Performance Measures
IRR looks at
ost an investment relative to cash flows produced
Which of the following expressions describes the current yield of a bond? A)Annual interest payment divided by par value. B)Yield to maturity divided by par value. C)Yield to maturity divided by current market price. D)Annual interest payment divided by current market price.
D)Annual interest payment divided by current market price. The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.
An investor purchased stock for $50 per share at the beginning of the year. In December, the investor liquidated his stock for $55 per share, while also receiving dividends of $2 per share during the year. Assuming an inflation rate of 3%, what is the investor's real rate of return? A)11%. B)10%. C)4%. D)14%.
A)11%. Given the fact the client liquidated his shares at a price of $55, we can conclude that he attained a 10% ($5 profit ÷ $50 initial investment) return based on capital appreciation of the stock. He also received dividends of $2 per share giving him an additional return of 4% ($2 ÷ $50). By adding these two percentages together, we can conclude that his total return is 14%, less an inflation rate of 3%, which would give a real rate of return of 11%.
An investor invests a total of $30,000 and creates a portfolio of three different stocks placing one third of his investment into each security. From his holding in Company A, he receives a dividend of $600; from Company B, a dividend of $500 and from Company C, no dividend. One year later, A has increased by 20%, B by 10% and C has remained the same. What is this investor's total return on this portfolio? A)13.67% B)3.67% C)4.56% D)10%
A)13.67% Total return includes both income (dividends) and appreciation. In this case, the total income was $1,100 and the appreciation was $3,000 (20% of $10,000 = $2,000 and 10% of $10,000 = $1,000). That is a total return of $4,100 on an investment of $30,000, or 13.67%
An investor owns a common stock that has been paying a $2.00 annual dividend. If the investor buys 100 shares of the stock at $50 and sells it 3 months later for $52, the approximate annualized rate of return is: A)4%. B)20%. C)12%. D)5%.
B)20%. Annualized rate of return is computed by taking the investor's total return and annualizing it. In this case, the investor had $2 of appreciation and $.50 (one quarter) in dividends. Total return of $2.50 divided by the $50 cost is 5%. But, that is for three months - one quarter. Multiply that by 4 to get the annual rate.
The holding period return (HPR) on a share of stock is equal to: A)the dividend yield plus the risk premium. B)the capital appreciation plus the dividend yield over the period. C)the current yield plus the dividend yield. D)the capital appreciation minus the inflation rate over the period.
B)the capital appreciation plus the dividend yield over the period. To compute holding period return, you calculate the total return for that holding period. Total return combines any dividend income plus appreciation (or minus depreciation).
An investor purchases 100 shares of RIF common stock. In the year following the purchase, the RIF shares appreciated by 12% and paid a 2% dividend. If inflation, as measured by the CPI, was at a 4% rate, the investor's total return on the RIF shares is closest to: A)8%. B)12%. C)14%. D)10%.
C)14%. This question is asking for the total return which is 14% (12% appreciation + 2% dividend). Had the question asked for the inflation-adjusted return, (which it doesn't), that is 14% minus the 4% CPI.
A customer purchases stock for $40 per share and holds it for one year, selling it for $50 per share exactly 12 months after the date of purchase. Four quarterly qualifying dividends of $.50 were paid during the year. If the customer's tax bracket is 30%, what is the after-tax rate of return? A)17.5%. B)18.40%. C)21.75%. D)21%.
C)21.75%. The customer's return on the stock includes the $10 per share short-term capital gain ($50 − $40) plus the $2 qualifying dividend (quarterly dividend of $.50 × 4). After-tax rate of return is found by computing the total after-tax earnings. Short-term gains are taxed at the same rate as ordinary income, and qualifying dividends are taxed at a maximum rate of 15% (except for very high income earners - not tested). The tax on the $10 gain is $3, and the tax on the $2 dividend is $.30. The investor's total return is the $12 total minus the $3.30 in taxes, or $8.70; $8.70 divided by the original investment of $40 results in an after-tax return of 21.75%.
A bond's yield to maturity reflects its: A)nominal return. B)taxable equivalent return. C)internal rate of return. D)return based on annual interest as a percentage of current price.
C)internal rate of return. Yield to maturity reflects the internal rate of return on a bond. Internal rate of return (IRR) equates the cost of an investment to the cash flows produced by that investment.
If the Consumer Price Index (CPI) rose 5% during the last year, during which time your client held a 6% municipal bond, what would be the approximate annualized inflation- adjusted return? A)6%. B)5%. C)0%. D)1%.
D)1%. Because inflation, as measured by the CPI, rose by 5% each year and the client's bonds returned 6% annually, inflation would have reduced the client's purchasing power by 5%, leaving an inflation-adjusted return of 1% each year.
What is the total return on a bond that cost an investor $950, was sold for $1,000, and paid $50 in interest payments? A)The return cannot be determined from the information supplied. B)10%. C)5%. D)10.50%.
D)10.50%. Total return is the sum of all payments ($50) plus the capital gains ($50) divided by the cost ($950). In this case, 50 + 50 ÷ 950 = .10526 or 10.5%.
If ABC common stock closed at 20 yesterday and ABC is currently paying a quarterly dividend of $.40, what is the stock's current yield? A)Between 1% and 5%. B)More than 10%. C)Less than 1%. D)Between 5% and 10%.
D)Between 5% and 10%. The annual dividend is $1.60 (4 × $0.40). The current yield is the dividend of $1.60, divided by the current price ($20). Thus, the yield of 8% is more than 5% (1/20) and less than 10% (2/20).
One of your clients is viewing a stock held in her portfolio and wishes to know how to calculate the holding period return for that security. In order to do that, she must know the: date the stock was purchased and the date it was sold. dividends received during the holding period. purchase price. current market price. A)I, II and III. B)III and IV. C)I, II, III and IV. D)II, III and IV.
D)II, III and IV. Holding period return is the total return on an investment over the period it was held. In order to compute this, one must know the income received (dividends) plus any capital appreciation (the difference between the purchase price and the sale price if sold, or current market price if still held). If you read the question carefully, it refers to a security "held" in her portfolio. Therefore, we don't have a sale date.
ABC Combination Fund has dual objectives of capital appreciation and current income. Last year, the fund paid quarterly dividends of $.25 per share and capital gains of $.10 per share. The annualized growth rate of the fund was 15%. The current net asset value (NAV) of the fund is $28.50 and the current public offering price (POP) is $30. Advertising and sales literature of the fund may report the fund's current yield to be: A)3.33%. B)27.20%. C)0.83%. D)3.85%.
A)3.33%. The current yield on mutual funds is calculated by dividing the annualized yield ($.25 × 4 = $1) by the POP. In this case, $1 ÷ $30 = .0333 × 100 = 3.33%. In calculating the current yield, the law prohibits the inclusion of capital gains and growth.
In order to calculate an investor's holding period return, it is necessary to know: value of the portfolio at the beginning of the period. value of the portfolio at the end of the period. income received during the period. capital appreciation or depreciation over the period. A)I, II, III and IV. B)I, II and III. C)III and IV. D)I and II.
B)I, II and III. An investor's holding period return is the total return received over the specified holding period. That return includes any income plus or minus any gain or loss. Once you know the original and ending value, you know the capital appreciation or depreciation.
In the formula for determining the real rate of return, the: A)investment return is divided by the inflation rate. B)inflation rate is subtracted from the investment return. C)inflation rate is divided by the investment return. D)marginal tax bracket is subtracted from the investment return.
B)inflation rate is subtracted from the investment return. In computing the real rate of return, which represents inflation-adjusted compounding (or discounting), a formula is applied in which the rate of inflation (usually as measured by the CPI) is subtracted from the investor's rate of return.
Early in the year, an investor purchased 100 shares of KAP common stock at a price of $60 per share. Just prior to the end of the year, after receiving three quarterly dividends of $1, the investor liquidated all of the KAP at a price of $59 per share. If the CPI increased by 3%, the investor's total return over the holding period was: A)0.33%. B)5%. C)3.33%. D)2%.
C)3.33%. An investor's total return is computed by adding together income plus capital gain (loss). In this case, the investor received $3 in dividends and lost $1. That resulted in a total return of $2 which, when divided by the $60 cost, results in a percentage return of 3.33%. Even though the CPI is given, the question is not asking for inflation adjusted or real rate of return.
An investor is reviewing his portfolio. To compute the real rate of return on an investment, it would be necessary to know the gain (or loss) recognized on the asset the income received from holding the asset the rate of inflation the tax bracket of the investor A)II and III B)I, II and IV C)I, II and III D)I and IV
C)I, II and III An investor's real rate of return is computed by dividing the total return received by the cost and then subtracting the inflation rate. If there is no realized gain, it is simply the nominal return based on the income minus the inflation rate. The investor's tax bracket is needed to compute after-tax returns.
A senior citizen had the following scenarios presented to him by his IAR. Which one had the lowest volatility: A)Stock high return: +12%; low return: -2%; Standard Deviation: 5.5%. B)Stock high return: +9%; low return: -2%; Standard Deviation: 4.9%. C)Stock high return: +5%; low return: -1%; Standard Deviation: 3.6%. D)Stock high return: +18%; low return: -4%; Standard Deviation: 8%.
C)Stock high return: +5%; low return: -1%; Standard Deviation: 3.6%. The higher the standard deviation the higher the volatility and the higher the risk. So, the lower the standard deviation the lower the volatility and the lower the risk.
An analyst is preparing a research report on a particular stock. At a time when 90-day Treasury bills are returning 3%, this stock, with a standard deviation of 6% and a beta of 1.20, had an actual return of 15%. The Sharpe ratio for this company is A)2.5 B)1.67 C)2.1 D)2
D)2 The Sharpe ratio is computed by subtracting the risk-free return (as measured by the 90-day Treasury bill) from the actual return and then dividing that result by the standard deviation. In this example, 15% −3% = 12% divided by 6% = 2. The higher the Sharpe ratio is, the better the return for the risk taken. Beta is not a component of the Sharpe ratio.
Your client is considering the purchase of a small-cap fund. Which of the following benchmarks would be most appropriate for comparing the fund's performance? A)Wilshire 5,000. B)DJIA. C)S&P 500. D)Russell 2,000.
D)Russell 2,000. The Russell 2,000 is a value-weighted index of stock price performance of 2,000 small capitalization corporations.
Expected return is: A)the worth of future income discounted to reflect what that income is worth today. B)the one discount rate that equates the future value of an investment with its net present value. C)the difference between an investment's present value and its cost. D)an estimate of probable returns an investment may yield.
D)an estimate of probable returns an investment may yield. The expected return is the estimate of probable returns that an investment may yield when taking the sum of all probabilities.
One of the critical components of making suitable recommendations is the ability to evaluate risk. Risk measurement tools would include all of the following EXCEPT: A)standard deviation. B)Sharpe ratio. C)beta. D)future value.
D)future value. Future value measures the time value of money and has no relationship to risk.
One element of the formula used to compute the Sharpe ratio is: A)net present value. B)alpha. C)beta. D)standard deviation.
D)standard deviation. Standard deviation is used as the denominator in the formula used to compute the Sharpe ratio, a risk-adjusted rate of return. Standard deviation generally reflects the variability of portfolios that are not well diversified, while beta generally reflects the volatility of portfolios that are well diversified. Net present value measures the theoretical intrinsic value of an investment having uneven cash flows.
A bond's yield to maturity is: A)determined by dividing the coupon rate by the bond's current market price. B)the annualized return of a bond if it is held to call date. C)set at issuance and printed on the face of the bond. D)the annualized return of a bond if it is held to maturity.
D)the annualized return of a bond if it is held to maturity. The yield to maturity is the annualized return of a bond if it is held to maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the YTC.
Shotr term gain tax
15%
Non qualifying dividend
dends that don't qual for 15% tax rate
GHI currently has earnings of $4 and pays a $.50 quarterly dividend. If GHI's market price is $40, the current yield is: A)5%. B)15%. C)10%. D)1.25%.
A)5%. The quarterly dividend is $.50, so the annual dividend is $2; $2 ÷ $40 market price = 5% current yield.
In order to compute an investor's after-tax return on a corporate bond, all of the following are necessary EXCEPT: A)inflation rate. B)marginal tax bracket. C)appreciation. D)interest payments.
A)inflation rate. The after-tax return is computed by taking the total return (appreciation plus income) and taking the investor's tax rate into consideration. The inflation rate is necessary for the inflation-adjusted or real rate of return.
An investor purchases shares of ABC stock at $50 per share. One year later, ABC is selling for $54 per share and, at the end of the second year, the price is $52 per share. ABC has paid dividends of $2 per year. Upon liquidation, the investor would have earned a return of: A)$4 per share. B)$6 per share. C)$8 per share. D)$2 per share.
B)$6 per share. The investor paid $50 and sold it for $52 for a $2 per share gain. During the two year holding period, $4 in dividends were paid. That is a total return of $6 per share.
During your annual review with a client, you go over all of the year's transactions. The beginning of the year balance in the account was $3,000. The client purchased 100 shares of ABC on February 1st at $30 per share and sold it on June 1st at $33 per share. During that period, ABC paid one quarterly dividend of $.30. The client used the proceeds of the ABC sale to purchase 66 shares of DEF on June 15th at $50 per share and sold it on December 15th at $60 per share. DEF pays quarterly dividends of $.25 on the first of each month on a cycle beginning with February. Based on this information, you would inform the client that the account's total return is: A)100%. B)34.10%. C)46%. D)102.70%.
B)34.10%. Total return in an account is computed by taking all income plus capital gains and dividing that by the original investment. In this example, the client received a $.30 dividend on 100 shares ($30) and two $.25 dividends (August 1st and November 1st) on 66 shares ($33). Add that $63 of income to the gain of $300 on the first transaction, and $660 on the second, to come up with a total of $1,023 divided by $3,000, which equals a total return of 34.1%.
When an investor's original value is subtracted from the ending value, and then has the income received over that time period added to it which is then divided by the original cost, the result is: A)annualized return. B)holding period return. C)internal rate of return. D)expected return.
B)holding period return. This is the method of computing holding period return.
What is the total return on a 1-year, newly issued (365 days to maturity) zero-coupon bond priced at 95? A)5.26% plus the implied coupon rate. B)The return cannot be determined without knowing current interest rates. C)5%. D)5.26%
D)5.26% To determine the total return on this zero-coupon bond, the $50 capital appreciation is divided by the cost of the bond (in this case, $50 divided by $950 equals a total return of 5.26%). Total return of a zero-coupon bond is made up entirely of the difference between the cost of the bond and the sale or maturity price of the bond.
GHI stock is at $10 par value and is selling in the market for $60 per share. If the current quarterly dividend is $1, the current yield is: A)1%. B)10%. C)1.7%. D)6.7%.
D)6.7%. Current yield is determined by dividing the annual dividend of $4 ($1 per quarter × 4 = $4) by the current stock price of $60 ($4 ÷ $60 = 6.7%).
An investment adviser representative is structuring a portfolio for a client. In attempting to achieve the projected growth rate, the IAR computes the expected return for each position. One of the stocks being investigated is GEMCO Metals, Inc. If this stock has a 40% chance of returning 10%, a 30% chance of returning 20%, and a 30% chance of returning -10%, the expected return is: A)13%. B)10%. C)4%. D)7%.
D)7%. The computation is: (40% × 10%) + (30% × 20%) + (30% × -10%). That is equal to .04 (or 4%) + .06 (or 6%) −.03 (or -3%), totaling 10% −3% or 7%. You will probably not have to do this calculation on the exam, but you should know the concept.
In order to compute a client's realized holding period return, it is not necessary to know A)value at the end of the holding period B)original investment C)income received during the holding period D)paper profits
D)paper profits The question is asking for realized return. That means that we ignore paper profits, (just another term for unrealized gain).
In order to compute the real rate of return for a security, it would be necessary to know all of the following EXCEPT: A)the purchase price. B)the CPI. C)the annual dividend. D)the beta of the security.
D)the beta of the security. The real rate of return is the actual return less the inflation rate as measured by the CPI.
A client purchased a security for $60 and sold it one year later for $59. If he received 4 quarterly dividends of $.50 each during the period, his total percentage return would be: A)1.67%. B)2%. C)3.30%. D)0%.
A)1.67%. The total return on an investment is the sum of the capital gains/losses plus any income distribution such as dividends or interest. In this case, the client had a capital loss of $1 ($60 − $59 = $1) which was offset by $2 (4 × $.50 = $2) in dividend distributions for a total dollar return of $1. In percentage terms, the return is calculated by dividing the dollar return amount by the total invested or $1 divided by $60 = 1.67%.
An investor purchases 100 shares of DEF common stock at a price of $40 per share. The investor sells the shares for $42 per share exactly 4 months later. The annualized rate of return is closest to: A)2%. B)15%. C)20%. D)5%.
B)15%. The approximate annualized return is calculated by taking the holding period return and multiplying it by the annualization factor. In this case, the investor profited by $2 on an investment of $40, or a 5% return. However, this was earned in a 4-month period, 1/3 of a year. Therefore, the 5% is multiplied by 3, resulting in an annualized rate of 15%.
A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of: A)5.60%. B)7.40%. C)5%. D)7.80%.
A)5.60%. Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.6%). Years to maturity is not a factor in calculating current yield.
The current yield of a 6% bond offered at 95 is: A)6.3%. B)6%. C)the yield to maturity. D)the nominal yield.
A)6.3%. The current yield of 6.3% is computed by dividing the annual interest payment ($60) by the current market price ($950).
If a client in the 30% marginal income tax bracket can earn an after-tax rate of return of 7% when the estimated inflation rate during the holding period of an investment is 4%, the client's real rate of return is: A)less than 7%. B)7%. C)more than 7%. D)10%.
A)less than 7%. Real return reduces nominal return by an inflation factor. Thus, the client's real return must be less than 7%.
Given the following information, calculate the risk-adjusted return 90-day T-bill rate: 4% Actual return: 14% Beta 1.40 CPI 3% Standard Deviation 5.0 A)10 B)2 C)5 D)11
B)2 Any question asking about the risk-adjusted return is going to be referring to the Sharpe Ratio. This is shown as a simple number and is calculated by subtracting the risk-free rate (90-day T-bill) from the actual return and dividing that remainder by the standard deviation. In this example, 14%−4% = 10% divided by 5 = 2.
Bill will put money into stocks only if he expects that stock returns, over time, will outpace bond returns by some amount that compensates him for the added volatility of owning stocks. This reflects: A)time premium. B)risk premium. C)option premium. D)premium priced bonds.
B)risk premium. Investors will put money into stocks only if they expect that stock returns, over time, will outpace bond returns by some amount that compensates them for the added risk of owning stocks. This extra return from stocks is known as risk premium-literally, the premium an investor receives in exchange for owning a riskier, more volatile instrument.
A growth mutual fund may be compared against all of the following benchmarks EXCEPT: A)the Dow Jones Industrial Average. B)the Barclays Capital Aggregate Bond Index. C)the Value Line Index. D)the S&P 500.
B)the Barclays Capital Aggregate Bond Index. Because a growth fund portfolio consists mainly of common stock, comparing the fund's performance against a bond index is obviously misleading.
On June 20, 2003, an investor in the 30% marginal federal tax bracket acquired a growth stock paying no dividend for $10 per share. On June 22, 2004, the investor sold the stock for $20 per share. Presuming capital gains rates are 15%, the investor's after-tax rate of return is closest to: A)70%. B)100%. C)85%. D)200%.
C)85%. Although the stock grew at a 100% rate of return (by doubling), the investor must pay capital gains tax on the investment at 15%, and the investor realizes an after-tax rate of return of approximately 85%. Because the investor held the stock for more than one year, the sale is taxed at a favorable capital gains rate rather than at the investor's ordinary income tax rate.
One measure of an investor's total return is called holding period return. The computation includes both income and appreciation and is used for both debt and equity securities. An investor's holding period return would be less than the bond's yield to maturity if A)the bond was called at a discount B)the bond was redeemed at a premium C)the coupons were reinvested at a rate below the yield to maturity D)the investor purchased a put option on the bond
C)the coupons were reinvested at a rate below the yield to maturity The calculation of yield to maturity assumes reinvestment of the bond's interest at the coupon rate. Therefore, if the investor was only able to do less than that, the holding period return would be decreased. This is part of the concept of internal rate of return (IRR), which takes into consideration the time value of money (compounding). It is tempting to choose the answer "a call at a discount," but bonds are never called at a price below par. Just keep it simple: If the question says you can earn less than the YTM, your return will be lower than the quoted YTM.
Which of the following measures the risk-adjusted return of an asset or a portfolio? A)Sharpe ratio. B)Beta coefficient. C)Standard deviation. D)Correlation coefficient.
A)Sharpe ratio. The Sharpe ratio is a measure of the risk-adjusted returns of a portfolio. Standard deviation by itself is not a risk-adjusted return; it is an absolute measure of an asset's volatility around its mean. However, the standard deviation of the portfolio or asset is used in the denominator when calculating the Sharpe ratio.
Which of the following is not related to the variability of a portfolio's returns? A)Total return. B)Asset allocation. C)Market timing. D)Security selection.
A)Total return. Total return is a measurement of the investor's return on the portfolio. It has nothing to do with market variability, which is a more complicated way of stating market risk.
ABC's stock has paid a regular dividend every quarter for the last several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABC's: A)current yield per share has increased. B)current yield per share has been unaffected. C)current yield per share has decreased. D)yield to maturity has gone up.
A)current yield per share has increased. The current yield would have increased because current yield is the income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a yield to maturity.
If you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20%, and a 20% chance of earning -10%, the stock would have a(n): A)expected rate of return of 10%. B)real rate of return of 10%. C)annualized return of 10%. D)total return of 10%.
A)expected rate of return of 10%. The expected return is computed by taking the probability of each possible return outcome and multiplying it by the return outcome itself. In this example, if you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20%, and a 20% chance of earning -10%, the expected return would be equal to 10%. = (0.4) (0.1) + (0.4) (0.2) + (0.2) (-0.1) = .04 + .08 = .12 −.02 = 0.10 = 10% You will not have to do this calculation on the exam, but you should know the concept.
An investor purchases 100 shares of Kapco stock at $50 per share. At the time of the purchase, the stock is paying a quarterly dividend of $.25. The dividend increases 5% each year over the next 5 years. The purchaser sells the 100 shares 5 years after purchase for $82 per share. What is the total return for the investor over the 5 years holding period? A)74%. B)75%. C)11%. D)10%.
B)75%. Total return includes capital appreciation plus income. The capital gain realized was $32 per share. The income was $1.00 per share (four quarterly dividends of $.25) the first year, 5% higher the second year ($1.05) and 5% higher each successive year. The total of the dividends received is $5.53. Adding that to the $32, we compute by dividing $37.53 by $50 resulting in a 75% total return.
The best known index is that of the Dow Jones 30 Industrials. It would be most accurate to characterize those 30 stocks as: A)small cap. B)large cap. C)mid cap. D)a blend of large, mid, and small cap.
B)large cap. Each of the 30 stocks in the Dow Jones 30 Industrials meets the large-cap standard.
An investment advisory firm tracks its performance against the S&P 400. From this, you could determine that this firm concentrates on A)large-cap securities B)mid-cap securities C)Nasdaq securities D)small-cap securities
B)mid-cap securities The S&P 400 is known as the mid-cap index.
If an agent recommends that a client invest a portion of his portfolio in an international stock fund and is asked whether she should compare the performance of the fund against the S&P 500 Index, how should the agent respond? A)Yes, the S&P 500 is an appropriate benchmark against which to compare the performance of all equity funds. B)There is no appropriate benchmark against which an investor can compare a portfolio of foreign securities. C)No, it is preferable to compare the fund against the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index because it covers international securities. D)No, it is preferable to compare the fund against the Russell 2,000 Index because it covers smaller corporation stocks.
C)No, it is preferable to compare the fund against the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index because it covers international securities. It is important that a particular mutual fund be compared against the appropriate benchmark. An international fund's performance should be compared against an index of foreign stocks such as the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index.
One of the important roles of an investment adviser representative is assisting clients in analyzing the performance of securities held in their portfolios. Which of the following is the best measurement of a security's performance? A)Standard deviation B)Beta C)Total return D)Yield
C)Total return Total return reflects the entirety of a security's performance because it includes both income and capital appreciation. Beta and standard deviation are risk measurements and, while they may be used to evaluate a security's performance when compared to the risk taken, they don't truly provide a measurement as does total return.
The formula for real rate of return would most likely be used when the adviser wishes to: A)analyze investment returns in terms of uneven cash flows. B)measure after-tax investment performance. C)measure inflation-adjusted performance. D)measure risk-adjusted performance.
C)measure inflation-adjusted performance. The real return formula measures inflation-adjusted performance.
A company has paid a dividend every quarter for the past 20 years. If the stock's price has fallen dramatically over the past quarter, but the dividend has remained the same, it may be concluded that: A)current dividend yield has decreased. B)current dividend yield has remained the same. C)dividend yield to maturity has decreased. D)current dividend yield has increased.
D)current dividend yield has increased. Current dividend yield is income dividend divided by price. If the price of a stock decreases and the dividend remains the same, dividend yield will increase.
If a company's dividend increases by 5% but its market price remains the same, the current yield of the stock will: A)remain at 5%. B)remain at 7%. C)decrease. D)increase.
D)increase. The current yield of a stock is the annual dividend divided by the market price. If a company's dividend increases and its market price remains the same, its current yield will increase.
When analyzing a specific common stock, the expected return is: A)the extent to which the net present value exceeds the internal rate of return. B)the projected annual dividend divided by the current market price. C)computed using the Sharpe ratio. D)the sum of a probability distribution of possible returns.
D)the sum of a probability distribution of possible returns. The expected return is computed by taking the probability of each possible return outcome, multiplying it by the return outcome itself, and then adding them all together. For example, if you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20%, and a 20% chance of earning -10%, the expected return would be equal to 10%, as illustrated below: = (0.4) (0.1) + (0.4) (0.2) + (0.2) (-0.1); = .04 + .08 = .12 − .02; = 0.10; and = 10%. You will not have to do this calculation on the exam, but you should know the concept. If you were trying to compute the expected return for a portfolio (more than one security), then you would take the average of the individual results to get an overall expected return.
Which of the following types of mutual funds is least likely to have its total return affected by capital gains or losses? A)Money market mutual fund. B)Balanced mutual fund. C)Bond mutual fund. D)Growth mutual fund.
A)Money market mutual fund. Money market mutual fund portfolios consist of short-term debt securities that react little, if at all, to interest rate fluctuations. Thus, capital gain or loss has little, if any, impact on the return of a money market mutual fund.
Which of the following statements regarding the Sharpe ratio is TRUE? A)The Sharpe ratio is often used to measure risk-adjusted return of an entire portfolio. B)The Sharpe ratio cannot be used to measure risk-adjusted performance for a single security. C)Portfolios with lower Sharpe ratios provided higher excess returns per unit of risk assumed than those with higher Sharpe ratios. D)The Sharpe ratio uses beta in its formula.
A)The Sharpe ratio is often used to measure risk-adjusted return of an entire portfolio. The Sharpe ratio is used to measure risk-adjusted performance of either a portfolio or an individual security. The Sharpe ratio uses standard deviation as the denominator in its formula: the higher the Sharpe ratio, the better the portfolio or security has performed on a risk-adjusted basis.
Which of the following securities has an easily determinable internal rate of return? A)Zero-coupon bond B)5% municipal bond C)6% Ginnie Mae D)7% corporate bond
A)Zero-coupon bond The only security that does not have reinvestment risk (the risk that periodic interest payments cannot be reinvested at the same yield as the bond providing the interest payments) is a zero-coupon bond such as Treasury STRIPS. With a zero-coupon bond, there are no periodic interest payments to reinvest, so a yield can be locked in. The interest rate that discounts the redemption price (par) to the discounted purchase price is the locked-in yield, which is the same as the internal rate of return, also referred to as the yield to maturity.
The minimum rate of return that a reasonable investor will accept to acquire an investment (required rate of return) is generally determined by the: A)current risk-free rate of return plus the risk premium. B)investor's marginal federal income tax bracket. C)investor's previous investment experience. D)Federal Reserve Board (FRB) through its Open Market operations.
A)current risk-free rate of return plus the risk premium. Reasonable investors relate return to the level of risk assumed; on Treasury bills, this is considered the risk-free rate. An investor in other than risk-free Treasury bills would require a premium to compensate for the additional risk taken.
In order to compute an investor's real rate of return on a common stock holding, all of the following are necessary EXCEPT: A)marginal tax bracket. B)appreciation. C)inflation rate. D)dividends.
A)marginal tax bracket. The real rate of return is another term for inflation-adjusted return. It is the total return, which is appreciation plus income adjusted for the inflation rate as expressed by the CPI. Tax bracket is necessary to compute after-tax return.
The Sharpe ratio is the average annual return of a security: A)minus the risk-free rate for the period divided by the security's standard deviation. B)plus the risk-free rate divided by the security's beta. C)divided by the expected return of the market. D)divided by the risk-free rate.
A)minus the risk-free rate for the period divided by the security's standard deviation. The Sharpe ratio is the average annual return of a security less the risk-free rate divided by the security's standard deviation. In other words, the Sharpe ratio is a risk-adjusted return because it measures the amount of return per unit of risk taken; the most common risk-free rate is that paid by 90-day U.S. Treasury bills.
When analyzing a specific common stock, the expected return is: A)the average of a probability distribution of possible returns. B)the extent to which the net present value exceeds the internal rate of return. C)the projected annual dividend divided by the current market price. D)computed using the Sharpe ratio.
A)the average of a probability distribution of possible returns. The expected return is computed by taking the probability of each possible return outcome and multiplying it by the return outcome itself. For example, if you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20%, and a 20% chance of earning -10%, the expected return would be equal to 10%, as illustrated below: = (0.4) (0.1) + (0.4) (0.2) + (0.2) (-0.1); = .04 + .08 = .12 − .02; = 0.10; and = 10%. You will probably not have to do this calculation on the exam, but you should know the concept.
An investment is made of $10,000. At the end of the year, $500 in non-qualifying dividends has been received and the value of the investment is $10,500. If the investor is in the 30% tax bracket, the after-tax yield is: A)6.5% B)3.5% C)8.5% D)5.0%
B)3.5% The only return (as far as yield is concerned) is the $500 of dividends. Remember, non-qualifying dividends do not "qualify" for the 15% rate. Subtracting 30% for taxes leaves $350 which, when divided by the $10,000 initial cost, is an after-tax yield of 3.5%. If the question had asked about total return, then the $500 unrealized profit would have been included, although there would have been no tax on it.
One of the quantitative measurements of investment performance is total return. In performing this computation, it would not be necessary to know: A)purchase price. B)length of time the investment was held. C)capital growth during the period. D)income received during the period.
B)length of time the investment was held. The computation of total return is the sum of all income plus capital growth divided by the original purchase price. It is not a function of time, so the holding period is not required.
An investment adviser is structuring a portfolio for a client. In attempting to achieve the projected growth rate, the IA computes the expected return for each position. Expected return is an average of: A)beta minus alpha. B)a stock's beta divided by its standard deviation. C)a probability distribution of possible returns. D)duration divided by yield to maturity.
C)a probability distribution of possible returns. The expected return of an investment is computed by taking an average of the likelihood of all of the possible returns. For example, if you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning 20% and a 20% chance of earning -10%, the expected return would be equal to 10%, computed as shown below: = (0.4) (0.1) + (0.4) (0.2) + (0.2) (-0.1), = .04 + .08 = .12 −.02, = 0.10, and = 10%. You will probably not have to do this calculation on the exam, but you should know the concept.
Sharpe =
(Return - Rf)/SD
If the return on Treasury bills is 3% and the equity risk premium is 4%, the expected equity returns should be: A)4%. B)7%. C)1%. D)12%.
B)7%. The expected return on an equity investment is the risk-free (for example, T-bill) rate of return added to the equity risk premium (3% + 4% = 7%).
To assess the performance of a small cap stock fund you compare its results against the: A)Dow Jones Industrial Average. B)Russell 2000. C)S&P 100. D)S&P 500.
B)Russell 2000. The appropriate benchmark for a small cap fund is the Russell 2000 because it is comprised of similar companies.
