Unit 20

Capital MArket Line

provides an expected return on the level of risk equation for CML uses exp return of the portfolio risk free rate return on the market SD on the market SD on the porfoloo Uses SD as the measure of risk alpha and beta aren't used in the CML equation

Strong Form

security prices fully reflect all info from both public and private sources (icluding past) no one should be able t have monopolistic access or consitently achieve positive abonotmal returns random walk theory will work

The goal of modern portfolio theory (MPT) is to construct the most efficient portfolio. An efficient portfolio is one that offers

the least risk for a given amount of return

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 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.

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.

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."

Both Jane and Malka are correct.

An advantage of dollar cost averaging is that it results in an average cost per share that is less than the stock's average price, assuming which of the following?

Dollar cost averaging results in a lower average cost per share, provided the share price fluctuates and the same number of dollars is invested at each interval (e.g., monthly).

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

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%.

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.

In general, the most passive investment style for a portfolio would be A) indexing.

Weak form

Technical analysis won't work but fundamental and insider info will (holds that cyrrent stock prives hae alrady incorp all histoical maket data and that historical price trends are therefore f no value in predicting future price changes

SML security market line

allows us to evaluate individual securities for us in a diversified portfolio the expected return for the asset the risk free rate the return on the market the beta of the asset basically want to determine how much over the risk free rate we should earn for making the investment risk differnece between risk free rate and market rate thenmultiply by beta then add the risk free back in MArket rate 13 risk free 3 beta 1.2 13-3=10 10x1.2=12 12+3= 15

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?

) Sell the security. 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.

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?

Barbell bonds 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).

The CAPM assumes frictionless markets, i.e., no taxes or transaction costs. Among the other assumptions of the CAPM are that all investors have the same time horizon and that all investments are infinitely divisible into fractional shares. The CAPM assumes that there is no inflation.

One of the assumptions underlying the capital asset pricing model is that there are no transaction costs or taxes.

Semi-Strong

Technical and Fundamental won't work but insider info will work holds that current stock prices notonly reflect all historical price data but also reflect data from analyzing finacial statments, industry, or current economic otlook

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

The most efficient portfolio will be the one that lies on the efficient frontier. It will offer the highest expected return at a given level of risk compared to all other possible portfolios.

An investment adviser who believes that we are in the early recovery portion of the business cycle would most likely recommend

cyclical stocks. 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).

Proponents of the efficient market hypothesis believe that

) markets operate efficiently and stock prices instantly reflect all available information.

The semi-strong form of the efficient market hypothesis (EMH) asserts that stock prices

The semi-strong form of the EMH states that security prices fully reflect all publicly-available information. This would include all historical information. The weak form relates to historical information only. The strong form relates to public and private (inside) information. One could conclude from this that both fundamental and technical analysis don't "work" in an efficient market.

That all market participants have equal access to information is a fundamental premise of

the efficient market hypothesis

Which of the following forms of the efficient market hypothesis claims that technical analysis works?

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.

Two of the major factors involved in the capital asset pricing model (CAPM) are

The model is made up of two separate components. One component is known as the stock risk premium and is the part of the model reflected by the following formula: (market return − the risk-free return) × beta of the stock. The other component is the market risk premium and is the part of the model reflected by the following formula: (market return − risk-free return). The stock risk premium is the inducement necessary to entice the individual to invest in a particular stock, whereas the market risk premium is the incentive required for the individual to invest in the securities market in general.