FINC 512 Quiz 1-4

The expected market return is 12% and the risk-free rate of return is 3%. Using CAMP, what is the expected return for a portfolio that has a standard deviation of 18% and a beta of 1.3?

14.7%

Phil is considering two portfolios: 1. Portfolio A with a return of 11% and a standard deviation of 16% 2. Portfolio B with a return of 6% and a standard deviation of 8% Assuming the correlation between A and B is -0.3, what of the following is the most efficient portfolio?

30% A/ 70% B The expected return is the weighted average return. The standard deviation of each combination is found using the SD for a two-security portfolio. Option a's return and SD =6.5% and 6.89% respectfully Option b's return and SD =7.0% and 6.24% respectfully Option c's return and SD =7.5% and 6.19% respectfully Therefore, the most efficient (highest return for a given level of risk) is option c. Options a and b are inefficient

OMB is considering two portfolios: 1. Portfolio A with a return of 14% and a standard deviation of 14% 2. Portfolio B with a return of 4% and a standard deviation of 7% Assuming the correlation between A and B is 0.5 and he invests 70% in A and 30% in B, what range of returns should this portfolio produce 95% of the time?

Between -11% and 33% SD=11 Expected return= 0.7(14%)+0.3(4%)=11% As noted in chapter 2, the 95% confidence interval equals 2 standard deviations from the mean. Therefore, the range -11 to 33% is the correct answer.

Which of the following statements is true about equity returns, as represented by the S&P 500 from 1928-2016?

Both a and b are false. Option a is false as the range is approximately 52% to 44%. Option b is false as there has not been a negative 20-year average return during this time period.

Assume that the three-month return for Hunter stock is 3%. Hunter's annualized return is closest to: a.) 11.85%. b.) 12.00%. c.) 12.55%. d.) 13.20%

C.) 12.55% Annualized return = (1.03)4 -1 = 12.55%

Assume Marleen adds security Y to her portfolio that is less than perfectly positively correlated with the portfolio. Security Y has the same standard deviation as the portfolio. After the addition of the security, the standard deviation of Marleen's portfolio will most likely:

It will decrease. The portfolio standard deviation should decrease as the security being added is not perfectly correlated with the portfolio. For example: Portfolio SD=20%, Security Y SD=20%. Correlation between the portfolio and Y= 0.95. WIth a weight of 95% for the portfolio and 5% for Security Y, the combined standard deviation equals 19.95%

For a market to be considered semi-strong form efficient, an investor would have to outperform an appropriate benchmark by using: a.) Publicly available information b.) Volume data c.) Private Information d.) Historical price data

Not A

Julio has a portfolio of mutual funds A, B, C. He has 50% in A, 40% in B, and 10% in C. The expected return on Julio's portfolio if the expected returns for A, B, and C are 10%, 8%, and 14% is closest to:

The weighted average expected return equals 0.5(10%)+0.4(8%)+0.1(14%)= 9.6%

Tori recently graduated from college with a degree in finance. She enjoys stock analysis and is eager to get started with investing in the market. Tori has approximately $30,000 of student loan debt at an average interest rate of 4.2%, and the $300 monthly payment is easily manageable even at the starting salary for a new college graduate. Although Tori does not currently have any savings, she has asked a financial planner to assist her in opening a brokerage account where she can begin buying stocks to save toward her goal of buying a condo in the next 7-8 years. which of the following is most accurate?

Tori's willingness (prosperity) to take on risk is greater than her ability (capacity) to take on risk, so the planner should encourage her to accumulate emergency funds prior to purchasing stocks in a brokerage account to save for the goal.

Emma Jones shows signs of being averse to losses. Jones will most likely: a.) Avoid selling stocks that would generate capital loss. b.) Divide her accounts into pre and post retirement segments. c.) Evaluate securities based on both risk and expected return. d.) Use momentum strategies to make buy/sell decisions.

a.) Avoid selling stocks that would generate capital loss.

The authority function of a self-regulatory organization is most likely characterized by: a.) Creation and enforcement of its own policies. b.) The effective management of conflicts of interest. c.) Establishment of clear standards of conduct. d.) Quick resolution of disputes.

a.) Creation and enforcement of its own policies. The authority of a SRO means that it can create a set of rules to which its members must adhere and then enforce them. Managing conflicts of interest is the management of conflicts function; clear standards is the supervisory function; and resolving disputes is the dispute resolution function.

Dylan Hope uses commodity futures contracts as part of his search for low correlations and diversification for his equity portfolio. Which of the following decisions would most likely be described as behavioral in nature? a.) Hope avoids tobacco stocks because his grandmother dies of lung cancer. b.) Hope avoids low price-to-book stocks because he prefers growth to value. c.) Hope takes long position in orange juice futures contracts when he expects commodity prices to rise d.) Hope takes short position in gasoline futures contracts when the price of gas at his local station rises by 10% during the previous month.

a.) Hope avoids tobacco stocks because his grandmother dies of lung cancer.

Blue-chip stocks are most likely: a.) Issued by reliable companies that have the potential to perform well in any market. b.) Characterized as having high growth potential. c.) Expected to outperform during economic expansions. d.) Securities with high levels of systematic risk.

a.) Issued by reliable companies that have the potential to perform well in any market. Blue-chip stocks are those that are supported by famous brand names and corporations. Blue chip firms are stable, have generated substantial operating cash flow for many years, and are expected to continue being market and industry leaders in the future.

A mortgage-backed security is most likely to be characterized as having: a.) Prepayment risk. b.) Little price risk. c.) Extremely low default risk levels. d.) Annual coupon payments.

a.) Prepayment risk. An MBS loses value when interest rates fall because homeowners refinance their mortgages. This is known as prepayment risk and is greatest when rates are falling. An MBS still has price risk and it typically pays interest monthly. Although historically, MBSs have had low default risk, during the crisis of 2008, they did not. In the current environment, they still have relatively low default risk, just not extremely low risk.

One part of the concept of Prospect Theory states that people place undue emphasis on low probability events that have large potential losses. Which of the following is the best example of this behavior mistake? a.) Purchasing insurance with excessive coverage at high premium cost. b.) Selecting an investment based on the expected returns and risks. c.) Holding onto an investment that has dropped 20% due to a poor earnings trend because the price is well below its 52 week high. d.) Making a decision based on rules of thumb rather than explicitly considering all available information.

a.) Purchasing insurance with excessive coverage at high premium cost.

Which of the following statements on securities laws and regulations is least accurate? a.) The Securities Act of 1933 created the Securities and Exchange Commission (SEC). b.) The Investment Advisers Act of 1940 requires investment advisors to register with the SEC (or their state) and to provide with a disclosure brochure. c.) The Securities Exchange Act of 1934 prohibits certain types of conduct in the securities markets. d.) FINRA is a self-regulatory organization that writes and enforces rules governing the activities of broker-dealers in the U.S.

a.) The Securities Act of 1933 created the Securities and Exchange Commission (SEC). The Securities Act of 1934 created the SEC.

Which of the following statements regarding returns is most accurate? a.) The internal rate of return is a geometric return b.) The arithmetic mean is always less than the geometric mean c.) The geometric return ignores compounding d.) The time weighted return is unique for all investors

a.) The internal rate of return is a geometric return The IRR is a specific type of geometric return. The AM is always greater than or equal to the GM. The AM ignores compounding (not GM). The dollar-weighted return is unique to all investors.

Portfolio D has a standard deviation of 17% and a correlation with the market of 1.00. If the standard deviation of the market is 15%, what is the beta for D? a.) 1.00 b.) 1.13 c.) 1.24 d.) 1.47

b.) 1.13 Beta equals the standard deviation of the portfolio times the correlation, divided by the standard deviation of the market: (0.17 x 1.00) ÷ 0.15 = 1.13.

Elmer has owned an interest in a company called Fudd Enterprises (FE). During the same time, Treasuries have yielded a 3% return. FE has an average return of -3% with a standard deviation of 6%. Assuming the returns are normally distributed, what is the probability that FE will have a return greater than the Treasury securities? a.) 2.5% b.) 16% c.) 34% d.) 66%

b.) 16%

Sissy invested in the Not-so-Good mutual fund five years ago. Her returns were -5%, -8%, -5%, -6% and -8%, respectively. What is the difference between the arithmetic average and the geometric average return over the five years? a.) 0%. b.) <0.01%. c.) Greater than or equal to 0.01%, but less than 0.1%. d.) Greater than or equal to 0.1%.

b.) <0.01%.

Which of the following statements concerning risk is least accurate? a.) Country risk, or political risk, is the variability in a security's returns resulting from the instability of a country's economy or government. b.) Financial risk is associated with the use of equity as part of a company's capital structure. c.) Market risk is the variability in a security's returns resulting from fluctuations in the overall market. d.) Business risk is the risk associated with the industry or environment in which a business operates.

b.) Financial risk is associated with the use of equity as part of a company's capital structure. Options a, c, and d are correct. Option b is incorrect as financial risk deals with debt as part of a capital structure, not equity.

A portfolio manager who earns a negative return to selectivity most likely has: a.) Underperformed its benchmark. b.) Invested in assets that are overvalued. c.) Outperformed a diversified portfolio. d.) Failed in invest in the appropriate risk-free asset allocation.

b.) Invested in assets that are overvalued.

Treasury bills most likely sell at a discount because they: a.) Are generally considered to be default risk-free. b.) Make no explicit interest payments. c.) Have yields lower than their coupon rates. d.) Have short maturities.

b.) Make no explicit interest payments. Treasury bills promise to pay the face value of the bill at maturity, which is typically less than one year. Since no coupon payments are made, the price of the bill will almost certainly sell for less than its face value.

Dinah's portfolio consists of a 50% equity index fund and a 50% fixed income index fund. The portfolio will be reallocated using the constant weighting method. More details are shown below: The price of the Equity Fund changes to $20.00 and the price of the Fixed Income Fund changes to $30.40. According to the rebalancing rules associated with the constant weighting strategy, Dinah will most likely: a.) Sell 33 shares of Equity and purchase 50 shares of Fixed Income. b.) Sell 50 shares of Equity and purchase 33 shares of Fixed Income. c.) Sell 33 shares of Fixed Income and purchase 46 shares of Equity. d.) Sell 46 shares of Fixed Income and purchase 33 shares of Equity.

b.) Sell 50 shares of Equity and purchase 33 shares of Fixed Income.

Which of the following is least likely to be a component of the mission of the Securities and Exchange Commission? a.) To protect investors. b.) To insure against large losses for issuers in the primary market. c.) To maintain fair, orderly, and efficient markets. d.) To facilitate capital formation.

b.) To insure against large losses for issuers in the primary market. The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

An investor buys $100,000 in par value of TIPS with a coupon rate of 8%. Inflation during the first six months is 2.4%. The first semi-annual coupon payment is closest to: a.) $2,000. b.) $2,048. c.) $4,096. d.) $8,192.

c.) $4,096. Semi-Annual CP= (100,000 * 1.024 * 0.08)/2= $4,096.

The International Growth Fund's (IGF) return exceeds the risk-free rate by 14.2%. IGF has a beta of 1.3, the risk-free rate is 3.2%, and the relevant market risk premium is 10%. Jensen's alpha for IGF is closest to: a.) -2.0 b.) +1.96 c.) +1.2 d.) +5.2

c.) +1.2

Horace bought 10,000 shares of LaLa at $40 per share. Two years later he sold the stock for $80 per share. LaLa declared and paid a dividend of $4 per share during the period Horace held the stock. Horace's holding period return is closest to: a.) 10% b.) 100% c.) 110% d.) 210%

c.) 110% HPR = [(sale price - purchase price) +/- cash flows] ÷ purchase price [(80-40) + 4] ÷ 40 = 110%

The Yoko Fund earns 11.2% during the year while the risk-free rate is 3.1%. The Yoko Fund has a beta of 1.20 and a standard deviation of 17.5%. The Treynor Ratio is closest to: a.) 0.463 b.) 0.640 c.) 6.750 d.) 9.333

c.) 6.750

Examples of anchoring most likely include: a.) An investor who avoids buying risky equity securities. b.) A money manager over allocating a sector believed to outperform in the future. c.) An investor holding an underperforming equity security until its price rises by 25%. d.) An investor owning gaming stocks because he has always enjoyed gambling at casinos.

c.) An investor holding an underperforming equity security until its price rises by 25%.

Parker has a portfolio with a beta of 1.0 and an alpha of 0. Based on the CAPM, the return for the portfolio is: a.) 10% b.) Greater than Rm c.) Equal to Rm d.) Less than Rm but greater than Rf

c.) Equal to Rm

Which of the following statements regarding the difference between mortgage-backed securities and fixed-rate bonds is least accurate? a.) MBSs pay coupons monthly while fixed-rate bonds pay coupons semi-annually. b.) MBSs pay principal monthly while fixed-rate bonds pay principal at maturity. c.) MBSs are subject to interest rate risk while fixed-rate bonds are not. d.) MBSs are subject to prepayment risk while fixed-rate bonds are not.

c.) MBSs are subject to interest rate risk while fixed-rate bonds are not. Both fixed-rate bonds and MBSs are subject to interest rate risk. When yields rise, the price of both a fixed rate bond and an MBS will fall.

A split bond rating would most likely occur when: a.) In issuer has two outstanding bonds. b.) The bonds are nearing default. c.) Two rating agencies disagree on the default level of an issue. d.) There are differences between default risk and systematic risk.

c.) Two rating agencies disagree on the default level of an issue. A split rating occurs only when two rating agencies assign a different grade for the same bond. This is not uncommon as each rating agency has its own method to compute default risk for each bond.

Firms are least likely to use the primary equity market to raise capital for: a.) Global expansion. b.) Research and development investments. c.) The launch of new product lines. d.) A desire to increase its financial leverage.

d.) A desire to increase its financial leverage. Firms use the equity markets for a variety of reasons, such as to raise capital for global expansion, for research costs, and for the introduction of new product lines. When firms issue new shared of equity, however, their debt-equity ratios are therefore financial leverage will fall.

Chris Cowlings, Chartered Financial Analyst®, uses fundamental analysis to evaluate equity securities in the country of Gooseburg. Cowling has been able to use inflation data, historical dividend information, and price to book rations to consistently outperform Gooseburg's broad equity index. Cowling would most likely identify the markets in Gooseburg as being: a.) Semi-strong form b.) Strong form c.) Inefficient d.) Weak form

d.) Weak form

An investor uses fundamental analysis to form a portfolio of equity securities. The portfolio has outperformed its benchmark for a period of almost a decade. The market under these conditions is most likely: a.) Inefficient b.) Semi-strong form efficient c.) Strong form efficient d.) Weak form efficient

d.) Weak form efficient

The T-bill has a beta equal to _____, while the market portfolio's beta is equal to _____.

zero; one Within the CAPM, the T-bills should not be affected by changes in the market. Thus, its beta should be equal to zero. The market portfolio is defined as having a beta of 1.0.