Quiz Questions (Investments)

A mutual fund is advertised with a beta of 1.6 and a R-squared of 0.24. A sales person tries to sell the fund to you based on the fact that it will outperform the market during an expansion. What is the flaw in his or her sales pitch?

With an R-squared of .24, the fund's beta is not a reliable statistic to use. Therefore, for the sales person to imply that a beta of 1.6 will outperform the market during an expansion is inappropriate, since 76% of the fund's variablility of return is due to unsystematic (company specific) forces.

Andrew wants to purchase a government-backed investment that adjusts the interest rate for inflation every six months. Which of the following investments should Andrew purchase? A. Series EE bonds B. Series HH bonds C. Series I bonds D. Treasury inflation-protected securities (TIPS)

C Response Feedback: Series I bonds is the answer. The government adjusts the interest rate paid on Series I bonds every six months. The principal amount is the item adjusted on TIPS. Series EE bonds adjust the interest rate every six months, but it is not necessarily tied to inflation. Series HH bonds are no longer being issued as of August 2004.

What is the standard deviation of returns given returns of 9%, 6%, 2%, -5%? A. 4.2% B. 5.1% C. 6.1% D. 7.8%

C Response Feedback: The average return is : (9 + 6 +2-5)/4 = 12/4 = 3%. The variance is [(9-3)2 + (6-3)2 + (2-3)2 + (-5-3)2]/(4-1)= [36+9+1+64]/3= 110/3= 36.67. The standard deviation is 36.67 squared= 6.06%

JKL portfolio has a realized return of 15% over the last several years and a beta of 1.10. The 3-month Treasury bill is currently yielding 4%. The S&P Index has a realized return of 14% and a beta of 1.00. What is the risk-adjusted return of JKL portfolio? A. 5% B. 8% C. 10% D. 14%

C Response Feedback: User the Treynor ratio, the risk adjusted return of JKL portfolio is: (0.15- 0.04)/1.10= 10%

Which of the following firm ratios will change after a stock split? a. Price to Earnings ratio b. Return on Equity ratio c. Earnings per Share ratio d. Gross Margin ratio

C. Earnings will not change after a stock split. However, shares outstanding will double after a stock split.

Your client purchased 100 shares of XYZ Corporation stock at $40 per share and deposited 50% of the purchase price for initial margin requirement. If the maintenance margin is 35%, at what price will your client receive a margin call? A. $29.63 B. $13.00 C. $32.57 D. $30.77

D Response Feedback: Price at which a margin call is initiated. [(1- Initial Margin Percentage)/(1- Maintenance Margin)] x Stock Purchase Price = [(1- 0.50)/(1- 0.35)] x ($40)= (0.5/0.65) x ($40)= $30.77

The advantages of investing in common stock include: A. Low Volatility of investment returns. B. Guarnateed higher returns than short-term bonds C. Guaranteed regular cash flows via dividends. D. Participation in the growth of the issuing company

D Response Feedback: An advantage of owning common stock is the participation in the growth of the firm via dividends or capital gains. Common stocks generally exhibit higher volatility than other types of investments, but are not guaranteed higher returns or regular cash flows via dividends. A stock can have negative returns and suspend dividend payments.

Which one of the following best describes a debenture? A. A long-term corporate promissory note B. An investment in the debt of another corporate party C. A long-term corporate debt obligation with a claim against securities rather than against physical assets D. A corporate debt obligation that allows the holder to repurchase the security at specified dates before maturity E. Unsecured corporate debt

E Response Feedback: A debenture has no specific assets pledged as collateral. Answer A is incorrect as it does not specify whether there is any collateral underlying the note. Answer B is simply a description of a corporate bond, and does not specify whether there is any collateral underlying the bond. Answer D is a description of a callable bond, which may or may not be a debenture.

All of the following statements concerning investment companies are correct EXCEPT: A. Both closed-end and open-end companies will, upon request, redeem their outstanding shares at NAV at any time B. A closed-end investment company doesn't make any additional share offerings after its initial public offering. C. An open-end investment company must redeem any outstanding shares owned by investors. D. An open-end investment company may sell new shares after the initial offering of shares to investors.

A Response Feedback: A closed-end company does not normally redeem any of its outstanding shares. Only open-end investment companies promise to redeem its shares at any time.

Preferred stocks with cumulative fixed dividends: A. Must pay the missed dividends before common shareholders can be paid dividends. B. Are taxed on accumulated dividends. C. Are required to pay dividends each quarter. D. All of the above are true.

A Response Feedback: Cumulative preferred stocks must pay missed dividends before common shareholders can be paid dividends. The other statements are not true. These types of preferred stocks are not required to pay dividends each quarter nor are taxed on accumulated dividends.

Each of the following four corporate bonds is currently selling at a discount: Bond Yield to Bond Coupon Maturity Rating Maturity A 5.2% 5 years AA 6.0% B 5.2% 10 years B 7.0% C 5.0% 15 years AA 6.0% D 4.8% 5 years AAA 5.8% Amber is considering investing in corporate bonds, but she is concerned about maintaining her principal over her 5-year time horizon. She anticipates market interest rates to increase over the next several years. The best choice for Amber is to invest in A. Bond A B. Bond B C. Bond C D. Bond D

A Response Feedback: If rates increase, bond prices will decrease causing the longer-term bonds (Bonds B and C) to be sold in 5 years for less than their current market price. Since Amber is concerned about her principal, she should not invest in these two bonds. Both Bonds A and D match Amber's time horizon. Since the bonds are selling for a discount, she will receive a capital gain if she holds the bonds to maturity. Even though Bond A has a slightly lower rating (AA versus AAA), the probability of default is not significantly increased. Bond A also has a higher coupon providing for a larger cash inflow that can be reinvested at the anticipated higher rates.

QUESTION 17 Your client purchased 100 shares of XYZ Corporation stock at $40 per share and deposited 50% of the purchase price for initial margin requirement. If the maintenance margin is 30%, the client will receive a margin call of $28.57. Assume the client enters into the margin loan agreement and buys XYZ stock. If the price drops to $28, how much money will the client have to put up to satisfy the margin agreement? A. $40.00 B. $85.00 C. $240.00 D. $500.00

A Response Feedback: If the price drops to $28, then the total value= $2,800, and the net equity is ($2,800-$2,000)/$2,800= 28.6% equity, less than the 30% maintenance margin required. The additional dollars needed to meet the maintenance margin requirement: 0.30*$2,800= $840-$800= $40

Answering the following case study requires reading the information in this link: Case Study: John Davis Which of the following is the benchmark line that corresponds to the graphic display of the Treynor index? A. Security Market Line (SML) B. Capital Market Line(CML) C. Efficient Frontier D. All of the above

A. Security Market Line Response Feedback: The Treynor index measures uses beta as the measure of risk and graphically displays the risk/return tradeoff. The CML uses the standard deviation, not beta, in estimating expected return and risk displays.

All of the following statements regarding Exchange-Traded Funds (ETFs) are correct EXCEPT: A. ETFs may be actively managed B. ETFs may not be sold short C. ETFs can be bought on margin D. ETFs may not be equal to NAV due to supply and demand for the shares.

B Response Feedback: Exchange-traded funds can be sold short.

CFP Board released question 1996 A client has a cash need at the end of seven years. Which of the following investments might initially immunize the portfolio? (1) a 9-year maturity coupon bond (2) a 7-year maturity coupon Treasury note (3) a series of Treasury bills A. (1), (2) and (3) only B. (1) only C. (2) only D. (2) and (3) only

B Response Feedback: Immunization of a portfolio involves matching the portfolio's duration with the duration of the investor's cash needs. A 7-year maturity coupon Treasury note would have a duration of less than seven years. Similarly, a series of Treasury bills would have a very short duration. A 9-year maturity coupon bond, on the other hand, will have a duration of less than nine years, perhaps something in the neighborhood of seven years.

JKL portfolio has a realized return of 15% over the last several years and a beta of 1.10. The 3-month Treasury bill is currently yielding 4%. The S&P Index has a realized return of 14% and a beta of 1.00. Aassume that the benchmark sector portfolio compared to a sector fund that reports a return of 12%. The standard deviation of the JKL portfolio and the sector fund are 5.75 and 4.25, respectively. What is the information ratio of portfolio JKL? A. 1.5 B. 2 C. 2.45 D. 3.25

B Response Feedback: The information ratio is found as follows: Return of portfolio- Return of benchmark/SD of portfolio-SD of benchmark = (0.15- 0.12)/(0.0575- 0.0425)= (0.03/0.015)= 2.0

A client desires to purchase 500 shares of a stock only when the price gets to a certain level, and is worried about a sudden stock movement once the price is near that level. The most appropriate market order for this client would be: A. Market Order B. Stop-Limit Order C. Limit Order D. Good unitl cancelled order

B Response Feedback: This type of order combines the benefits of a market order and a limit order to constrain the price of execution.

CFP Board released question 1996 Smith invests in a limited partnership which requires an outlay of $9,200 today . At the end of years 1 through 5, he will receive the after-tax cash flows shown below. The partnership will be liquidated at the end of the fifth year. Smith is in the 28% tax bracket. YEARS CASH FLOWS 0 ($9,200) CFo 1 $600 CF1 2 $2,300 CF2 3 $2,200 CF3 4 $6,800 CF4 5 $9,500 CF5. Which of the following statements is/are correct? (1) The IRR is the discount rate which equates the present value of an investment's expected costs to the present value of the expected cash inflows. (2) The IRR is 24.18% and the present value of the investment's expected cash flows is $9,200. (3) The IRR is 24.18%. For Smith to actually realize this rate of return, the investment's cash flows will have to be reinvested at the IRR. (4) If the cost of capital for this investment is 9%, the investment should be rejected because its net present value will be negative. A. (2) and (4) only B. (2) and (3) only C. (1), (2) and (3) only D. (1) only E. (1) and (4) only

C Response Feedback: (1) is correct, by definition, since the IRR is the rate that equates the present value of the project's inflows with the present value of its outflows, thereby producing a new present value of zero. (2) is correct, by definition of the internal rate of return. That is, if the inflows are discounted at a 24.18% rate of interest, they will produce a present value that is equal to the present value of the one outflow of $9,200. (3) is correct. It is an assumption of the IRR methodology that any cash flows spun off by an investment are reinvested at the internal rate of return of that investment. (4) is incorrect. With the same data in the calculator as were entered in Question 21, now enter 9 as the value of "I" and compute the net present value. It is a positive $5,976.77.

Revenue municipal bonds are subject to which of the following investment risks? (1) Default risk (2) Unsystematic risk (3) Reinvestment rate risk (4) Sovereign risk A. (1) and (2) only B. (1), (2) and (4) only C. (1), (2) and (3) only D. (1), (2), (3) and (4)

C Response Feedback: All municipal bonds are subject to reinvestment rate risk because the coupon payments must be reinvested at the same rate in order to maintain the yield-to-maturity. Defaults can happen with revenue municipal bonds. Because there are specific attributes related to the revenue structure that is backing these types of bonds, there is unsystematic risk.

If the mean return for Sarconics, Inc. is 16% and the standard deviation is 4%, what will the range of returns be within two standard deviations? A. Between 4% and 16% B. Between 8% and 16% C. Between 8% and 24% D. Between 8% and 30%

C Response Feedback: At two standard deviations, approximately 95% of the outcomes will fall between [16%-(2x4%)] = 8%, and [16%+(2x4)]= 24%

CFP Board released question 1996 Smith invests in a limited partnership which requires an outlay of $9,200 today . At the end of years 1 through 5, he will receive the after-tax cash flows shown below. The partnership will be liquidated at the end of the fifth year. Smith is in the 28% tax bracket. YEARS CASH FLOWS 0 ($9,200) CFo 1 $600 CF1 2 $2,300 CF2 3 $2,200 CF3 4 $6,800 CF4 5 $9,500 CF5 The after-tax IRR of this investment is A. 17.41% B. 19.20% C. 24.18% D. 28% E. 33.58%

C Response Feedback: On the financial calculator, enter a negative $9,200 as the initial cash flow. Then, enter the remaining positive cash flows at the end of years 1,2,3,4 and 5, as indicated the problem. The internal rate of return is 24.18%. Note that the fact that Smith is in the 28% tax bracket is irrelevant to this answer since the cash flows are identified in the question as being after-tax flows.

Orion mutual fund has a portfolio of 300 stocks with a total market value of $700 million. The fund also has $30 million in liabilities. If the mutual fund has 15 million shares outstanding, what is the net asset value (NAV)? A. $33.67 B. $37.56 C. $41.25 D. $44.67

D Response Feedback: NAV= (market value of portfolio- liability)/shares = (700-30)/15 = $44.67

Risk factors faced by corporate bond investors include all of the following EXCEPT: A. liquidity risk B. interest rate risk C. default risk D. derivative risk E. purchasing power (inflation) risk

D Response Feedback: This is not a legitimate risk affecting corporate fixed income issues. All other risks listed above are risks affecting corporate bond investors.

CFP Board released question 1999 To immunize a bond portfolio over a specific investment horizon, an investor would do which of the following? A. Match the maturity of each bond to the investment horizon. B. Match the duration of each bond to the investment horizon. C. Match the average weighted maturity of the portfolio to the investment horizon. D. Match the average weighted duration of the bond portfolio to the investment horizon.

D Response Feedback: This is, by definition, the immunization of a portfolio.

Assume that a company has total assets of $3.0 million, total liabilities of $1.2 million, preferred stock of $0.5 million and 5,000 shares of common stock. The book value per share of common stock is: A. $130 B. $180 C. $220 D. $260

D Response Feedback: Total book value= assets- liabilities - preferred stock. Here, total book value= $3.0M- $1.2M- $0.5M= $1.3M. On a per share basis, book value per share is $1.3M/5,000= $260

CFP Board released question 1999 Bond A has a 6% annual coupon and is due in 2 years. Its value in today's market is $900. Bond B has a 10% annual coupon and is due in 4 years. It is priced to yield 12%. Bond C is a 9% zero-coupon bond priced to yield 11% in 8 years. The yield to maturity of Bond A is closest to A. 9.90% B. 10.40% C. 10.90% D. 11.40% E. 11.90%

E Response Feedback: To find the yield to maturity of Bond A, on your financial calculator enter $1,000 as the FV, $900 +/- as the PV, $60 as the end-of-period PMT, and 2 as the value of n. Solver for i, which is 11.90%

An immunization strategy protects a portfolio from: Prepayment risk Liquidity risk Interest Rate Risk Default Risk

Interest rate risk Response Feedback: Immunization protects an interest rate sensitive portfolio from losing value given unexpected rate changes. An immunization strategy must be monitored and adjusted over time.

A bell curve whose left side tail is longer than the right side is an example of: Positive skewness Negative skewness Abnormal distribution Low kurtosis

Negative skewness

If Coca-Cola's correlation coefficient is 0.785, then what portion of its risk during that period is nondiversifiable?

The nondiversifiable portion of the return would be R-squared or the correlation of coefficient squared. (0.785)² = 0.616 or 61.6%. Therefore, 61.6% of Coca-Cola's return for that period is based on the systematic risk.

Roy met with his financial planner who discussed the benefits of investing in common stocks. Which of the following statements about common stocks is not correct? a. Stocks provide high current income relative to other asset classes b. Stocks generate better returns over the long term c. Stocks are affected by several risks including interest rate risk d. Some company specific risk can be diversified by investing in a variety of companies.

a Typically, common stocks outperform other investments over the long term. Usually, a common stock's total return comes from capital appreciation (or depreciation) rather than from dividends. The company specific factors that contribute to the risk of common stocks can be diversified through investing in various companies. Stocks price movements can be affected by a number of factors beyond interest rates.

On which of the following exchanges would you most likely find a technology stock like Google? a Nasdaq b AMEX c Boston Stock Exchange d NYSE e Chicago Exchange

a The Nasdaq lists many of the U.S.'s high tech stocks. The NYSE only allows large established companies in its membership. AMEX companies are smaller than the NYSE. Boston and Chicago stock exchanges cater to more of the local companies.

If preferred stock is cumulative: a. Unpaid dividends of one period must be carried forward and paid in subsequent periods. b. The yearly dividend rate must be adjusted upward if previous dividends have not been paid. c. Dividends must be paid on an equal basis with common stock , as long as earnings permit. d. Dividends cannot be declared and paid if they are not earned.

a. With cumulative preferred stock, dividends accumulate; that is, a missed dividend and the current dividend must both be paid prior to dividends being paid to common shareholders.

Carl ended the year with a total investment in McDonald's of $7,000 (100 shares x the $70 market price of the stock). McDonald's has just announced a 3-for-2 stock split, payable May 30th. If the market price of the stock does not change (except for the split effect), which of the following best represents Carl's McDonald's holdings on May 30th? a Total investment $4,667 (100 shares x $46.67) b Total investment $7,000 (150 shares x $46.67) c Total investment $10,500 (150 shares x $70) d Total investment $7,000 (120 shares x $58.33)

b For a stock split, the shares outstanding are multiplied by the multiplication factor (in this example, 1.5), and the market price of the stock is divided by the multiplication factor.

All of the following statements concerning common stock are correct, EXCEPT: a. Owners of common stock are entitled to dividends declared by the board of directors. b. Owners of common stock have a right to vote either in person or by proxy at annual meetings. c. Owners of a share class with disproportionate voting power can be sued for debts of the business. d. Companies have the right to either lower or raise dividend rates on common shares.

c. Common stock owners cannot be sued for debts of the business even if they own a class of shares of disproportionate voting power.

Common stocks have voting rights that give shareholders the power to do which of the following EXCEPT: a Vote by proxy b Elect the board of directors c Vote of major company issues d Vote on everyday management decisions

d Voting rights allow shareholders to elect the board of directors, vote on major company issues and vote by proxy when not available to be present at shareholder meetings. Everyday management decisions are left to the management of the company.

Which of the following statements concerning the Standard and Poor's 500 Index are correct? 1. Takeovers and leveraged buyouts have resulted in as many as 30 changes per year in the composition of the Index, so that the Index has been reshaped as new, rapidly growing companies have been included. 2. It is value-weighted, and there is an attempt to match the broad industry groups that appear in the New York Stock Exchange population. 3. It includes 500 stocks traded on the New York and NYSE MKT (formerly the American Stock Exchange), plus stocks traded on the over-the-counter market. a. (1) and (3) only b. (1) and (2) only c. (2) and (3) only d. (1), (2) and (3) only

d. All three of these statements regarding the S&P 500 Index are correct.

Jessica owns 10 shares of ACME Tools, Inc. stock at $50 per share. The stock splits 2 for 1. What would be the number of shares Jessica owns after the split and total value of Jessica's investment? Click all that apply. a. 5 shares at a total value of $1,000 b. 5 shares at a total value of $500 c. 20 shares at a total value of $1,000 d. 20 shares at a total value of $500

d. Share amount will double due to the stock split. However, since share price is halved, total stock value will not change after the split.