FINA 469 Exam 1 Review

Which of the following correlation coefficients will produce the most diversification benefits? A. -.6 B. -.9 C. 0 D. .4

-.9 More negative = More diversification

A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. This portfolio had a Sharpe ratio of ____. a. .22 b. .60 c. .42 d. .25

.42 (15-4.5) / 25 = .42

An investor purchases one municipal bond and one corporate bond that pay rates of return of 5% and 6.4%, respectively. If the investor is in the 15% tax bracket, his after-tax rates of return on the municipal and corporate bonds would be, respectively, ________. A) 5.75% and 5.44% B) 4.25% and 6.4% C) 5% and 5.44% D) 5% and 6.4%

5% and 5.44%

The buyer of a new home is quoted a mortgage rate of .5% per month. What is the APR on the loan? a. .50% b. 5% c. 6% d. 6.5%

6% .5 x 12 Months = 6

You have an EAR of 9%. The equivalent APR with continuous compounding is _____. a. 8.47% b. 8.62% c. 8.88% d. 9.42%

8.62% LN[1 + .09] = 8.62%

If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn? a. 5.48% b. 8.74% c. 9% d. 12%

8.74% Real rate = (1.12/1.03) - 1 = 8.74%

Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this investment? a. 12.8% b. 11% c. 8.9% d. 9.2%

9.2% (.2)(30%) + (.5)(10%) + (.3)(-6%) = 9.2%

________ represents an ownership share in a corporation. A) Preferred stock B) A call option C) Common stock D) A fixed-income security

Common Stock

You short-sell 200 shares of Rock Creek Fly Fishing Co., now selling for $50 per share. If you want to limit your loss to $2,500, you should place a stop-buy order at ____. a. $37.50 b. $62.50 c. $56.25 d. $59.75

$62.50 Amount from Short Sale = 200 x 50 = 10,000 Loss = 2,500 2,500 = 200P - 10000 12,500 = 200P P = 62.50

Assume you purchased 500 shares of XYZ common stock on margin at $40 per share from your broker. If the initial margin is 60%, the amount you borrowed from the broker is _________. a. $20,000 b. $12,000 c. $8,000 d. $15,000

$8,000

Assume that you have just purchased some shares in an investment company reporting $500 million in assets, $50 million in liabilities, and 50 million shares outstanding. What is the net asset value (NAV) of these shares? a. $12 b. $9 c. $10 d. $1

$9 NAV = (500-50)/50 = 9

A T-bill quote sheet has 90-day T-bill quotes with a 4.92% bank discount rate (in other words 4.92 bid). If the bill has a $10,000 face value, an investor could buy this bill for ________. A) $10,000 B) $9,880.16 C) $9,877 D) $9,878.50

$9,878.50

An investment earns 10% the first year, earns 15% the second year, and loses 12% the third year. The total compound return over the 3 years was ______. a. 41.68% b. 11.32% c. 3.64% d. 13%

11.32% (1.10)(1.15)(1 - .12) - 1 = 11.32%

The historical average rate of return on large company stocks since 1926 has been ________ . A) 8% B) 20% C) 11.5% D) 5%

11.5%

Under SEC rules, the managers of certain funds are allowed to deduct charges for advertising, brokerage commissions, and other sales expenses directly from the fund assets rather than billing investors. These fees are known as ____________. a. direct operating expenses b. back-end loads c. 12b-1 charges d. front-end loads

12b-1 charges

You purchased a share of stock for $29. One year later you received $2.25 as dividend and sold the share for $28. Your holding-period return was _________. a. -3.57% b. -3.45% c. 4.31% d. 8.03%

4.31% (28 + 2.25 - 29) / 29 = 4.31

________ is not a money market instrument. A) Commercial paper B) A Treasury bill C) A Treasury bond D) A certificate of deposit

A Treasury bond

Which of the following is not a true statement regarding municipal bonds? A) The interest income from a municipal bond is exempt from state and local taxation in the issuing state. B) A municipal bond is a debt obligation issued by the federal government. C) A municipal bond is a debt obligation issued by state or local governments. D) The interest income from a municipal bond is exempt from federal income taxation.

A municipal bond is a debt obligation issued by the federal government.

________ is not a derivative security. A) None of the options B) A share of common stock C) A call option D) A futures contract

A share of common stock

Currently, the Dow Jones Industrial Average is computed by ________. A) adding the prices of 30 large "blue-chip" stocks and dividing by a divisor adjusted for stock splits and large stock dividends B) adding the prices of 30 large "blue-chip" stocks and dividing by 30 C) measuring the current total market value of the 30 stocks in the index relative to the total value on the previous day D) calculating the total market value of the 30 firms in the index and dividing by 30

Adding the prices of 30 large "blue-chip" stocks and dividing by a divisor adjusted for stock splits and large stock dividends

The systemic risk that led to the financial crisis of 2008 was increased by ________. A) collateralized debt obligations B) all of the options C) credit default swaps D) subprime mortgages

All of the options

Financial markets allow for all but which one of the following? A) channel funds from lenders of funds to borrowers of funds B) shift consumption through time from higher-income periods to lower C) price securities according to their riskiness D) allow most participants to routinely earn high returns with low risk

Allow most participants to routinely earn high returns with low risk

_____ is an example of an exchange-traded fund. a. An SPDR or spider b. A samurai c. A Vanguard d. An open-end fund

An SPDR or spider

You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________. a. dollar-weighted return b. geometric average return c. arithmetic average return d. index return

Arithmetic average return

Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______ A. asset A B. asset B C. no risky asset D. The answer cannot be determined from the data given.

Asset A

Which one of the following stock return statistics fluctuates the most over time? A. Covariance of returns B. Variance of returns C. Average return D. Correlation coefficient

Average return

Mutual funds that hold both equities and fixed-income securities in relatively stable proportions are called ____________________. a. income funds b. balanced funds c. asset allocation funds d. index funds

Balanced funds

The process of polling potential investors regarding their interest in a forthcoming initial public offering (IPO) is called ________. a. interest building b. book building c. market analysis d. customer identification

Book building

If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ______. A. calculate two covariances and one trivariance B. calculate only two covariances C. calculate three covariances D. average the variances of the individual stocks

Calculate three covariances

Real assets in the economy include all but which one of the following? A) buildings B) land C) consumer durables D) common stock

Common Stock

You are considering investing in one of several mutual funds. All the funds under consideration have various combinations of front-end and back-end loads and/or 12b-1 fees. The longer you plan on remaining in the fund you choose, the more likely you will prefer a fund with a __________ rather than a __________, everything else equal. a. 12b-1 fee; front-end load b. front-end load; 12b-1 fee c. back-end load; front-end load d. 12b-1 fee; back-end load

Front-end load; 12b-1 fee

Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk A. I only B. I and II only C. I, II, and III D. I and III

I and III

Money market securities are characterized by: I. Maturity less than 1 year II. Safety of the principal investment III. Low rates of return A) I and II only B) I only C) I, II, and III D) I and III only

I, II, and III

The cost of buying and selling a stock includes: I. Broker's commissions II. Dealer's bid-asked spread III. Price concessions that investors may be forced to make a. I and II only b. II and III only c. I and III only d. I, II, and III

I, II, and III

Which of the following are financial assets? I. Debt securities II. Equity securities III. Derivative securities A) I and II only B) I, II, and III C) I only D) II and III only

I, II, and III

You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security's: I. Expected return II. Standard deviation III. Correlation with your portfolio A. I only B. I and II only C. I and III only D. I, II, and III

I, II, and III

Rank the following from highest average historical return to lowest average historical return from 1926 to 2010. I. Small stocks II. Long-term bonds III. Large stocks IV. T-bills a. I, II, III, IV b. III, IV, II, I c. I, III, II, IV d. III, I, II, IV

I, III, II, IV

Preferred stock is like long-term debt in that ________. A) the preferred dividend is a tax-deductible expense for the firm B) it promises to pay to its holder a fixed stream of income each year C) in the event of bankruptcy preferred stock has equal status with debt D) it gives the holder voting power regarding the firm's management

It promises to pay to its holder a fixed stream of income each year

Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________. A. 1 B. less than 1 C. between 0 and 1 D. less than or equal to 0

Less than 1

An order to buy or sell a security at the current price is a ______________. a. limit order b. market order c. stop-loss order d. stop-buy order

Market order

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

Negatively correlated

An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolio B. risk-free rate C. optimal mix of the risk-free asset and risky asset D. capital allocation line

Optimal mix of the risk-free asset and risky asset

________ assets generate net income to the economy, and ________ assets define allocation of income among investors. A) Real, real B) Financial, financial C) Real, financial D) Financial, real

Real, Financial

The Dodd-Frank Reform Act does all of the following except: A) reduces capital requirements for banks. B) requires public companies to set "claw-back" provisions C) creates an office within the SEC to oversee credit rating agencies. D) increases transparency in the derivatives market E) limits the risk-taking in which banks can engage

Reduces capital requirements for banks

The Sarbanes-Oxley Act tightened corporate governance rules by requiring all but which one of the following? A) Required that corporations have more independent directors. B) Required that the CFO personally vouch for the corporation's financial statements. C) Required the creation of a new board to oversee the auditing of public companies. D) Required that firms could no longer employ investment bankers to sell securities to the public.

Required that firms could no longer employ investment bankers to sell securities to the public.

Specialized-sector funds concentrate their investments in _________________. a. bonds of a particular maturity b. geographic segments of the real estate market c. government securities d. securities issued by firms in a particular industry

Securities issued by firms in a particular industry

If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________. A. stock's standard deviation B. variance of the market C. stock's beta D. covariance with the market index

Stock's standard deviation

__________ often accompany short sales and are used to limit potential losses from the short position. a. Limit orders b. Restricted orders c. Limit loss orders d. Stop-buy orders

Stop-buy orders

You purchased XYZ stock at $50 per share. The stock is currently selling at $65. Your gains could be protected by placing a _________. a. limit buy order b. limit sell order c. market order d. stop-loss order

Stop-loss order

If an investor places a _________ order, the stock will be sold if its price falls to the stipulated level. If an investor places a __________ order, the stock will be bought if its price rises above the stipulated level. a. stop-buy; stop-loss b. market; limit c. stop-loss; stop-buy d. limit; market

Stop-loss; stop-buy

TIPS are ________. A) securities that trade on the Toronto stock index B) Treasury bonds that protect investors from inflation C) Treasury bonds that pay no interest and are sold at a discount D) U.K. bonds that protect investors from default risk

Treasury bonds that protect investors from inflation

Which one of the following would be considered a risk-free asset in real terms as opposed to nominal? a. Money market fund b. U.S. T-bill c. Short-term corporate bonds d. U.S. T-bill whose return was indexed to inflation

U.S. T-bill whose return was indexed to inflation

According to multiple studies by Ritter, initial public offerings tend to exhibit __________ performance initially and __________ performance over the long term. a. bad; good b. bad; bad c. good; good d. good; bad

good; bad

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________. A. -.0447 B. -.0020 C. .0020 D. .0447

-.0020 -.50(.10)(.04) = -.0020

You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is approximately _________. a. 1.040 b. .80 c. .50 d. .25

.50 Slope = (16 - 6)/20 = .50

You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible gain, ignoring transactions cost? a. $50 b. $150 c. $10,000 d. Unlimited

10,000 Tuckerton's Stock could fall all the way to 0 Max Gain = Proceeds - Min. Replacement Cost = 200(50) - 200(0) = 10,000

The Hydro Index is a price weighted stock index based on the 5 largest boat manufacturers in the nation. The stock prices for the five stocks are $10, $20, $80, $50 and $40. The price of the last stock was just split 2 for 1 and the stock price was halved from $40 to $20. What is the new divisor for a price weighted index? A) 4.50 B) 4.75 C) 5.00 D) 4.85

4.50 Index 1 = (Sum of Stocks) / 5 Stocks = 40 - (200 / 5) = 40 Index 2 = (Sum of Stocks - 20) / "X" Stocks = 40 - (180 / X) = 40 - X = 180/40 = 4.50

The margin requirement on a stock purchase is 25%. You fully use the margin allowed to purchase 100 shares of MSFT at $25. If the price drops to $22, what is your percentage loss? a. 9% b. 15% c. 48% d. 57%

48% Loss = (22-25) x 100 = -300 Amount Invested = .25 x 25 x 100 = 625 Loss % = -300/625 = 48%

The geometric average of -12%, 20%, and 25% is _________. a. 8.42% b. 11% c. 9.7% d. 18.88%

9.7% [(1 + −.12)(1 + .20)(1 + .25)]1/3- 1 = 9.70%

A benchmark index has three stocks priced at $23, $43, and $56. The number of outstanding shares for each is 350,000 shares, 405,000 shares, and 553,000 shares, respectively. If the market value weighted index was 970 yesterday and the prices changed to $23, $41, and $58 today, what is the new index value? A) 985 B) 975 C) 960 D) 970

975 (Sum of Stocks Day 0 / Sum of Stocks Day 1) x 970 = 975

You decide to purchase an equal number of shares of stocks of firms to create a portfolio. If you wanted to construct an index to track your portfolio performance, your best match for your portfolio would be to construct ________. A) a bond price index B) a value-weighted index C) a price-weighted index D) an equally weighted index

A price-weighted index

Which of the following is not a financial intermediary? A) an insurance company B) a credit union C) a mutual fund D) a real estate brokerage firm

A real estate brokerage firm

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

Borrow $375,000

Advantages of investment companies to investors include all but which one of the following? a. Record keeping and administration b. Low-cost diversification c. Professional management d. Guaranteed rates of return

Guaranteed rates of return

The _________ reward-to-variability ratio is found on the ________ capital market line. A. lowest; steepest B. highest; flattest C. highest; steepest D. lowest; flattest

Highest; steepest

Which of the following are true statements about T-bills? I. T-bills typically sell in denominations of $10,000. II. Income earned on T-bills is exempt from all federal taxes. III. Income earned on T-bills is exempt from state and local taxes. A) I and II only B) I, II, and III C) I and III only D) I only

I and III only

Active trading in markets and competition among securities analysts helps ensure that: I. Security prices approach informational efficiency. II. Riskier securities are priced to offer higher potential returns. III. Investors are unlikely to be able to consistently find under- or overvalued securities. A) I and II only B) II and III only C) I, II, and III D) I only

I, II, and III

Higher portfolio turnover: I. Results in greater tax liability for investors II. Results in greater trading costs for the fund, which investors have to pay for III. Is a characteristic of asset allocation funds a. I only b. II only c. I and II only d. I, II, and III

I, II, and III

Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk. A. I only B. II only C. II and III only D. I, II, and III

II and III only

The optimal risky portfolio can be identified by finding: I. The minimum-variance point on the efficient frontier II. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier III. The tangency point of the capital market line and the efficient frontier IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier A. I and II only B. II and III only C. III and IV only D. I and IV only

III and IV only

According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return trade-offs B. identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion D. choosing which risky assets an investor prefers according to the investor's risk-aversion level; minimizing the CAL by lending at the risk-free rate

Identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion

Which of the following is not a characteristic of a money market instrument? A) low risk B) maturity greater than 1 year C) marketability D) liquidity

Maturity greater than 1 year

Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? A. Market risk B. Unique risk C. Unsystematic risk D. None of these options (With a correlation of 1, no risk will be reduced.)

None of these options (With a correlation of 1, no risk will be reduced.)

__________ funds stand ready to redeem or issue shares at their net asset value. a. Closed-end b. Index c. Open-end d. Hedge

Open-end

______________________ are often called mutual funds. a. Unit investment trusts b. Open-end investment companies c. Closed-end investment companies d. REITs

Open-end investment companies

The ratio of trading activity of a portfolio to the assets of the portfolio is called the ____________. a. reinvestment ratio b. trading rate c. portfolio turnover d. tax yield

Portfolio turnover

According to the Flow of Funds Accounts of the United States, the largest single asset of U.S. households is ________. A) real estate B) mutual fund shares C) pension reserves D) corporate equity

Real Estate

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 should choose as part of her complete portfolio to achieve the best CAL would be _________. a. security A b. security B c. security C d. security D

Security A Slope = (.15 − .05)/(.04).5 = .5000

Investors who want to liquidate their holdings in a closed-end fund may ___________________. a. sell their shares back to the fund at a discount if they wish b. sell their shares back to the fund at net asset value c. sell their shares on the open market d. sell their shares at a premium to net asset value if they wish

Sell their shares on the open market

Initial public offerings (IPOs) are usually ___________ relative to the levels at which their prices stabilize after they begin trading in the secondary market. a. overpriced b. correctly priced c. underpriced d. mispriced, but without any particular bias

Underpriced

Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk? A. Market risk B. Nondiversifiable risk C. Systematic risk D. Unique risk

Unique risk

You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible loss? a. $50 b. $150 c. $10,000 d. Unlimited

Unlimited

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. A. up; right B. up; left C. down; right D. down; left

Up; left

In a ________ index, changes in the value of the stock with the greatest market value will move the index value the most, everything else equal. A) equally weighted index B) price-weighted index C) bond price index D) value-weighted index

Value-weighted index

Which of the following statistics cannot be negative? A. Covariance B. Variance C. E(r) D. Correlation coefficient

Variance