Series 66 Chapter 20

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A mutual fund investor is using a dollar cost averaging strategy. For the average price per share to exceed the investor's average cost, which of the following conditions must be present? The market price per share fluctuates with each purchase. A fixed dollar amount is invested at regular intervals. A fixed number of shares is purchased monthly. A constant dollar value is maintained in the account.

1, 2

An efficient portfolio is one that offers the most return for a given amount of risk the least risk for a given amount of return the least return for a given amount of risk the most risk for a given amount of return

1, 2

Formula methods of investing that involve selling equities in rising markets and buying them in falling markets would include constant dollar plan constant ratio plan dollar cost averaging DRIPs

1, 2 In both a constant dollar plan and a constant ratio plan, the goal is to maintain a balance between equity and debt securities in the portfolio. This is done by selling equities as their price rises (the proportion has now changed) and buying equities when the prices fall to get back to the constant dollar or ratio.

Which of the following statements are generally TRUE of the buy-and-hold strategy? Equities would grow relative to fixed income Lower taxes and transactional costs Easy to manage The portfolio would more accurately demonstrate the client's investment objectives and risk tolerance

1, 2, 3

Customer A and Customer B each have an open account in a mutual fund that charges a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments? Receiving cash distributions may reduce Customer A's proportional interest in the fund. Customer A may use the cash distributions to purchase shares later at NAV. Customer B's reinvestments purchase additional shares at NAV rather than at the offering price. Due to compounding, Customer B's principal will be at greater risk.

1, 3

Which of the following statements regarding hedging with options is CORRECT? A long stock position is hedged with a long put. A long stock position is hedged with a short put. A short stock position is hedged with a short call. A short stock position is hedged with a long call.

1, 4

An investment manager is looking at 10 possible stocks to include in a client's portfolio. In order to create the most efficient portfolio, the manager must A) find the combination of stocks that produces a portfolio with the maximum expected rate of return at a given level of risk. B) include only the stocks that have the highest volatility at a given expected rate of return. C) include all 10 stocks in the portfolio in equal amounts. D) include only the stocks that have the lowest volatility at a given expected rate of return.

As compared to value investors, growth investors tend to A) look for companies whose sales, earnings, or market share are increasing at an above-average rate B) take more of a long-term approach to their investments C) be very price-conscious when purchasing stocks D) look for companies that are undervalued or overlooked by other investors

Due to an escalating trade war, the portfolio manager of an equity mutual fund anticipates a negative impact on his fund's assets. To protect his investment portfolio, the fund manager would A) buy S&P 500 index puts B) sell S&P 500 index puts C) sell S&P 500 index calls D) buy S&P 500 index calls

A securities market investment theory that attempts to derive the expected return on an assetbased upon the asset's systematic risk is A) the capital asset pricing model (CAPM). B) the random walk theory. C) the efficient market hypothesis (EMH). D) the Monte Carlo simulation.

An increase in the earnings per share growth rate from one reporting period to the next is called A) earnings momentum. B) profitability. C) finding alpha. D) price-to-earnings ratio.

An investment adviser representative is evaluating ABC stock to see if it is a good fit for a client's portfolio. Using the security market line (SML), what is the expected return for ABC when the return on the market is 20%, the 91-day Treasury bill is yielding 4%, ABC's beta is 0.70, and the inflation rate, as measured by the CPI, is 3%? A) 15.2% B) 14.0% C) 10.2% D) 11.2%

Growth companies tend to have all of the following characteristics EXCEPT A) low P/E ratios B) low dividend payout ratios C) potential investment return from capital gains rather than income D) high earnings retention ratio

If the current risk-free rate is 4%, and the expected return from the market is 10%, what return should we expect from a security that has a beta of .9? A) 9.4% B) 6.4% C) 9% D) 13%

If the current risk-free rate is 5%, and the expected return from the market is 10%, what return should we expect from a security that has a beta of 1.5? A) 12.5% B) 15% C) 11.5% D) 10%

In which of the following funds would a buy-and-hold style most likely be used by the manager? A) Equity index fund B) Market timing fund C) Information technology fund D) Options income fund

Janice is investing in stocks that are temporarily neglected by the market and often have high-dividend yields. Which of the following investment styles might she be following? A) Value B) Contrarian C) Growth D) Momentum

Olga holds XYZ stock. The stock recently increased in value by 50%. She would like to preserve as much of this gain as possible and retain the potential for additional price increases. Which strategy best meets Olga's goal? A) Buy a put option B) Write a call option C) Short the stock D) Buy a call option

The bond strategy used most often by those with a target goal is A) the bullet strategy. B) the barbell strategy. C) the laddering strategy. D) the duration strategy.

The capital asset pricing model (CAPM) is used by many to assess the expected return of a security. If the current risk-free rate is 3%, the current return on the market is 10%, and a particular stock's beta is 1.4 with a standard deviation of 2.2, the expected return would be A) 12.8% B) 9.8% C) 17.0% D) 14.0%

The goal of modern portfolio theory (MPT) is to construct the most efficient portfolio. An efficient portfolio is one that offers A) the least risk for a given amount of return B) the most return for the most risk C) the lowest Sharpe ratio D) the highest correlation coefficient

The management style that is most similar to buy and hold is A) strategic management B) tactical management C) contrarian D) active management

The semi-strong form of efficient market hypothesis (EMH) asserts that A) all public information is already reflected in security prices making fundamental analysis valueless. B) both public and private information is already incorporated into security prices. C) only fundamental analysis and inside information can bring added value to a portfolio. D) all inside information is already reflected in current stock prices.

The semi-strong form of the efficient market hypothesis (EMH) asserts that stock prices A) fully reflect all publicly-available information. B) fully reflect all historical price information. C) fully reflect all relevant information, including insider information. D) don't reflect any information.

Two portfolios have the same expected return of 10%. Portfolio A has a standard deviation of 5% and Portfolio B has a standard deviation of 18%. Under modern portfolio theory (MPT), A) Portfolio A would be preferred by investors because the portfolio has the same return as Portfolio B but bears less risk B) neither portfolio would be acceptable because the risk is too high for the expected return C) neither portfolio would be preferred because both portfolios have the same 10% expected return D) Portfolio B would be preferred by investors because its standard deviation is more than 3 times that of Portfolio A

Under the modern portfolio theory (MPT), risk aversion means that if two assets have identical expected returns, an investor will choose the asset with the A) lower risk level. B) shorter payback period. C) longer payback period. D) higher standard deviation.

Which of the following bond diversification strategies involves purchasing only short-term and long-term bonds? A) Barbell strategy B) Laddering strategy C) Bullet strategy D) Immunization

Which of the following is NOT a characteristic of the active management approach to investing? A) Belief in random walk theory and efficient markets B) Attempt to predict market changes C) Focus on beating the market D) Higher expenses as compared to passive approaches

Which of the following is NOT associated with passive investment management approaches? A) The belief that the market can be timed B) Belief in efficient markets C) Belief in the random walk theory D) Use of index investing

Which of the following would you most likely consider characteristics of a growth stock? A) High P/E and low dividend yield B) High P/E and high dividend yield C) Low P/E and high dividend yield D) Low P/E and low dividend yield

While reading the prospectus of a mutual fund, you notice that the management describes their style as contrarian. They further explain that they A) generally buy when the majority of other investors are selling and sell when the majority of other investors are buying. B) have higher-than-average income as their goal. C) tend to invest in stocks with a high correlation coefficient. D) believe that indexing provides the most attractive returns.

A corporation sponsors a defined benefit pension plan. The assets of the plan are invested in a diversified portfolio of large-cap stocks. Which of the following options positions would be most appropriate if the corporation wished to protect their ability to meet their obligations to employees? A) Sell S&P 500 index puts B) Buy S&P 500 index puts C) Sell S&P 500 index calls D) Buy S&P 500 index calls

A new client's principal objective is income with a moderate degree of capital preservation. When reviewing his existing portfolio, you notice that the client's bond holdings are evenly split between those maturing in the next 1 to 2 years and those maturing in the next 10 to 11 years. This indicates that the client has been using which of the following strategies? A) Contrarian B) Barbell C) Ladder D) Bullet

A securities analyst who recommends allocating to industries based on changes to the business cycle would most likely be said to be A) a tactician B) sector rotating C) laddering D) a contrarian

Although most investors are buying common stock issued by LMN corporation, Jack is selling it short. In this action, Jack appears to be A) an institutional investor B) a contrarian C) a fundamentalist D) a writer

An adviser that seeks to outperform a market index (such as the S&P 500) is said to be engaged in A) fundamental management B) active management C) technical management D) passive management

An individual is a participant in the 401(k) plan offered by her employer. If she were to invest $400 per month into a large-cap growth fund, she would be A) using a tactical asset allocation style B) dollar cost averaging C) matching her employer's contribution D) following a constant ratio plan

An individual who is a proponent of the efficient market hypothesis (EMH) will likely invest in which of the following? A) Sector mutual funds B) Index funds C) Growth mutual funds D) Balanced mutual funds

An investment adviser representative is discussing various investment strategies with a prospective client. When discussing the "buy and hold" strategy, it would be correct to state that a characteristic of this strategy is it A) outperforms most equity indexes. B) has low expenses. C) better aligns with the risk tolerance of the investor. D) is favored by market timers.

An investment adviser representative may describe dollar cost averaging to a customer as A) a means of purchasing more shares when share prices are high B) a funding technique that will cause the average cost per share to be less than the average price per share C) a form of a mutual fund withdrawal plan D) a program for investing that will ensure profits even in a declining market

An investor is short stock at 60. The current market price of the stock is 35, and he anticipates it will continue to decline. If he thinks the price will rise temporarily and if he does not wish to close out his short position, his best strategy to prevent a loss would be to A) sell an XYZ 35 call B) buy an XYZ 35 call C) buy an XYZ 35 put D) sell an XYZ 35 put

An investor plans to fund the college education for her newborn child by purchasing $5,000 of investment-grade bonds on an annual basis. She is most likely using A) the 529 plan strategy. B) the bullet strategy. C) the laddering strategy. D) the barbell strategy.

As a rule, which of the following is NOT a characteristic of micro-cap stocks? A) Sometimes have great potential for growth B) Represent mature, well-established companies C) Have lower liquidity because they are thinly traded D) Are typically subject to higher business risk than large-cap stocks

Buying stocks with high P/E ratios normally reflects which of the following investment styles? A) Turnaround B) Growth C) Value D) Special situations

Emanuel owns 500 shares of IJKL common stock with a cost basis of $63 per share. IJKL is now priced at $82 and Emanuel is concerned that the stock may suffer a sharp decline in the near term. As his IAR, you would suggest his best move to protect his profit would be to A) sell 500 shares of IJKL short. B) buy 5 IJKL 80 put options. C) buy 5 IJKL 80 call options. D) sell 5 IJKL 80 put options.

In the field of portfolio management, there are a number of different management styles. One of those styles involves committing additional capital to the market when others are reducing their exposure, or eliminating positions while others are increasing theirs. This style is generally referred to as A) growth B) contrarian C) value D) active

Investment company portfolio managers are apt to classify common stocks into groups. One measurement is the product of multiplying the market price per share times the number of shares outstanding. The result is known as A) market value B) market capitalization C) debt-to-equity ratio D) total value

Jane and Malka are discussing the possible form of efficient markets. Jane states that, "A weak form price-efficient market is one in which security prices fully reflect past share price and trading volume data." Malka retorts that she is not sure of Jane's thoughts and says, "If markets are weak form efficient, we cannot consistently outperform the market based on technical analysis." A) Malka is correct, but Jane is incorrect. B) Both Jane and Malka are correct. C) Jane is correct, but Malka is incorrect. D) Both are incorrect.

One feature employed by portfolio managers using a passive style is rebalancing. The purpose of this technique is A) to ensure that the client's account is being properly reviewed B) to bring the portfolio mix back to the original asset allocation percentages C) making sure the client's account is profitable D) to follow a constant dollar plan

One of the assumptions underlying the capital asset pricing model is that A) each investor has a unique time horizon. B) there are no transaction costs or taxes. C) only whole shares are available. D) inflation must be taken into consideration.

One of your clients is confused about the difference between active and passive styles of management. It would be correct to state that, compared to the active style, passive portfolio managers A) tend to try to time the market. B) would be more likely to include index funds or ETFs in their portfolio. C) are likely to charge higher fees. D) generally manage mutual funds while active managers manage closed-end companies.

Professor William Sharpe stipulated that certain assumptions must be present for the capital asset pricing model (CAPM) to be useful. Which of the following is not one of these assumptions? A) Investors can always borrow and lend money at the risk-free rate of return. B) Investment expenses, such as taxes and transaction costs, are relevant in investment decision making. C) At all times, capital markets are in equilibrium. D) All investors have the same expectations for a given investment.

The capital asset pricing model (CAPM) is used by many to assess the expected return of a security. If the current risk-free rate is 2%, the current return on the market is 10%, and a particular stock's beta is 1.5 with a standard deviation of 3.2, the expected return would be A) 12% B) 14% C) 18.2% D) 15%

The chief analyst at your firm suggests that some of the IARs add emerging market securities to some client's portfolios. Among the benefits of doing so would be A) tax efficiency B) diversification C) positive correlation D) increased income

The purpose of portfolio rebalancing is used to make sure that A) the dollar amounts invested in various asset classes remain constant B) the percentage of the portfolio invested in various asset classes remains constant C) the total value of the portfolio does not fall below a certain amount D) the portfolio responds to major swings in the business cycle

The risk/return pyramid where the bottom is lowest risk and the "point" is the highest, generally places commodities A) at the bottom. B) at the top. C) halfway between the middle and the top. D) in the middle.

The statistical method used to determine the return profile of a security or portfolio that recreates potential outcomes by generating random values based on the risk and return characteristics of the securities themselves is known as A) the optimal portfolio B) the Monte Carlo simulation C) the efficient market hypothesis D) the capital asset pricing model (CAPM)

The weak form of the efficient market hypothesis A) implies that fundamental analysis is not worthwhile. B) implies that technical analysis is not worthwhile. C) implies that inside traders cannot earn superior risk-adjusted returns. D) reinforces the value of technical analysis.

What is the risk measure associated with the capital market line (CML)? A) Systematic risk B) Standard deviation C) Beta D) Alpha

Which of the following does NOT refer to a style of investing? A) Passive B) Equity C) Value D) Growth

Which investment style does NOT take into consideration whether a specific security is under or overvalued? A) Growth B) Indexing C) Contrarian D) Active

B The style known as indexing merely attempts to mimic the underlying index. Therefore, security selection is not based upon any fundamental (or technical) parameters, but only changes made to that index.

An analyst observes that the beta of a security is 1.3, the market return is 6%, and the risk-free rate is 1%. The analyst forecasts that the security will return 7% over the next year. Based on these assumptions, the security is A) overvalued, because the forecasted return exceeds the required return. B) overvalued, because the required return exceeds the forecasted return. C) undervalued, because the required return exceeds the forecasted return. D) undervalued, because the forecasted return exceeds the required return.

B Under the CAPM, the required return is the RF rate plus the beta times (the market return - RF rate). Using the numbers in this question, it is 0.01 + 1.3 (0.06 - 0.01) = 0.01 + 1.3 (0.05) = 0.01 + 0.065 = 0.075 which is 7.5%. Because the forecasted return of 7% is less than the required return of 7.5%, this security is considered to be overvalued.

That all market participants have equal access to information is a fundamental premise of A) Monte Carlo simulation B) the efficient market hypothesis C) asset allocation D) portfolio correlation

B When all market participants have equal access, the theory is that stock prices will reflect that efficiently.

There are several popular investment styles and, in many cases, portfolio managers use a blended approach to security selection. If a portfolio manager adhered to a pure value style, he would put most of his focus on A) using technical analysis B) projecting future earnings based on past earnings C) the company's financial statements D) lagging indicators

Under modern portfolio theory (MPT), the optimal portfolio has A) no risk for a given amount of return B) the most return for the most amount of risk C) the most return for a given amount of risk D) the least return for a given amount of risk

Which form of the efficient market hypothesis (EMH) suggests that fundamental analysis and insider information may produce above-market returns? A) Semi-strong B) Strong C) Weak D) Random walk

Which of the following characteristics best exemplifies a value stock? A) Low price-to-book, high price-to-earnings ratio B) High earnings-per-share growth, high profitability C) Low price-to-book, low price-to-earnings ratio D) Low earnings-per-share growth, high profitability

Which of the following investment styles would be most suitable for a long-term investor who seeks capital growth but is concerned about execution costs? A) International B) Growth style C) Buy/hold D) Market timing

Which of the following is an example of dollar cost averaging? A) Buying 20 shares of the XYZ Fund each month on the 20th of the month B) Maintaining a constant ratio plan C) Investing $100 into the XYZ Fund each month on the 20th of the month D) Rebalancing your portfolio each quarter on the 20th of the month

Which of the following is an example of dollar cost averaging? A) Buying shares of the KAPCO Growth Fund when the price is declining and selling shares when the price is rising B) Purchasing 25 shares of the KAPCO Growth Fund on the 15th of each month C) Investing $200 into the KAPCO Growth Fund on the 15th of each month D) Maintaining a constant dollar plan in the KAPCO Growth Fund

Which of the following is not an assumption of the capital asset pricing model (CAPM)? A) All market participants are well-diversified investors, and specific risk has been diversified away. B) All investors want to achieve a maximum return for minimum risk. C) Corporate and government taxes affect all transactions. D) All market participants borrow and lend at the same risk-free rate.

Which of the following portfolio management styles would most likely incur the highest transaction costs? A) Indexing B) Strategic asset allocation C) Tactical asset allocation D) Buy and hold

Which of the following securities would most likely be included in the portfolio of a mid-cap manager? ABC, $12 per share, 100,000,000 shares outstanding DEF, $150 per share, 8,000,000 shares outstanding GHI, $40 per share, 75,000,000 shares outstanding JKL, $70 per share, 200,000,000 shares outstanding A) JKL B) ABC C) GHI D) DEF

Which of the following strategies would most effectively protect an investor with a short stock position? A) Buy a put B) Sell a call C) Buy a call D) Sell a put

Jasper Quartermaine is interested in using the options market to create "insurance" against a severe drop in the value of a stock portfolio that he owns. How could he best accomplish this goal and what is this type of strategy called? Type of option Strategy A) Write call options Protective call B) Write call options Covered call C) Buy put options Protective put D) Buy call options Protective call

C An investor who is long securities can obtain portfolio insurance by purchasing put options. Losses in the underlying portfolio are offset by gains in the put position. This is known as a protective put strategy. Buying calls would be "insurance" when having a short position and would be considered protective calls. Writing covered calls provides downside protection to the extent of the premium received, but if you want real insurance, you have to buy it.

A portfolio that maximizes an investor's preferences with respect to return and risk is called A) a diversified portfolio B) an uncorrelated portfolio C) an optimal portfolio D) the efficient frontier

C An optimal portfolio will generally lie on the efficient frontier (which is a graph, not a portfolio). The special nature of an optimal portfolio is that it may not always be the most efficient portfolio (offering the greatest return for the least risk) because it takes into consideration the specific preferences of the individual investor, which might create a bias.

A portfolio manager who is engaging in rebalancing on a semiannual basis is most likely using which portfolio management style? A) Active asset allocation B) Tactical asset allocation C) Strategic asset allocation D) Buy and hold

C At least annually, and sometimes more frequently, a portfolio manager who follows strategic asset allocation will examine the relative proportion of the selected asset classes and, based on market performance, rebalance the portfolio to bring it back to its ideal. Active (also called tactical) asset allocation attempts to time the market and doesn't pay the same amount of attention to proportionate holdings as does strategic asset allocation. By its very nature, buy and hold can go years without a portfolio change.

Wrap fee accounts would tend to be most suitable for investors who follow A) a buy-and-hold philosophy B) a passive approach to investing C) a tactical approach to investing D) a strategic approach to the market

C Because one of the key benefits to the wrap fee program is the elimination of transaction fees (commissions), it is most suitable for those who are active traders, such as those who take a tactical approach to investing. The other 3 choices engage in far less trading activity, potentially not being able to take full advantage of all of the benefits of the wrap program.

A computerized mathematical technique that is often used by investment advisers to project future financial outcomes, such as the probability of a client's funds lasting through retirement, is called A) capital asset pricing model (CAPM). B) efficient market hypothesis (EMH). C) asset allocation modeling (AAM). D) Monte Carlo simulation (MCS).

A customer who follows a strict dollar cost averaging program to acquire shares in a diversified common stock mutual fund should achieve A) reasonable assurance against loss of principal, presuming the customer dollar cost averages over an extended period B) allocation among various funds within a single investment company's family of funds C) significant reduction of market risk due to enhanced diversification D) lower average cost to acquire fund shares relative to the fund's average price over the buying period

A strategy used by bond investors to mitigate interest rate risk that involves buying bonds with short-term, intermediate-term, and long-term maturities is called A) diversifying B) barbelling C) bulleting D) laddering

All of the following statements regarding asset allocation done by or on behalf of an investor are true EXCEPT A) the process is concerned with the relationship among the returns of different assets B) the process is concerned with the risk associated with different assets C) it is the process of dividing investable assets into different asset classes D) individual security selection is far more important than the asset allocation decision

The capital asset pricing model (CAPM) is most commonly used to determine an investor's A) risk-adjusted return B) holding period return C) time-weighted return D) expected return

D The CAPM suggests that we can determine the expected return of any security (or portfolio) by using the following mathematical formula: Er = Rf + Beta(expected return on the market − Rf). Er stands for expected return, Rf is the risk-free return. Remember, expected return is a form of risk-adjusted return and is the more specific answer to this question.

A high-risk investment strategy is the short sale of stock. Each of the following is a method of offering some degree of protection EXCEPT A) buying a put on the short stock. B) entering a buy stop order for the short stock. C) selling a put on the short stock. D) buying a call on the short stock.

Which of the following statements about diversification through asset class allocation are true? Diversification involves investing a portfolio in at least 20 different securities of the same asset class Diversification is a way to reduce unsystematic risk in a portfolio. Diversification is a defensive investment strategy.

2, 3

Two of the major factors involved in the capital asset pricing model (CAPM) are interest rates stock risk premium tax rates market risk premium

2, 4

Which of the following are disadvantages of index investing relative to active portfolio management? Indexed portfolios have higher transaction costs. Indexed portfolios have lower management fees. Indexed portfolios restrict the universe of potential investments. Indexed portfolios may not represent optimal performance for a specific investor.

3, 4

Arthur M. Munger recently joined Piedmont Partners LLP as an analyst and is curious about modern portfolio theory (MPT). He approaches his senior, Sarah, to describe MPT. Sarah tells Arthur that MPT suggests that A) by combining securities into a diversified portfolio, the overall portfolio risk will be less than the weighted average risk of the individual stocks. B) by combining securities into a diversified portfolio, the overall portfolio risk will be more than the weighted average risk of the individual stocks. C) we cannot outperform the overall market. D) the total risk of a portfolio cannot be reduced at all.

A A diversified portfolio of stocks that are not perfectly positively correlated with each other will have portfolio risk (as measured by standard deviation of returns) less than the weighted average risk of the individual stocks.

In a financial market that is efficient, A) the prices of securities will not differ from their justified economic values for any length of time. B) investors will take an active investment strategy if they are strong believers in the efficient market hypothesis (EMH). C) investors who do not believe in the efficient market hypothesis (EMH) will stop seeking undervalued securities. D) new information will be slowly reflected in securities prices.

A An efficient market is a market that quickly reflects all new information. Accordingly, securities prices will not depart from their justified economic value for any extended period of time. Investors who are strong subscribers to the efficient market hypothesis (EMH) will be passive investors because they believe you just can't beat the market. On the other hand, investors who do not believe in the EMH will become active investors and will seek to identify undervalued securities.

In an efficient market: A) any information that could affect a stock's value is quickly reflected in its price B) information is disseminated slowly C) investors have a good chance of beating the market D) it is fairly easy to predict major market swings

A An efficient market is one in which every individual can quickly obtain and use information about new events in the marketplace. Because information is disseminated quickly, any new information that could affect a stock's value is quickly reflected in its price.

You have a client who has sold short 100 shares of RIF at $50 per share. If the client wished to use options to protect against unlimited loss, you would suggest the client A) buy 1 RIF 55 call B) sell 1 RIF 45 put C) buy 1 RIF 55 put D) sell 1 RIF 45 call

A Buying a call option on stock where you have a short position will give you a guaranteed cost to cover the position, thus preventing against unlimited loss. This is the most common way to protect a short stock position.

An investment adviser who believes that we are in the early recovery portion of the business cycle would most likely recommend A) cyclical stocks. B) value stocks. C) long-term bonds. D) defensive stocks.

A Cyclical stocks have a high correlation to the swings in the economy as reflected in the business cycle. The ideal time to purchase stocks that are affected by economic cycles is right as the recovery begins from a trough (or recession). Defensive stocks are good to hold when the economy is in the early contraction period of the cycle. During a recovery, interest rates usually rise and that is not good for holders of long-term bonds because as interest rates go up, bond prices fall. Value stocks might also perform well, but many studies have shown that they offer better relative performance in periods of contraction rather than expansion.

Phocine and Ursus, LLC, a covered investment adviser, has a client with a large short position in PQR common stock. Their chief analyst believes that PQR is an attractive target for an acquisition. Based on this information, it might be wise for the firm to suggest this client A) purchase call options on PQR. B) take a long position in PQR. C) purchase put options on PQR. D) sell call options on PQR.

A If the analyst is correct, a takeover usually occurs at significant premium to the current market. That would be bad news for the client with a short position because covering the short would be at that higher price. The best protection for a short stock position is buying a call because that fixes the future purchasing price. In the event the analyst is wrong, or the takeover bid fails, the client has maintained the short position and is only out the premium paid for the "insurance".

The current market interest rate for a bond rated AA with 20 years to maturity is 5%. In an efficient market, a similar bond with a coupon of 4% could be expected to have an internal rate of return of A)5%. B)6%. C)8%. D)4%.

A In an efficient market, bonds are priced so that their NPV is zero. That means the bond's yield to maturity is equal to the current market interest rates for similar bonds. When that rate is 5%, as is given in this question, all AA bonds with 20 years remaining to maturity should have a YTM of 5%.

If the current risk-free rate is 3% and the expected market risk premium is 6%, what return should we expect from a security that has a beta of 2? A)15% B)12% C)9% D)18%

A In most questions of this type, we are given the market return. Here, there is a trick. We are told there is a market risk premium of 6%. That means that the market return must be 6% above the risk-free rate, or 9%. Now, we can plug in the formula. Expected return = 3% + ([9% -3%] × 2) = 3% + (6% x 2) = 3% + 12% = 15%. In this question, because we're already given the risk premium, we can avoid the first step. That would be 3% + (6% x 2) = 3% + 12% = 15%.

Each of the following terms is commonly found in modern portfolio theory EXCEPT A) the internal rate of return B) the feasible set C) the capital asset pricing model D) the efficient set

A Internal rate of return (IRR) is not a component of modern portfolio theory as are the other 3 terms.

Two contrasting styles of portfolio management are growth and value. Which of the following pairs best describes the contrast? A) Earnings momentum/book value B) Capital structure/earnings per share C) High P/E ratio/low current ratio D) Dividend yield/dividend payout ratio

A One of the important metrics to growth managers is the rate at which the company is growing. Earnings momentum is an excellent indicator of that. On the other hand, the primary tool of the value manager is the company's financial statements. Value managers frequently look for companies whose market price is less than their book value. Perhaps you misread "low current ratio" as "low P/E ratio" (which would have been a correct contrast). This is why you have to read each word carefully.

One of the most significant risks taken by bond investors is interest rate risk. All of these steps could be used to mitigate the effects of this risk EXCEPT A) buying bonds of highest quality B) holding bonds to maturity C) buying bonds with short-term maturities D) laddering the portfolio

A Quality has no substantial impact on interest rate risk. When interest rates rise, all bonds fall in price. However, those that are closer to their maturity date are impacted less (they have a shorter duration). If one can hold the bonds until maturity, there is no interest rate risk because, regardless of the prevailing market, you receive par value. One very effective way to lessen this risk is to ladder the maturities. That means that the portfolio is spread among a series of maturities, some near, some mid-term, and some long-term.

If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio? A) Tangible assets B) Fixed annuities issued by an insurance company with Best's highest rating C) Preferred stock D) AAA bonds

A Tangible assets, such as real estate, precious metals, and other commodities, tend to keep pace with inflation. Fixed dollar investments do not.

Due to an inheritance, one of your clients now owns a large position in LMN stock. She is concerned that the stock may decline in the upcoming months while she is deciding what to do with the investment. What type of investment strategy could she employ to protect the stock from substantial downside risk? A) Purchase put options on LMN stock B) Write call options on LMN stock C) Purchase call options on LMN stock D) Diversify into an index fund

A The best way to protect a long stock position against a potential substantial loss is to purchase put options on that stock. This is generally referred to as a protective put or portfolio insurance. Assuming the strike price is the same as the current market, the holding is fully protected and the investor's loss on the option is limited to the amount of the premium paid for the puts. Writing calls on LMN also offers protection against loss, but that protection is limited to the premium received on the calls. This question refers to substantial loss and the puts are the only way to protect against that. Once the client decides what she wants to do with the stock, she may decide to diversify into an index fund, but that does not answer the immediate need expressed in the question.

Investment advisers who preach the benefits of strategic asset allocation do so because they believe A) the market is perfectly efficient because stock prices reflect all available information B) active management of a portfolio offers tactical benefits C) the market is basically inefficient and there is a strategy that can beat it D) over the long run, strategic management will eventually outperform the market

A The primary difference between strategic and tactical asset allocation comes down to the belief by those following the strategic style that it is not possible, over a long period of time, to beat the market.

The strong-form efficient market hypothesis (EMH) asserts that stock prices fully reflect which of the following types of information? A) Public and private B) Inside only C) Market D) Public, private, and future

A The strong form EMH assumes that stock prices fully reflect all information from public and private (inside) sources. That is why proponents of EMH engage in passive strategies, such as using index funds and ETFs.

Which of the following investors aligns most closely with the strong form of the efficient market hypothesis (EMH)? A) An investor using a buy-and-hold strategy dollar cost averaging into an S&P 500 Index fund. B) An investor who researches corporate annual reports and industry publications to uncover buy-and-sell opportunities within an industry or individual security. C) An investor using dollar cost averaging to purchase shares in growth mutual funds having the highest portfolio turnover. D) An investor who uses stock charts to predict price movements and capitalize on buy-and-sell opportunities.

A The strong form of EMH maintains that there is no information, public or private, that can assist an investor in achieving consistently superior investment returns. The strong form holds that stock prices follow a random walk and no technical analysis (price charting) or fundamental analysis (annual report or industry publication research) is of value in obtaining superior results. Dollar cost averaging is a passive strategy, which a subscriber to the strong form may use, but using a buy-and-hold strategy by dollar cost averaging into an index fund is more aligned with the strong form than investing in a fund with the highest portfolio turnover.

One popular method used to predict the expected return of a stock is the capital asset pricing model. Analysts using CAPM rely on all of these EXCEPT A) the standard deviation of the stock B) the risk-free rate available in the market C) the beta coefficient of the stock D) the expected return on the market

A Under the CAPM, using the SML, we can determine the expected return of any given stock by taking the risk-free rate and adding to that the product of that stock's beta coefficient and the difference between the expected return on the market and the risk-free rate. Standard deviation is not a factor in this computation.

An investor has arranged with her bank to have $1,000 sent to the KAPCO Balanced Fund on the same day each month. For the first 4 months of this arrangement, the prices of the fund have been: Month 1 - $10.00 per share Month 2 - $12.50 per share Month 3 - $15.00 per share Month 4 - $13.25 per share What is the difference between the investor's average cost per share and average cost per transaction? A) The average cost per share is approximately $0.27 less. B) There is no difference. C) The average cost per share is approximately $0.19 less. D) The average price per transaction is approximately $0.27 less.

A When investing $1,000 per month, the investor acquired 100 shares the first month, 80 shares the second month, 66.667 shares the third month, and 75.472 shares the fourth month. That is a total of 322.139 shares purchased for a total cost of $4,000. That is an average cost per share of $12.42 per share. The average of the four transaction prices ($10, $12.50, $15, and $13.25) is $12.69. That is $0.27 higher than the cost per share. This demonstrates the advantage of dollar cost averaging.

You have a client who wishes to manage his own portfolio of individual stocks. The simplest style for him to follow would be A) buy and hold B) indexing C) core D) tactical

A When it comes to individual stocks, nothing is simpler than buy and hold. If the client wished to have the simplest overall portfolio and didn't want to manage things, then indexing would be the answer.

"Stock prices adjust rapidly to the release of all new public information." This statement is an expression of which of the following ideas? A) Tactical allocation B) Efficient market hypothesis C) Arbitrage pricing theory D) Odd-lot theory

A 75 year-old client's $500,000 portfolio is 40/60 equity/debt. Six months later, the portfolio balance is $480,000 of which $180,000 is equity. If the investment adviser recommends semiannual rebalancing, the client will A) stay put because selling now would realize a loss. B) sell $12,000 of the debt and use the proceeds to purchase $12,000 of equity. C) purchase $12,000 of debt and $8,000 of equity to return to the original $500,000. D) sell $12,000 of the equity and use the proceeds to purchase $12,000 of debt.

Which of the following statements is an accurate description of dollar cost averaging? A) An investor buys the same number of shares each interval, averaging his purchase prices over time. B) An investor invests a set amount of money each interval to buy more shares when the prices are low and fewer shares when prices are high. C) An investor averages the costs of his shares purchased and then enters limit orders to purchase additional shares at the average price. D) An investor sells shares when the market rises and buys shares when the market declines in order to average his costs.

Which of the following statements is correct in relation to the efficient frontier? A) It identifies the required rate of return on a particular stock. B) It represents the maximum return for a given level of risk. C) It allows an investor to create a risk-free portfolio. D) It implies an inefficiency in stock valuations.

Which of the following statements regarding modern portfolio theory is NOT correct? A) The optimal portfolio offers the highest return for a given level of risk. B) The optimal portfolio will always lie above the efficient frontier. C) The optimal portfolio has the lowest risk for a given level of return. D) The optimal portfolio for an investor depends upon the investor's ability to assume risk.

Which of the following would an investor who believes in MPT probably select for a client? A) GHI, with a return of 13% and a standard deviation of 20 B) JKL, with a return of 15% and a standard deviation of 15 C) ABC, with a return of 11% and a standard deviation of 15 D) DEF, with a return of 13% and a standard deviation of 18

While managing a client's portfolio, an investment adviser representative attempts to take advantage of perceived market inefficiencies. The IAR is not concerned with the client's long-term goals; rather, the interest lies in continuously changing the investment mix in an attempt to take advantage of overall investor sentiment. Based on this information, what type of portfolio management style is the investment adviser representative using to manage the client's money? A) Strategic asset allocation B) Tactical asset allocation C) Portfolio ratio analysis D) Buy-and-hold

Under modern portfolio theory (MPT), all portfolios that can be constructed from a given set of stocks is referred to as A) the efficient set B) the feasible set C) the capital market line D) the correlation coefficient

B A feasible portfolio is defined as a portfolio that an investor can construct given the assets available. The feasible set is the collection of all feasible portfolios. Once we have the feasible set, we can select the efficient set (the most return for a given amount of risk, or the least risk for a given amount of return).

An analyst is reviewing a report on Company X. The report shows a P/E ratio of 10, compared with an industry average of 27. Based on the most current quarterly payment, X has a dividend yield of 3.65%. The analyst notices there is a footnote indicating the company has put $1.2 billion away for what it refers to as a rainy day fund. most likely, Company X would be considered A) a growth stock B) a value stock C) a small-cap stock D) a utility stock

B Although there are no hard and fast rules, when a company's P/E ratio is substantially lower than its industry average and the dividend yield is fairly high, it will be considered to have great value. Solidifying this decision is the notation that there is the rather large rainy day fund. Yes, utility stocks do pay liberal dividends but what must be noticed here is the low P/E ratio compared with its peers.

Which of the following is a characteristic of the passive investment style? A) High portfolio turnover B) Rebalancing C) Income rather than growth objective D) Tactical management

B Because the passive (strategic) style of investing does not involve frequent trading (as does the tactical or active style), periodically the portfolio will be rebalanced to insure that the asset mix is at the desired level. This style may be used for either income or growth objectives.

Which of the following is not correct regarding the capital asset pricing model (CAPM)? A) CAPM only considers the systematic risk. B) CAPM uses standard deviation as a measure of market risk. C) The market risk premium is the incentive required for the individual to invest in the securities market. D) The stock risk premium is the inducement necessary to entice the individual to invest in a particular stock.

B CAPM accounts for the impact of systematic risk (as measured by beta) only and does not take into consideration unsystematic risk, which is assumed to have been diversified away.

An investor diversifying a corporate bond portfolio does NOT consider A) quality B) domicile of the investor C) maturity D) issuer

B Domicile, or geographic location of the investor, is not relevant in diversifying a corporate bond portfolio. For example, it is irrelevant if the client is located in Michigan or New Jersey or any other state; that will have no impact on the risks facing the issue. This could be a factor for municipal bond investors due to the possibility of avoiding state income tax. A corporate bond portfolio can be diversified by issuer, quality (rating), domicile of the issuer, and maturity.

Based on the following information, which stock is most likely to appeal to a growth investor? A) Book value of $22 per share, current market value of $17 per share B) Dividend yield of 0.3% C) Dividend payout ratio of 65% D) P/E ratio of 8:1

B Growth investors usually seek stocks with high-growth expectations, reflected by a higher-than-normal P/E ratio, typically 20:1 or higher, and a low dividend yield, usually caused by a low dividend payout ratio. It would be unlikely to find a growth stock selling for close to its book value and certainly not below it.

Which of the following statements regarding the growth style of investing is correct? A) Growth managers focus on the numerator in the P/E ratio, desiring a low stock price relative to earnings or book value of assets. B) Growth managers focus on the denominator in the P/E ratio, searching for firms and industries where high expected earnings growth will drive the stock price up even higher. C) Growth managers believe that, although a firm's earnings are depressed now, the earnings will rise in the future as they revert to the historical range. D) Growth managers look for a high-dividend yield and often take a contrarian approach.

B High P/E ratios are one of the keynotes of growth investing. The other choices here all relate to the value style.

Hexagon Portfolio Advisors (HPA) believes that the market is semi-strong efficient. The firm's portfolio managers most likely will use A) technical analysis to create portfolio management strategies. B) passive portfolio management strategies. C) active portfolio management strategies. D) an enhanced indexing strategy that relies on trading patterns.

B If the market is semi-strong efficient, portfolio managers should use passive management because they believe neither technical analysis nor fundamental analysis will generate positive abnormal returns on average over time. A semi-strong proponent opines that private (inside) information can work (beat the market), but because that information is generally prohibited from use, portfolio managers can't claim that as their investment strategy.

A firm declares a $3.00 cash dividend to its shareholders. The firm has issued dividends of only $.07 per share for each of the last 15 quarters, and market analysts had anticipated a similar dividend this quarter. In an efficient market, one would expect A) a price increase before the announcement. B) a price change upon the announcement. C) a price decrease after the announcement. D) no price change before or after the announcement.

B In an efficient market, the price of the stock will represent all information that is public. Because the increase in the dividend was not public knowledge until it was declared, no price change would take place before the announcement. A price change, representing the increase in dividends, would be expected immediately after the information became public.

Which of the following is a characteristic of index investing? A) Relatively high costs B) A portfolio that mirrors the performance of a specific market C) A chance to achieve returns that beat the market D) No guarantee of matching market returns

B Index investing involves investing in a portfolio that has a high correlation to a specific market index, such as the S&P 500. The advantages of this approach are its low cost and the guarantee of achieving returns that tend to match the market's performance. In exchange for these advantages, index investors give up the opportunity to beat the market.

Which of the following statements concerning market efficiency is not correct? A) The efficient market hypothesis (EMH) is the proposition that the securities markets are efficient, with the prices of securities reflecting their current economic value. B) Investors who accept the efficient market hypothesis (EMH) usually adopt an active investment strategy. C) The fundamental assumption of market efficiency is that current stock prices reflect all available information for a company and that prices rapidly adjust to reflect any new information. D) Any new information must be unexpected; therefore, any changes in the stock price resulting from this new information will be random.

B Investors who accept the EMH usually adopt a passive investment strategy; investors who do not accept the EMH, pursue an active investment strategy. If the market is efficient, the best strategy is indexing rather than stock picking.

A well-diversified investor following a rebalancing portfolio strategy in a rising market will most likely A) purchase additional stock B) sell part of the stock in the portfolio C) write covered calls on the long stock currently in the portfolio D) sell all the stock in the portfolio

B Portfolio rebalancing is a strategy that seeks to maintain a constant ratio (percentage) of a portfolio's original investment allocation. If stock increases in value, some of it will be sold to maintain the proportion of stock in the portfolio.

Which of the following is the form of portfolio management that rotates between sectors based on changes to the business cycle? A) Cyclical rotation B) Segment rotation C) Tactical portfolio management D) Strategic portfolio management

B Segment rotation, more commonly known as sector rotation, involves altering portfolio composition based on which sectors are poised to outperform as the business cycle is changing phases.

The capital asset pricing model (CAPM) is based on several limiting assumptions. Which of the following statements is correct regarding the CAPM? A) The CAPM does not assume that the expected excess returns for the market are known. B) The CAPM assumes that the optimal portfolio should be the one with the highest Sharpe ratio of all possible portfolios. C) The CAPM does not assume that investors have access to the same information. D) The CAPM assumes that investors' expectations regarding risk and return are not identical but normally distributed.

B The CAPM assumes that investors should construct a portfolio with the highest Sharpe ratio because that offers the highest risk-adjusted return. It also assumes that the expected excess returns for the market are assumed to be known in that investors have access to the same information. As well, it assumes that returns are normally distributed and investors' expectations for risk and return are identical.

Which investment strategy is consistent with a belief in the efficient market hypothesis? A) Searching for undervalued securities B) Selecting a random set of stocks for a portfolio C) Comparing the calculated value of a security, through fundamental analysis, to the market value of the stock D) Waiting to purchase a stock until it increases above the 40-day moving average

B The efficient market hypothesis states that an investor cannot consistently outperform the market. Selecting a random set of stocks is consistent with this theory. The other strategies are aligned with technical and fundamental analysis.

The capital asset pricing model (CAPM) is used by many to assess the expected return of a security. If the current risk-free rate is 2%, the current return on the market is 12%, and a particular stock's beta is 0.8 with a correlation coefficient of 0.60, the expected return would be A) 7.2% B) 10.0% C) 11.6% D) 9.6%

B The formula for this computation is as follows: 12% (the return on the market is a beta of 1.0) minus the risk-free rate of 2%, or 10%. Then, multiply that by the beta of this stock (0.8) to arrive at 8%. That is, the stock should return 8% above the risk-free rate of 2%, or 10%. The correlation coefficient is not relevant to this computation.

Which efficient market hypothesis suggests that an investor can achieve above-market returns by only utilizing insider information? A) Strong B) Semi-strong C) Super-strong D) Weak

B The semi-strong form suggests that fundamental analysis is of no value and only through the use of insider information can an investor achieve above-market returns. The weak form suggests that technical analysis is of no value and the strong form suggests that nothing has any value - efficient markets are totally random.

There are several financial models that refer to the "risk-free" rate of return. Which of the following instruments is used to measure that rate? A) Federal funds B) 30-year Treasury bond C) 91-day Treasury bill D) 1-year CD

A company has 15 million shares of stock outstanding, and the price per share is $10. The company's market capitalization is A) $15 million B) $25 million C) $150 million D) $1.5 million

A portfolio manager using index options is trying to hedge which of the following types of risks? A) Selection B) Purchasing power C) Systematic D) Financial

All of the following are advantages of the buy-and-hold strategy except A) the investor may effectively manage any investment tax obligations. B) the investor will not be out of the market during an upturn in stock prices. C) the investor is guaranteed a profit. D) the investor can minimize transaction costs.

All of the major equity indexes have been making new highs. A portfolio manager employing which of the following management styles would be the most likely to have significant short positions? A) Growth B) Passive C) Contrarian D) Value

An investment adviser recommended a portfolio allocation for a client with an initial deposit of $100,000 that is 50% equities, 40% bonds, and 10% cash. One year later, the portfolio value is $120,000 and consists of $10,000 cash, $65,000 equities, and $45,000 bonds. In order to rebalance the portfolio, the account would need to A) buy $5,000 more equities, sell $3,000 of the bonds, and add $2,000 to the cash. B) use the cash to buy $3,000 of bonds and leave everything else as is. C) sell $5,000 of the equities and purchase $3,000 of bonds and put $2,000 into cash. D) sell $5,000 of the equities and purchase $2,000 of bonds and put $3,000 into cash.

An investor who uses dollar cost averaging to purchase a mutual fund would A) allocate assets equally among cash, stocks, and bonds B) purchase the same number of shares each month C) invest the same amount of money each month D) invest in a bond fund during a falling market and a stock fund during a rising market

Corpulent Asset Services of Hamburg (CASH), a covered investment adviser, has a philosophy of placing most of their clients' assets into broad market index funds and ETFs. This would indicate that CASH's portfolio management style is most likely A) tactical B) active C) passive D) conservative

If an investor purchases 500 shares of an aggressive growth stock, which strategy would limit his downside risk? A) Writing 5 puts on the stock B) Writing 5 straddles C) Buying 5 puts on the stock D) Buying 5 calls on the stock

If the risk and return profiles of all the possible risky portfolios were plotted on a graph, those portfolios that would be the most attractive to investors would lie on A) the y-axis B) the capital market line C) the efficient frontier D) the security market line

If the risk-free rate of return is 3.5%, the expected market return is 9.5%, and the beta of a stock is 1.3, what is the required return on the stock according to the capital asset pricing model? A) 12.35% B) 8.85% C) 11.30% D) 7.80%

Investors wishing to employ a passive strategy for their bond portfolios would most likely elect which of the following? A) Laddering B) Bullet C) Buy and hold D) Barbell

Market timing is normally associated with which of the following portfolio management styles? A) Modern portfolio theory B) Passive management C) Tactical asset allocation D) Strategic asset allocation

Proponents of the efficient market hypothesis believe that A) time horizon is one of the most important investment constraints. B) active portfolio management will generally produce better results than passive management. C) markets operate efficiently and stock prices instantly reflect all available information. D) careful stock selection can produce positive alpha without increasing risk.

Some risk is involved in almost all investments. In general, the greater the risk, A) the longer the period until a return will be realized B) the more expensive the investment C) the greater the potential return D) the smaller the potential return

The statement, "Stock prices fully reflect all information from public and private sources," can be attributed to which form of the efficient market hypothesis (EMH)? A) Semi-strong form B) Weak form C) Strong form D) Semi-weak form

The tactical approach to the asset allocation review process A) requires no predictive abilities B) is designed to maintain a minimum or floor for the value of the portfolio's assets C) intentionally deviates from the normal asset mix to take advantage of market opportunities D) strives to maintain a constant asset mix over a long period of time

Derivatives have a major role to play in the management of many large portfolios and can be used for all of the following except A) income. B) asset allocation. C) highly risk-averse investors. D) hedging.

C Derivatives are generally not appropriate for highly risk-adverse investors due to the risk and sophistication involved. Some of the common uses of derivatives are for: Hedging to reduce the impact of adverse price movements (e.g., by buying put options or selling futures contracts). Anticipating future cash flows. Asset allocation changes. Income (selling options).

Which of the following is NOT a type of diversification that is achieved by investing in international equities? A) Asset class B) Currency C) Style D) Geographic

C Following a value or a growth style, or using a buy-and-hold strategy, is independent of the continent of domicile of the issuer. Investing in different countries diversifies investments among various currencies, other than the client's domestic currency. Different geographic areas have different types of industries whose performance may vary on the basis of regional resources. International equities are considered another asset class for purposes of asset allocation in one's portfolio.

Which of the following investment strategies is likely to have the lowest tax impact for the client? A) Indexing B) Passive C) Buy and hold D) Contrarian

C If one buys and holds without selling, there are never any capital gains on which to pay tax. And when there is a sale, the gain is invariably long term. Indexing (a very popular form of passive strategy) is a very tax-efficient strategy; however, because there are periodic changes to the portfolio to match the changes in the index, there are tax consequences, some of which could be short-term capital gain.

Which of the following statements is correct? A) The efficient frontier represents individual securities. B) As the correlation coefficient moves from +1 to zero, the potential for diversification diminishes. C) When a risk-averse investor is confronted with two investment opportunities having the same expected return, the investor will take the opportunity with the lower risk. D) The efficient frontier represents portfolios that have the lowest expected return for each level of risk.

C It is expected that investors will always choose the lower risk investment if both generate the same return. The other statements are incorrect. As the correlation coefficient declines, the potential for greater diversification increases. Efficient portfolios, not individual securities, lie on the efficient frontier. The efficient frontier contains portfolios with the highest expected return at each level of risk.

Which of the following is not an assumption of the capital market theory? A) All investors want to achieve a maximum return for minimum risk. B) Market participants have the same expectations about the returns and standard deviations of all assets. C) All market participants borrow and lend at different risk-free rates. D) There are no taxes or transaction costs.

C One of the assumptions of the capital market theory is that all market participants borrow and lend at the same risk-free rate. The other choices are all true statements (and might be tested).

All of the following statements concerning the EMH are correct EXCEPT A) the weak form of market efficiency involves market data, whereas the semi-strong and strong form involve the assimilation of all public and private information, respectively. B) the efficient market hypothesis states that securities markets are efficient, with the prices of securities reflecting their current economic value. C) investors usually react slowly to new and random information pertaining to all currently available security market information. D) an efficient market is one in which the prices of securities quickly and fully reflect all currently available security market information.

C The efficient market hypothesis (EMH) posits that an efficient market is one in which the prices of securities quickly and fully reflect all currently available security market information. Therefore, there is little chance that an investor can "beat the market." The weak form uses historical market data, such as price and volume movements; semi-strong involves financial information, which is publicly available; strong involves inside information. But, according to adherents, none of that really helps.

Riley, as an investor, prefers to be on the lower end of the efficient frontier. We would expect to see which of the following risk and return combinations? A) Low risk and medium return B) Low risk and high return C) Low risk and low return D) High risk and low return

C The lower end of the efficient frontier includes low-risk and low-return portfolios. The higher end includes high-risk and high-return portfolios. It is all about the risk-reward ratio - the more risk the investor is willing to assume, the higher the potential rewards.

The pundits are predicting slowly-rising inflation over the next 5 years. An IAR recommends that one of her clients splits his bond portfolio into equal percentages with maturities ranging from 1 to 5 years. As each bond matures, the proceeds are used to purchase bonds with a 5-year maturity. The IAR is using A) the interest discount model. B) the bullet strategy. C) the laddering strategy. D) the barbell strategy.

C The theory behind the laddering strategy is that with bonds maturing every year, the investor is reinvesting the principal at current market rates. In a period of rising inflation, interest rates follow along, so annually, the maturing bonds will be used to purchase new bonds with higher coupons. The barbell strategy has all bonds purchased at the same time with two different sets of maturities - half of the bonds mature near term and half mature intermediate term. The bullet strategy is used when aiming at a target. This strategy involves buying bonds at different intervals, but all with approximately the same maturity date. There is no such thing as the interest discount model - perhaps you confused it with the dividend discount model used with equity securities.

A popular funding technique that involves investing the same amount at regular intervals is known as dollar cost averaging. Participating in this funding approach tends to lessen which risk? A) Market B) Inflation C) Timing D) Credit

C Timing risk, sometimes called market timing risk, is the uncertainty that an investor will be buying at the market top or selling at the market bottom. In other words, at the wrong time. When one dollar cost averages, that risk is lessened because you automatically acquire more shares when the market is down and less when it is high. Is it foolproof? No, but it does take some of the timing risk away.

The capital asset pricing model (CAPM) is an investment theory that serves as a model for A) pricing securities based on their total risk B) pricing securities based on their unsystematic risk C) pricing securities based on their systematic risk D) measuring the correlation between a security and the overall market

C Under the CAPM, securities are priced based on their systematic risk only, because this risk cannot be eliminated through diversification. The expected return of a security or portfolio is calculated by adding the rate on a risk-free security to a risk premium multiplied by the asset's systematic risk.

Over the past year, the market, with a beta of 1.0, has returned 15%. Under CAPM, which of the following stocks would be considered overvalued? A) ACR, beta 0.9, return 13.6% B) LQR, beta 0.7, return 11% C) RJP, beta 1.2, return 17.5% D) BED, beta 1.5, return 23.5%

C We compare the expected return to the actual return to determine if the security outperformed (making it undervalued) or underperformed (making it overvalued). RJP's beta of 1.2 would have led to an expected return of 120% of that of the market. That would be 15% x 120% = 18%. With an actual return of 17.5%, the stock did not perform relative to the additional risk taken. The actual return for all of the others exceeded the expected return. LQR was 11% compared to 10.5%; BED was 23.5% compared to 22.5%; and ACR was 13.6% compared to 13.5%.

An investor decides to make monthly investments into the KAPCO Growth Fund. Each month, the investor purchases 10 shares of the fund. Over a 4-month period, the investor accumulated 40 shares at the following prices: Month 1 - $10 Month 2 - $8 Month 3 - $12 Month 4 - $10 If, instead of purchasing 10 shares per month, the investor had invested $100 per month, A) the investor would have acquired 40 shares in either case. B) the investor would have paid slightly more in the second case. C) the investor's cost basis would be the same. D) the investor would have acquired 40.833 shares instead of 40 shares.

An investor following the buy and hold model of investing would most likely be A) holding a stock until its ex-dividend date and then selling it to capture the dividend. B) looking to shelter income from taxation. C) buying a stock during the recovery cycle and selling at the peak. D) buying a stock as a long-term investment to reach a specific goal.

An investor wishes to save for her retirement. She arranges to have $250 per month withdrawn from her account to be invested into a commodity fund. This type of saving plan is called A) constant dollar plan B) investing in futures C) speculation D) dollar cost averaging

High-tech Industries (HTI) went public 4 years ago by issuing 100 million shares of common stock at $1 per share. HTI's earnings have soared and the stock is now selling for $13 per share. HTI would be considered A) a mid-cap stock. B) a micro-cap stock. C) a large-cap stock. D) a small-cap stock.

Ian is a technical analyst who believes the market, as represented by the S&P 500 Index, is overbought. Over the next several months, there is a 12% correction. Which of the following strategies would have been successful for Ian? A) Buy call options on the S&P 500 Index B) Buy futures contracts on the S&P 500 Index C) Sell put options on the S&P 500 Index D) Sell futures contracts on the S&P 500 Index

It is agreed by most investment advisers that diversifying an investment portfolio can reduce the overall risk. Benefits of diversification would include all of the following except A) increasing risk-adjusted returns. B) lowering the volatility of the portfolio. C) mitigating the effects of a bankruptcy of a security held in the portfolio. D) lowering trading costs.

Management style is a phrase that is often used to describe the methodology employed by a particular portfolio manager. If the manager under discussion used earnings momentum to select stocks, it could be said that the style being used was A) value B) passive C) asset allocation D) growth

One of the goals of modern portfolio theory (MPT) is to construct a portfolio that provides the highest return with the lowest risk. This would be known as A) the managed portfolio B) the risk-free portfolio C) the Sharpe's portfolio D) the efficient portfolio

The concept of creating a model portfolio, through asset allocation principles, that both increases return and reduces risk is known as A) risk reduction fundamentals B) corrective adaptation C) rebalancing D) portfolio optimization

The process of making changes to an asset allocation model over time, in an effort to adapt for any allocation percentages that are no longer in tandem with the original portfolio allocation model, is called A) allocation adjustment theory B) corrective adaptation C) portfolio modification D) rebalancing

What investment style is employed by a portfolio manager whose list of eligible securities includes only those with a market capitalization in excess of $20 billion? A) Indexing B) Conservative C) Blue chip D) Large-cap

Which of the following is NOT a characteristic of a Monte Carlo simulation? A) It is a technique used to model uncertainty in retirement planning. B) It provides insight into the range of outcomes. C) The user gets a best-case scenario and a worst-case scenario. D) Large changes in the projected rate of return will make small differences in the outcome.

Which of the following is an example of a passive investment management style? A) Use of index funds in conjunction with selecting specific securities in the index to overweight certain sectors B) Value investing C) Investment in small capitalization technology securities D) Exclusive use of index funds

Which of the following stocks would probably be most appealing to a value investor? A) A stock that has relatively high volatility B) A stock with a relatively high price-to-book value ratio C) A stock with a relatively low dividend yield D) A stock with a relatively low P/E ratio

While managing a client's portfolio, an investment adviser representative attempts to take advantage of perceived market inefficiencies. The IAR is not concerned with the client's long-term goals; rather the interest lies in continuously changing the investment mix in an attempt to take advantage of overall investor sentiment. Based on this information, what type of portfolio management style is the investment adviser representative using to manage the client's money? A) Portfolio ratio analysis B) Buy and hold C) Strategic asset allocation D) Tactical asset allocation

An investment strategy where a higher price is paid for a stock based on expected returns is A) return on investment. B) futures investing C) dollar cost averaging D) growth investing

D A growth investor purchases shares that have exhibited faster-than-average gains in earnings over the past few years that is likely to continue to show high levels of margin. Over the long run, growth stocks tend to outperform the market but are riskier than most other stocks and generally pay little or no dividend.

An investor wants to moderate overall portfolio risk and return profile with assets that have a low correlation to traditional asset classes. Which of the following is an appropriate asset class for the investor? A) Corporate bonds B) Small-cap shares C) Treasury bills D) Private equity

D Alternative asset classes like hedge funds, private equity, and commodities help moderate overall portfolio risk and different return profiles from traditional asset classes like stocks and bonds.

All of the following statements concerning capital market theory are correct EXCEPT A) the security market line (SML) depicts the tradeoff between risk and expected return for all assets, whether individual securities, inefficient portfolios, or efficient portfolios. B) the security market line (SML) is the graphical depiction of the capital asset pricing model (CAPM). C) the market risk premium is the difference between the expected return for the equities market and the risk-free rate of return. D) beta is a measure of volatility, or relative unsystematic risk, for stock or portfolio returns.

D Beta is a measure of relative systematic risk for stock or portfolio returns. A stock or portfolio with a beta of 1.0 would have the same systematic risk as the overall market.

Which of the following investment strategies is used to determine an appropriate allocation based on the long-term goals and risk tolerance of the client? A) Efficient market allocation B) Tactical asset allocation C) Top-down fundamental analysis D) Strategic asset allocation

D In strategic asset allocation, once the allocation is determined, it remains relatively constant until some change to the investor's objectives occurs. Periodically, the portfolio is re-balanced to reflect any changes in market conditions.

If a client who holds a convertible preferred stock believes the company may go bankrupt within the next 3 years, what would you advise the client to do with the stock? A) Sell calls on the preferred stock. B) Buy puts on the common stock as a hedge. C) Immediately convert to common stock because the preferred dividends may no longer be paid. D) Sell the security.

D In the event of bankruptcy, all debt holders have priority over equity holders in claims on the assets of the corporation in liquidation. The safest alternative is to sell the stock. Buying puts on the underlying common stock would be an effective hedge, but with a 3-year wait, the position would have to be renewed several times because the usual option only has a life of 9 months; this would lead to increased transaction costs.

Which of the following statements concerning market efficiency is least accurate? A) If semi-strong form market efficiency holds, technical and fundamental analysis cannot be used to earn abnormal returns over the long run. B) If strong form of market efficiency holds, even insider information cannot be used to earn abnormal returns. C) If weak form market efficiency holds, technical analysis cannot be used to earn abnormal returns over the long run. D) An efficient market assumes one can generate abnormal returns with active portfolio management.

D Market efficiency assumes active portfolio management cannot help earn abnormal (excess) risk-adjusted returns. The weak form indicates that technical analysis doesn't work. The same is true for the use of inside information under the strong form. Semi-strong says that neither technical nor fundamental analysis will work.

Which of the following is NOT associated with passive investment management approaches? A) Use of index investing B) Belief in the random walk theory C) Belief in efficient markets D) Goal of beating the market

D Proponents of passive-management approaches believe in the random walk theory (market movements are unpredictable) and efficient markets (any information that could affect a stock's price is quickly reflected in its price). As a result, they feel that it is impossible to consistently beat the market. Index investing is a commonly used passive-management approach.

A portfolio manager who routinely shifts portfolio assets to take advantage of the business cycle is said to be engaging in A) rebalancing B) asset allocation C) correlation D) sector rotation

D Sector rotation is the practice of moving out of those industries that are heading for a decline and into those whose fortunes are likely to rise as the economy follows the business cycle.

Amie Lear is a securities analyst employed by Empyreal Benefits, Inc., a registered broker-dealer. She is assigned to cover a number of different equity and debt investments. One of the investments is Taylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensive analysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. However, when applying the capital asset pricing model (CAPM), the result is a 12% rate of return. Based on Lear's analysis, Taylor's stock is A) undervalued. B) correctly valued. C) neither overvalued nor undervalued. D) overvalued.

D The CAPM gives us the expected rate of return on an investment. It is sometimes referred to as the required rate of return. That is, based on the risks, the CAPM reveals the return that should be earned. In this example, that return is 12%.Lear's computation expects the return to be only 10%. Therefore, Lear is showing that instead of providing the required return of 12%, she believes the stock will only return 10%. That makes the stock overpriced (a lower price will generate a higher rate of return). As a result, Lear would not recommend this stock because her calculations indicate it will not return as much as it should for the risk being taken.

Your customer, age 29, is seeking a long-term growth investment, is concerned about the loss of purchasing power as a result of inflation, and often complains about high commissions that reduce his investment returns. When he was in college, he took a few economics courses and firmly believes that securities analysts cannot consistently outperform the overall market. Which of the following mutual funds is the most suitable for the customer? A) NC Growth & Income Fund B) ATF Biotechnology Fund C) ZB Asset Allocation Fund D) ARG Stock Index Fund

D The customer requires a mutual fund that offers potential for long-term capital growth. Because the client believes that money managers cannot outperform the market, an index fund, which simply mimics the market, is the appropriate investment. The client's complaint about high commission charges is a further argument for index funds, which have low expense ratios.

Which of the following forms of the efficient market hypothesis claims that technical analysis works? A) Weak B) Strong C) Semi-strong D) None of these

D The efficient market hypothesis is in direct contradiction to technical analysis because the efficient market hypothesis is founded on the notion that all historical price and volume data, which is used by technical analysts, is already accounted for in the current stock price. The weak form claims that fundamental analysis works and the semi-strong form claims that inside information works. True believers in EMH claim that none of these can outperform random selection.

While attending a seminar given by one of your firm's analysts, you hear the term, feasible set. That would mean the discussion was dealing with the topic of A) convexity B) opportunity cost C) a range of returns D) the efficient frontier

D The feasible set of portfolios represents all portfolios that can be constructed from a given set of stocks. An efficient portfolio is a feasible portfolio that provides the greatest expected return for a given amount of risk, or equivalently, the least risk for a given amount of expected return. This is also called an optimal portfolio. The efficient frontier is the set of all efficient portfolios. Obviously, an investor should choose a portfolio along the efficient frontier.

An investment adviser representative is evaluating DEF stock to see if it is a good fit for a client's portfolio. Using the security market line (SML), what is the expected return for DEF when the return on the market is 8%, the 91-day Treasury bill is yielding 6%, DEF's beta is 1.50, and the inflation rate, as measured by the CPI, is 4%? A)12% B)8% C)5% D)9%

D The formula for this computation is as follows: 8% (the return on the market is a beta of 1.0) minus the risk-free rate of 6%, or 2%. Then, multiply that by the beta of this stock (1.5) to arrive at 3%. That is, the stock should return 3% over the risk-free rate of 6%, or 9%. Inflation rate is only important if we are looking for the real (inflation-adjusted) return, not the expected return.

Jim Cantore is a 45-year-old client with a $1.5 million portfolio that is heavily weighted toward equities. Cantore will continue working for the next 20 years and has a substantial retirement portfolio through his current employer. Cantore's 3 children are now nearing college age and will all attend premiere universities in the United States, which each cost $50,000 per year to attend. All college expenses will be paid out of Cantore's portfolio. Cantore should A) rebalance his portfolio toward aggressive small-cap stocks because he needs to increase the return of his portfolio to cover the upcoming college expenses. B) not rebalance his portfolio because his children should all pay their own way through school. C) rebalance his portfolio toward large-cap common stocks and international securities because education costs are highly correlated with the returns to these securities. D) rebalance his portfolio toward high quality, intermediate-term debt instruments to service the expected liquidity needs of his portfolio.

D The liquidity needs of sending his children to school should take precedence over his retirement needs, which are already well funded. Although the equities have liquidity, the potential market risk makes it wise to diversify such that the portfolio becomes less sensitive to market swings.

When attempting to construct the optimal portfolio, the investment adviser is looking to obtain A) returns that fall within the efficient frontier curve. B) the maximum return in the shortest time period. C) the maximum return with the greatest risk. D) the maximum return for the least risk.

D The optimal portfolio is the one which provides the greatest return for the least risk. It will fall on the efficient frontier. It is important not to get hung up on terminology when common sense works. As an investor, wouldn't you always want the highest return you could get for the least risk?

Which of the following is TRUE of the weak form of the efficient market hypothesis? A) It implies that throwing darts is just as efficient as analyzing the market. B) It implies that insiders cannot make a profit from their trading. C) It implies that stock prices react to information when it becomes publicly available. D) It implies that market information cannot be used to identify future price movements.

D The weak form of the EMH states that all market information has already been incorporated into the current stock price. Therefore, having that information is of no help in predicting movements in the market.

In general, the most passive investment style for a portfolio would be A) value. B) buy and hold. C) contrarian. D) indexing.

D This is a close call between indexing and buy and hold. We believe that the NASAA philosophy on this would be that buy and hold does require some management after the portfolio is set up. That is, some companies go out of business or are merged into other entities or go private and that requires making new decisions. The same can happen with the companies in an index, but the investor doesn't have to make the changes. When you invest in an index, it is sort of like (with credit to Ron Popeil) "set it and forget it". Clearly, the other two choices are not passive in the same way.

Based on the following information, which stock is most attractive to a value investor? A) Dividend yield of 1.3% B) Net worth per share of $13, current market price of $23 per share C) P/E ratio of 32:1 D) Book value of $22 per share, current market value of $17 per share

D Value investors look for stocks that appear to be underpriced in the market. These stocks are characterized by prices that may be below book value, low P/E ratios, and higher dividend yields.

Value investors A) seek undervalued stocks through careful chart analysis B) attempt to find value through diversification C) seek to find securities with high Sharpe ratios D) seek securities that are undervalued or selling for less than their intrinsic value

D Value investors seek securities that are undervalued or selling for less than their intrinsic value. Value investors tend to use fundamental analysis and do not determine value from charting.

When preparing an asset allocation program, all of these would be considered asset classes EXCEPT A) debt securities B) equity securities C) cash or cash equivalents D) Brady bonds

D When describing an asset class, we are not looking at a specific security. IBM common stock is considered as an equity security—it is not an asset class by itself. Brady bonds are considered a debt security, but not an asset class. Brady bonds are issued by a developing country as a result of a restructuring of its defaulted bank debt. They are government obligations issued after the debtor nation negotiates with the creditor banks' advisory committee to restructure loans that are no longer performing. The creditor banks exchange the nonperforming loans for various Brady bonds offered by the debtor government.

An investor has $50,000 to invest in bonds. Currently, 10-year bonds are offering very attractive yields, but the client is concerned that in a few years, rates will be even higher. What would you suggest? A) Laddering B) Diversifying C) Bullet bonds D) Barbell bonds

D With the barbell strategy, the investor would place $25,000 into bonds maturing in 10 years and the other half into bonds maturing in two years. This makes $25,000 available for reinvestment in two years enabling the investor to take advantage of the higher rates (if they materialize).

Writing an option provides all of the following EXCEPT A) hedging B) income C) limited downside protection when long the underlying asset D) maximum protection against loss

D Writing an option provides only limited protection for a long or short position. That protection is limited to the amount of the premium received and is why this is called a partial hedge.

An investor begins contributing $600 on the third day of each month to a purchase plan for the KAPCO Total Return Fund. For the first six months, the per share prices were: $10 $12 $15 $20 $12 $8 What is this investor's breakeven point? A) $12.83 per share B) $12.50 per share C) $11.80 per share D) $8.00 per share

This is a dollar cost averaging question. This investor has purchased a total of 305 shares with a total cost of $3,600. Here's the math: Month 1- $600 divided by $10 = 60 shares Month 2 - $600 divided by $12 = 50 shares Month 3 - $600 divided by $15 = 40 shares Month 4 - $600 divided by $20 = 30 shares Month 5 - $600 divided by $12 = 50 shares Month 6 - $600 divided by $8 = 75 shares The total expenditure was $3,600 (6 months××$600) and the total number of shares purchased was 305. That makes the average cost per share $11.80 ($3,600 divided by 305). With the investor's average cost per share being $11.80, a sale of the shares at that price will cause the investor to break even.

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