a portfolio. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

All of the following statements regarding the use of the correlation coefficient in reducing portfolio risk are correct EXCEPT A. Combines securities that have perfect positive correlation with each other provides no portfolio risk reduction B. Combining two securities that have zero correlation with each other reduces portfolio risk C. Combining two securities that have perfect negative correlation provides no portfolio risk reduction D. Investors should seek out securities with the least correlation possible to reduce portfolio risk

C. Combining two securities that have perfect negative correlation provides no portfolio risk reduction

All of the following statements regarding the machines of future trading are correct EXCEPT A. Because a futures contract is a commitment to buy or sell a specific commodity at a specified feature settlement date, no money is exchanged at the time the contract is negotiated. B. In futures trading, the seller and the buyer are agreeing to make and take delivery, respectively, at some future time for a price agreed upon today. C. Similar to an options contract, a features contract involves the right to make or take delivery. D. When buyers sell their positions and sellers buy their positions sometime before delivery, an offsetting transaction has occurred and holders have liquidated their positions.

C. Similar to an options contract, a features contract involves the right to make or take delivery.

Which of the following definitions best describes risk? A. The return expected by investors over some future holding period B. Actual return on an investment for a previous period C. The chance that the actual return on an investment will be different from the expected return D. The return on a riskless asset, often proxied by the rate of return on U.S. Treasury securities

C. The chance that the actual return on an investment will be different from the expected return

Which of the following statements regarding derivative securities is(are) CORRECT? I. A call option is an option to sell a specified number of shares of stock at a stated price within a specified period. II. A put option is an option to buy a specified number of shares of stock at a stated price within a specified period. A. I only B. II only C. Both I and II D. Neither I nor II

D. Neither I nor II

All of the following statements regarding capital market theory are correct EXCEPT A. The capital asset pricing model (CAPM) allows an analyst to measure the relevant risk of an individual security as well as to assess the relationship between the risk and returns expected from investing. The capital asset pricing model (CAPM) relates the required rate of return for any security to the risk for that security as measured by beta. C. The market portfolio is the portfolio of all risk assets, with each asset weighted by the ratio of its market value to the market value of all risky assets. D. The capital market line (CML), also known as the security market line, is the trade-off between expected return and risk only for efficient portfolios.

D. The capital market line (CML), also known as the security market line, is the trade-off between expected return and risk only for efficient portfolios.

Anomalies are occurrences in the stock market that are supposed by the concept of an efficient market.

False

Beta is commonly used measure of total risk that is derived from regression analysis.

False

Bonds provide investors with little security because they generally make irregular coupon payments.

False

Call options are derivatives that give the holder the right to sell the underlying security, whereas put options are derivatives that give the holder the right to purchase the underlying security.

False

Changes in interest rates influence only the current market price of the bond and not the value of reinvested coupon payments.

False

Financial growth is the only element to consider in achieving financial goals.

False

Foreign power risk is the risk that a change in the relationship between the value of the dollar and the value of the foreign currency will occur during the period of investment.

False

Geometric mean is not as accurate as the arithmetic mean, and the difference becomes greater as returns become more volatile.

False

LEAPS are long0term options with expiration dates extending past 5 years.

False

Market risk, interest rate risk, purchasing power risk, country risk, and reinvestment rate risk are all examples of systematic risks.

False

Only bonds issued by municipalities are subject to default risk.

False

Passive investment management is an attempt to find undervalued or mispriced securities in order to earn higher returns than the overall market.

False

Semivariance only considers the returns and volatility above the expected or average return.

False

Speculators and hedgers use futures contracts for the same reasons.

False

Systematic risks are only affected by narrow economic factors that influence a few securities.

False

Tangible assets, such as collectibles, are usually characterized by an efficient market and liquidity.

False

The United States is generally thought to have the lowest country risk because its political and economic systems are the most unstable.

False

The higher the correlation coefficient between asset classes, the lower the standard deviation of the total portfolio.

False

The internal rate of return (IRR) measures the discounted future cash flows to the future value of the asset.

False

The range for covariance is from +10 to -10.

False

The systematic risk where changes in interest rates will affect the value of securities is known as default rate risk.

False

The use of debt magnifies return on equity (ROE) and makes gains and losses less volatile.

False

Unsystematic risks are risks that are not unique to a single company, industry, or country.

False

An indirect relationship exists between risk and return.

False.

An asset allocation for a client's portfolio is derived through a mean-variance optimization model.

True

Asset allocation provides an investor with a guide to how much of the portfolio should be invested in each representative asset class.

True

Behavioral finance is a branch of personal finance that proposes psychology-based theories to explain investor behavior and stock market anomalies.

True