Investment Management Exam
What are the mechanics for short selling
Borrow stock through a dealer-Sell it and deposit proceeds and margin in an account-Closing out the position: buy the stock and return to the party from which was borrowed
12) Suppose that in 2016 the Federal Reserve Bank can take three actions with equal probability: 1) not increasing short-term interest; 2) increasing short-term interest rate moderately; 3) increasing short-term interest rate aggressively. Further assume that the returns on the stock market will be 16%, 3%, and -10% respectively in these three scenarios, and the returns on the bond market will be 8%, 3%, and -2% in these three scenarios. Will the stock market or the bond market be more volatile (i.e., having higher standard deviation of returns)? a) Stocks b) Bonds c) Stocks and bonds have the same standard deviation
a
3) ____ is NOT a derivative security a) A share of common stock b) A call option c) A future contract d) None of these options (All of the answers are derivative securities)
a
9) Over the past century, the average return of the stock market was on average more than 4% higher than that of the 10-year Treasury Bond. Which of the following statements is NOT true? a) Investors should all invest in just the stock market to earn higher returns, regardless of risk preference b) The excess return of the stock market compensates investors for bearing higher risks c) The Sharpe ratio of the stock market could be lower than that of the Treasury bond market d) The standard deviation of stock market return could also be higher than that of the Treasury bond market
a
13) Mr. Donovan orders his broker to short-sell 1000 shares of Wildcats Inc. when the stock price is $30 per share. The initial margin requirement is 60%. Maintenance margin is 25%. Mr. Donovan only wants enough in the account to satisfy the initial margin requirement. At what price would Mr. Donovan receive a margin call? a) $18.4 b) $28.4 c) $38.4 d) $48.4
c
16) Suppose that you can invest only in two risky assets: one stock fund and one bond fund. Suppose that the stock fund' expected return and standard deviation of return are both higher than that of the bond fund. Which of the following statements is NOT true? a) The optimal allocation between the two funds depends on your risk preference b) In theory, if you want to achieve an expected return higher than that of the stock fund, you should short the bond fund and invest the proceeds from the short sale and your own cash in the stock fund 0.0%2.0%4.0%6.0%8.0%10.0%12.0%14.0%0.0%5.0%10.0%15.0%20.0%25.0%FixedincomeInternational stocksLarge cap value US stocks c) If you want to achieve an expected return greater than that of the bond fund, the standard deviation of your portfolio must also be higher than that of the bond fund. d) All of the above are true 1
c
5) Suppose that you have $10,000 to invest for this year. You can either invest it in the stock market or deposit it in the bank. The annual interest rate paid by the bank is 2%. You can also borrow money from the bank at 2% interest rate. Suppose that the return of the stock market will be 10% if the economy expands this year and -2% if the economy dips into recession. Each of the two scenarios is equally likely to occur. Suppose that there is no risk associated with bank deposits. Which of the following investment strategies will you choose if you goal is to maximize your expected return? a) Investing $8,000 in the stock market and depositing $2,000 in the bank b) Investing all $10,000 in the stock market c) Borrow $2000 from the bank and invest $12,000 in the stock market d) All above three have the same risk
c
7) Suppose investors can only choose to invest in one risk-free asset and one of the four stocks (A through D) in the adjoining picture. The risk-free rate, as well the expected returns and standard deviation of returns of each of the four stocks are given in the picture. Which stock will the investors choose? a) Stock A b) Stock B c) Stock C d) Stock D e) It depends on the investors' risk preference
c
) Which of the following statements about stock indexes is NOT true? a) Dow Jones Industrial Average is a price-weighted index b) S&P 500 is a value-weighted index c) If the returns of all stocks in an index on a given day are all positive, the return of the index must also be positive d) If a company in the Dow Jones index does a 2-for-1 stock split (an additional share is given for each share held by a shareholder), the importance of this company relative to other companies in the index will not change.
d
1) Which of the following statements about Capital Allocation Line (CAL) is NOT true? a) As you move along the CAL, your expected return changes b) As you move along the CAL, your risk changes c) As you move along the CAL, your Sharpe Ratio doesn't change d) As you move along the CAL, the risk premium (i.e., return in excess of the risk free rate) of your complete portfolio doesn't change
d
17) The adjoining picture shows the risk-return combinations of two risky assets with expected returns and standard deviations shown in the picture. The correlation coefficient of the two risky assets is -0.5. If the correlation coefficient becomes 0.2, which of the following statements about the new opportunity set in the picture is true? a) It will shift leftward b) It will shift downward c) The minimum variance you can achieve becomes smaller d) Investing 100% in A is still not a good strategy
d
20) You manage $1000 for your client and your client wants an expected return of 8%. What's the range of the money you invest in risk-free T-bill fund? a) $200-$300 b) $300-$400 c) $400-$500 d) $500-$600
d
4) Suppose investors can only choose to invest in one of 5 stocks (A through E) in the adjoining picture (there is no risk-free asset to invest in.) Every risk averse investor would prefer: a) only stock A b) only stock C c) either stock A or stock C d) either stock A or stock B or stock C e) either stock A or stock E
d
6) Which of the following statements about short sales is NOT true? a) Short sales allow you to make money when you believe an asset is overvalued b) You profit will be highest if the price of the stock you sold short drops to zero. c) Imposing constraints on short sales could hurt price discovery d) Everything else equal, an increase in the price of the asset that you are selling short will lead to an increase in the margin of your account
d
Price weighted indexes, example and define
DJIA Measure the return on a portfolio that holds one share of each stock
U looking thing is
Expected Return
What are the three derivatives?
Futures Options Credit Default Swaps
Imposing constraints on short sales could ______ price discovery
Hurt
Rf is
Risk Free Rate
Market-value weighted, example and define
S&P500, NASDAQ Measure the return on a portfolio that invests in proportion to the outstanding value
Investing in one risk-free asset must keep in mind...
Seeking highest expected return without excessive standard deviation
To profit from a decline in the price of a stock or security
Short selling
O thing is
Standard deviation
What form of risk has the higher standard deviation of returns
Stocks
T/F: ) S&P 500 is a value-weighted index
T
T/F: Dow Jones Industrial Average is a price-weighted index
T
What are the uses on stock indexes
Track average returns, Comparing performance of managers, Base of derivatives
Studying Portion
-
Short sales allow you to make money when you believe an asset is
Overvalued
You profit will be highest if the price of the stock you sold short drops to
Zero
2) Which of the following statements about corporate bonds is NOT true? a) Corporate bonds usually promise a fixed income stream or an income stream specified by a formula b) If a company declares bankruptcy, bond investors typically will not suffer a loss c) Bond holders are the not last in line among all claimholders to receive payment when a company is liquidated d) Even if a company does not default, your return on investing in corporate bonds can still be negative if you don't hold the bond to maturity
b
4) The return of three stocks A, B, C, during last week was -10%, 0, and 10%, respectively. At the beginning of last week, all three stocks was trading at $10 per share, and the market value of the companies A, B, C was $30B, $20B, and $10B. Which of the following index constructed at the beginning of last week using the three stocks had the lowest return during last week? a) A price weighted index b) A value weighted index c) An equally weighted index (each stock has the same weight) d) a) and c)
b
5) When plotting on risk (x-axis) and return (y-axis) graph, 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
b
8) You have $100,000 available to invest. The risk free rate is 7%. The return on the risky portfolio is 14%. If you wish to earn an expected return of 12.6%, you should _______. a) invest $80,000 in the risk-free asset and $20,000 in the risky portfolio b) invest $20,000 in the risk-free asset and $80,000 in the risky portfolio c) borrow $80,000 at the risk-free rate and invest $180,000 in the risky portfolio. d) borrow $20,000 at the risk-free rate and invest $120,000 in the risky portfolio.
b
8) You have $100,000 available to invest. The risk free rate is 7%. The return on the risky portfolio is 14%. If you wish to earn an expected return of 12.6%, you should _______. a) invest $80,000 in the risk-free asset and $20,000 in the risky portfolio b) invest $20,000 in the risk-free asset and $80,000 in the risky portfolio c) borrow $80,000 at the risk-free rate and invest $180,000 in the risky portfolio. d) borrow $20,000 at the risk-free rate and invest $120,000 in the risky portfolio.
b
9) Use the formula below to compute the optimal portfolio weights. What is the Sharpe ratio of the optimal risky portfolio? a) 0.29 b) 0.39 c) 0.49 d)0.59
b
An investor buys $16,000 worth of a stock priced at $20 per share using 60% initial margin. The broker charges 8% on the margin loan and requires a 35% maintenance margin. The stock pays a $.50-per-share dividend in 1 year, and then the stock is sold at $21 per share. What was the investor's rate of return? a) 3.52% b) 7.17% c) 12.83% d) 25.75%
b
In class we used Excel Solver to find the efficient frontier for three risky assets shown in the figure below: fixed income portfolio, international stocks, and large cap value US stocks. In the figure below, the vertical line shows the expected return and the horizontal line shows that standard deviation. Which of the following statements is NOT true? a) The estimation result shows that none of the three risky assets is on the efficient frontier b) The estimation result shows that for some very risk-averse investors, investing 100% in the fixed income portfolio could be optimal c) The estimation result suggests that even though international stocks are very risky with low expected returns, investing in all three assets may allow investors to achieve better risk-return opportunity set than just investing in fixed income securities and US stocks d) The estimation result suggests that, if historical returns and risk are good predictors of future expected returns and risk, it is impossible to achieve an expected return of 12% and standard deviation of 10% by investing in the three portfolios
b