FINC 315 Final

slope of the security market line

(Rm-Rf)

slope of the capital market line

(Rm-Rf)/(market std dev)

Assume the risk-free rate is 5%. The expected return on the market portfolio is 12% and its standard deviation is 20%. A company has an expected return of 18%, a standard deviation of 90%, and a correlation of 0.5 with the market. What is the company's Treynor ratio?

0.058 β = COR(I,M) x σi / σm = 0.5 x 0.9 / 0.2 = 2.25 ->(18% - 5%) / 2.25 = 0.058

64. A portfolio consists of 45% of wealth invested in the market portfolio and the remaining in risk¬free T-bills yielding 6.3%. The market portfolio has an expected return of 17% and a standard deviation of 19%. The beta of the portfolio is ______.

0.45 If your wealth is divided between the market portfolio and the risk¬free asset, the portfolio beta equals the fraction invested in the market portfolio. It is instructive to prove this either by using the CAPM equation directly or by calculating the covariance between the portfolio and the market.

Portfolios located on the CML may be constructed by:

1) investing a portion of an investor's capital in the riskfree asset and the balance in the market portfolio (which consists of all risky assets) or 2) borrowing capital at the risk-free rate and investing all of an investor's capital plus all borrowed capital in the market portfolio.

Macro-economic variables that affect industry growth are:

1)GDP, 2)Interest rates, 3) Inflation, and 4) Availability of credit.

13. An investor opens a margin account with an initial deposit of $5,000. He then purchases 300 shares of a stock at $30. His margin account has a maintenance margin requirement of 30%. Ignoring commissions and interest, the price (in $) at which the investor receives a margin call is closest to:

19.05 IM=5000/(300 x 30)=55.56% Margin call price= Po x (1-IM)/(1-MM)= 30 x (1-55.56%)/(1-30%)=19.05

A portfolio has an expected rate of return of 15% and a standard deviation of 15%. The risk-free rate is 6 percent. Which value of aversion makes this investor indifferent between the risky portfolio and the risk-free asset?

8 6%=15% 0.5*A*(15%)->A=8

84. If the weekly return is 0.15%, the compound annual return is ______.

8.1% [(1+0.0015)^52]-1

Which of the following statements concerning the Security Market Line (SML) is incorrect?

A shift in the security market line will affect only an individual security.

You are an analyst and you have studied Firm Q's financial statements as well as the prospects for the economy. You have come up with your projection of return for Q as well as its index of systematic risk. How might you use SML?

A. You would compute the expected return from the SML and compare it to your projections to evaluate whether your stock is priced correctly.

34. The minimum variance zero-beta portfolio most likely has some:

A. diversifiable risk and no non-diversifiable risk.

61. Which statement about portfolio diversification is correct?

As more securities are added to a portfolio, total risk typically would be expected to fall at a decreasing rate.

67. A client's ability to take risks is mainly determined by these factors: I. Investment time horizon II. Psychological factors III. Level of financial knowledge IV. Net wealth

B. I and IV

66. Which of the following statements regarding the efficient frontier are incorrect? I. The efficient frontier represents the set of portfolios that provides the maximum rate of return for every given level of risk. II. The efficient frontier provides the maximum risk for each level of return. III. Points along the efficient frontier dominate all points beneath the curve. IV. Points along the curve to the right of other points on the curve must have a higher expected return and higher level of risk.

B. II only

Making the investment decision involves subdividing the major steps into several concrete considerations. The process of the investment decision involves all of the following except ______

B. determining the relevant constraints of security selection and investor preference along with accumulated investor experience and historical investment benchmarks.

Which of the following is a misconception about beta?

Beta is the relevant measure of risk in the CAPM and is equivalent to unsystematic risk.

72. Beta and standard deviation are common measures of investment risk. How are these risk measures best characterized?

Beta measures covariance risk and standard deviation measures total risk.

10. Which of the following is mostly true about the security market line?

C. Each asset on the security market line has the same reward-to-risk measured by its Treynor ratio.

For investments made by banks, the risk tolerance is typically ______ and the liquidity needs are typically______.

C. low; high

81. What are the main criteria to consider in the policy statement with regard to asset allocation? I. What asset classes to consider for investment II. What normal policy weights to assign to each eligible asset class III. The allowable allocation ranges based on policy weights

I and II

Which of the following statements is (are) true with respect to setting the proper constraints in managing a portfolio? I. The more certain an investor's financial future, the less liquidity will be in the portfolio, holding everything else constant. II. The longer the investment horizon, the more emphasis must be placed on any current expectations with regards to the relative performance of the various asset classes. III. It would be imprudent to include many income-¬oriented securities in a portfolio that belongs to an investor in a high tax bracket. IV. Low levels of sophistication are an indication that an investor is inexperienced and hence the manager should overestimate the investor's level of risk tolerance.

I and II

52. Consistent with capital market theory, systematic risk ______ I. refers to the variability in all risky assets caused by macroeconomic and other aggregate market-¬related variables. II. is measured by the coefficient of variation of returns on the market portfolio. III. refers to non¬-diversifiable risk.

I and II only

68. The CAPM assumes ______ I. investors make rational decisions. II. investors make different investment decisions based on their different degrees of risk aversion and different expectations. III. investors' valuations of assets are identical.

I and III

Steve is more risk¬averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I. Steve and Edie's indifference curves might intersect. II. Steve's indifference curves will have flatter slopes than Edie's. III. Steve's indifference curves will have steeper slopes than Edie's. IV. Steve and Edie's indifference curves will not intersect.

I and III

99. Which of the following is (are) true about the Capital Market Theory? I. A portfolio that lies above the Security Market Line (SML) is underpriced. II. The correlation between two portfolios on the SML equals +1. III. Portfolios that lie on the Capital Market Line (CML) are as completely diversified as possible. IV. Portfolios that lie on the SML are not necessarily completely diversified.

I, III, and IV

49. Which of the following statements is (are) true with respect to the portfolio management process? I. Individuals generally define risk in terms of standard deviation. II. The investment horizon for investors in the accumulation phase will be the longest (relative to the other phases). III. The level of return that the investor desires will determine how much risk the investment manager should take on. IV. The investment horizon is deemed to end at the investor's death.

II only

76. Which of the following statements is (are) inconsistent with the Markowitz theory of portfolio management? I. Investors maximize a one-¬period expected utility curve with inherent diminishing marginal utility of wealth. II. Investors use the measure of beta as the basis of determining risk. III. Investors base their investment decisions exclusively on the basis of expected risk and return. IV. a single asset or portfolio of assets is considered to be efficient if no available asset has a superior return for a given risk level or lower risk given a return level.

II only

Which of the following is (are) true? I. A portfolio that lies above the efficient frontier is undervalued. II. Efficient portfolios minimize variance for a given level of expected returns. III. A zero¬beta portfolio is always efficient. IV. A stock with a zero correlation coefficient with a portfolio is not useful for further diversification.

II only

70. Which of the following statement(s) is (are) true with respect to constructing the proper objectives for an investor? I. The required rate of return that an investor demands will determine how much risk the manager should take. II. As the client's risk aversion increases, the manager may include more aggressive investments in the portfolio. III. If the investor's objective is heavily focused towards income, then it would not be prudent to include securities that are growth ¬oriented into the portfolio. IV. An account that will need to generate income in step with inflation must be measured in terms of real performance.

IV only

62. Which of the following statements is least likely to be an assumption about investor behavior underlying the Markowitz model?

Investors maximize one-period expected return.

Which of the following statements is incorrect concerning the CAPM?

It is intended to allow investors to calculate the realized rate of return on a security.

37. Which of the following about the efficient frontier and the global minimum variance portfolio is most accurate?

Moving towards the right further away from the global minimum variance portfolio, portfolio returns increase at a decreasing rate.

9. Which of the following is least likely included in the assumptions of an informationally efficient securities market?

New information regarding securities comes to the market in a predictable manner.

Margin call price=

Po x (1-IM)/(1-MM)

hich portfolio is off the Markowitz efficient frontier based on the dominance principle?

Portfolio B, with an expected return of 15% and a standard deviation of 21%.

portfolio management process steps in the appropriate order

Prepare the policy statement, construct the portfolio, monitor and update investor needs

Which statement is true?

Sharpe ratio cannot be applied to risk¬free assets.

2. Which of the following statements about the short sale of a stock is least accurate?

Short sales involve time limits for returning the shares borrowed to the lender.

Which institutional investor has the longest investment time horizon?

Stanford University Endowment Fund

11. Capital market efficiency is desirable, but there are limitations to achieving full market efficiency. Which of the following is least likely to be a limitation to achieving full capital market efficiency?

Survivorship bias

55. Which statement is true?

Treynor ratio can be used to rank portfolios

The optimal portfolio includes all of the following characteristics except which of the following?

Utility curves may be different for individual investors even though the optimal portfolio for each investor is presumed to be the same.

predatory pricing

When a company uses offensive pricing to drive its competitors out of the business by compromising its near term profitability (with the hope to increase prices in future),

58. A and B are efficient portfolios. Therefore, ______

a combination of investments in A and B is necessarily an efficient investment

Compared to the traditional Capital Asset Pricing Model (CAPM), where lending and borrowing are carried out at the risk-free rate, a zero beta CAPM would most likely result in a security market line (SML) with ______.

a flatter slope

PIPE (private investment in public company)

a public company offers securities to private equity investors at a discount to prevailing market price. The discount depends on the urgency of the needs of the funds and the size of the capital requirement.

Points under the capital allocation line are ______ by investors.

achievable but not desirable

A shift in the security market line will

affect the risk¬return trade¬off for all of the securities and portfolios portrayed on it

CAPM is intended to

allow investors to calculate the required or appropriate expected rate of return on a security, not a realized rate of return.

5. Which of the following is the least likely source of unreliability of a pricing anomaly?

arbitrage activity

6. The best characterization of the strong-form of efficient market hypothesis (EMH)

both weak-form and semistrong-form hypotheses.

Realized returns are

calculated, by definition, after the fact, while the CAPM is used before the fact.

For T-bills which are riskless, the risk-aversion coefficient ______

can be positive, 0, or negative

73. An upward sloping line in total risk-return space along which completely diversified portfolios plot, is called the ______.

capital market way

In the presence of a risk¬free security, the efficient frontier ______

changes and is replaced by a straight line

An investor maximizes her utility by ______

choosing a point that is tangent to the efficient frontier and is on the highest feasible indifference curve.

14. An equity analyst working for a growth oriented mutual fund has a tendency to misvalue the stocks of popular companies that she has previously recommended and the fund already owns. Her behavior is most likely consistent with which of the following biases?

confirmation bias

15. In an efficient market, fundamental analysis most likely requires that the analyst must:

do a superior job of estimating the relevant variables and predict earnings surprises.

4. The behavior of investors who put more money into a failure that they feel responsible for, rather than into a success, is most accurately described as:

escalation bias

A security characteristic line graphs a portfolio's ______.

excess return against the market's excess return

The security characteristic line is the line of best fit

for a scatter diagram showing the excess rates of return of an individual risky asset and the excess return of the market portfolio of risky assets over time.

Asset based valuation models work well for

for companies that do not have a high proportion of intangibles or off the book assets and that have a high proportion of current assets and current liabilities.

3. Value Line Index, an unweighted index, uses which of the following methods in the computation of the holding period returns of underlying stocks?

geometric mean

93. Which of the following is not an assumption of the Markowitz model? Investors ______

have homogeneous expectations.

The five influences that affect an industry's growth, revenues and profits are

i. Macroeconomic influences ii. Technological influences iii. Demographic influences iv. Governmental influences v. Social influences

For an investor borrowing money at the risk¬-free interest rate to invest in the market portfolio, the estimated rate of return of his portfolio is most likely to ______.

increase

63. Which of the following statements is least accurate? An investor may construct a portfolio located on the capital market line (CML) by ______

investing a portion of his capital in the risk¬free asset and the balance in a fully diversified portfolio of all equities.

53. According to the CAPM, the market portfolio ______

is perfectly positively correlated with other portfolios on the CML

Which of these characteristics does not apply to the CML?

it is dependent on beta

If M¬squared is positive

it means the portfolio outperforms the market.

Markowitz model investors

maximize one-period expected utility, and their utility curves demonstrate diminishing marginal utility of wealth.

85. Investors earn an equilibrium rate of return corresponding to the ______.

nondiversifiable risk of a security

The ______ of the investor is (are) his or her investment goals, expressed in terms of both risk and return.

objectives

A change in the slope of the SML

occurs in response to a change in the attitudes of investors towards risk.

8. Assuming efficient markets and a lack of access to superior analysts, which of the following is the least important activity in managing portfolios?

paying close attention to the monetary policy environment

7. An analyst is creating a new stock market index that is not affected by stock splits. The index the analyst is least likely to develop is:

price-weighted

16. A security market with price continuity is most accurately characterized as a market in which:

prices do not change much from one transaction to the next in the absence of new information.

87. Which of the following statements concerning diversification is incorrect?

proper diversification can eliminate market risk

Sharpe ratio can be used to

rank portfolios but does not give any information about the economic significance of differences.

Treynor ratio can be used to

rank portfolios with positive beta

a security market line graphs a portfolio's

required return against beta

a capital market line graphs a portfolio's

required return against standard deviation

What is the expected return of a zero-¬beta security?

risk free rate of return

The line of best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time is called the ______.

security characteristic line

An individual asset's relative systematic risk is calculated based on the ______.

security market line

1. In securities exchange markets, a member who executes stop loss or stop buy orders when the specified price occurs is most likely a:

specialist

The Capital Market Line reflects risk in terms of ______.

standard deviation

When graphing investor utility to show the tradeoff of risk and return, the utility curves of more risk-averse investors are ______.

steeper and facing up and to the left

11. Which of the following is false regarding the separation theorem?

the investor identifies risky assets with positive alpha (excess return)

57. The market portfolio, M, is ______.

the optimal risky portfolio

beta is the slope of

the security characteristic line

CML return is a function of

total risk

10. A continuous market most likely exists for a stock when:

trades occur at any time the market is open wherein stocks are priced either by auction or by dealers.

56. The risk-free interest rate is 5 percent and the return on market portfolio is 8 percent. A stock with a beta of 0.5 that has an estimated rate of return of 7 percent is most likely ______. A. undervalued

undervalued The required return = E(Ri)= RFR + Bi (E(Rm)- RFR) = 5 +0.5(8¬5) = 6.5. But the estimated return is 7%. Therefore, the stock is undervalued because its estimated return, given the risk, lies above the SML, i.e., 7% > 6.5%.

51. A completely diversified portfolio will most likely result in the elimination of ______.

unsystematic variance

39. A portfolio manager is attempting to develop a risk-return tradeoff curve for one of its largest private wealth clients. While developing the client's investment policy statement, the manager determines that he is risk-neutral. The client's risk-return tradeoff curve will most likely have a:

zero slope

Advantages of using the price to book (P/B) ratio include:

‣ Book value is a cumulative amount that is usually positive, even when the firm reports a loss and EPS is negative. Thus, a P/B can typically be used when P/E cannot. ‣ Book value is more stable than EPS, so it may be more useful than P/E when EPS is particularly high, low, or volatile ‣ Book Value is an appropriate measure of net asset value for firms that primarily hold liquid assets. Examples include finance, investment, insurance, and banking firms. (answer C) ‣ P/B can be useful in valuing companies that are expected to go out of business (answer A) ‣ Empirical research shows that P/Bs help explain differences in long-run average stock returns.