Unit 23 Test

**********With the current rate of the 91-day Treasury bill at 2%, a stock paying dividends at a rate of 4% and having a total return over the measured period of 7% would have a risk premium of A) 4% B) 9% C) 5% D) 2%

******C The risk premium is a premium demanded for internal and external risk factors. It is the amount of total return in excess of the risk-free rate. In this case, the total return is 7% (the dividend return is included in the total) minus the 2% T-bill rate.

In order to compute yield to maturity, all of the following are necessary EXCEPT A) the nominal yield B) the call price C) the maturity date D) the current market price

B Computing the yield to maturity (YTM) does not require the call price or call date—that is necessary to compute the yield to call (YTC). We do need to know the current market price, the coupon (nominal yield) and the maturity date.

An investor buys 100 shares of KAPCO stock for $120 per share. During the year, he receives $260 in dividends and, at the end of the year, the stock is worth $13,000. The investor's holding period return is A) 9.69% B) 10.50% C) 8.33% D) 2.17%

B Holding period return is computed by dividing the total return from income (dividends or interest) plus appreciation (or minus depreciation), by the original cost. In this example, the investor received $260 in income and has $1,000 of appreciation. That is a total return of $1,260 divided by $12,000 or 10.50%

Which of the following quantitative tools is used to measure risk-adjusted returns? A) Standard deviation B) Sharpe ratio C) Correlation D) Beta

B The Sharpe ratio is used to measure risk-adjusted returns. Beta does enable one to evaluate the potential market risk, but, strictly speaking, does not measure risk-adjusted return. Correlation measures the movement of one security in relationship to the movement of another. Standard deviation measures the volatility of a security, not its risk-adjusted returns. Standard deviation has input in the Sharpe ratio but it is the ratio itself that measures risk-adjusted returns.

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 exceed the bond's yield to maturity if A) the investor purchased a put option on the bond B) the bond was redeemed at a discount C) the coupons were reinvested at a rate exceeding the yield to maturity D) the bond was called at a premium

C The calculation of yield to maturity assumes reinvestment of the bond's interest at the coupon rate. Therefore, if the investor were able to do better than that, the holding period return would be increased. This is part of the concept of internal rate of return (IRR) which takes into consideration the time value of money (compounding).

**In the formula for determining the real rate (AKA True Rate of Return) of return, A) the investment return is divided by the inflation rate B) the inflation rate is divided by the investment return C) the inflation rate is subtracted from the investment return D) the marginal tax bracket is subtracted from the investment return

C** In computing the real rate (AKA True Rate of Return) 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.

Using the following information, compute the inflation-adjusted rate of return for an investor holding the ABC Corporation's 20-year bond: Coupon rate 5%, paid semi-annually Rating Aa Maturity date December 1, 2046 CPI 2% Par value $1,000 Purchase price 90 Call date December 1, 2033 Call price 101 A) 4.50% B) 2.50% C) 5.00% D) 3.56%

D The inflation-adjusted rate of return is the actual return (income received divided by the purchase price) less the inflation rate as measured by the CPI. In this example, the bond pays $50 per year on an investment of $900. 50/900=.0555 That is an actual return of 5.56%. Subtracting the CPI of 2% gives us an inflation-adjusted, or real, rate of return of 3.56%.

Which of the following indices or averages is based on the prices of only 65 stocks (30 industrial, 20 transportation, and 15 utility)? A) Value Line B) S&P Composite C) Wilshire 5,000 D) Dow Jones Composite Average

D The most widely quoted and oldest measures of changes in stock prices are the Dow Jones averages. They are also the smallest in terms of the number of stocks included in the averages with only 65 stocks. *It is the only price-weighted index on the exam;* all of the others are cap-weighted.

****Which of the following is a method for determining the internal rate of return by portfolio managers without the influence of additional investor deposits or withdrawals to or from the portfolio? A) Discounted cash flow B) Dollar-weighted return C) Dollar cost averaging D) Time-weighted return

D********* Time-weighted returns are used to evaluate the performance of portfolio managers separate from the influence of additional investor deposits or withdrawals. Dollar-weighted return is more commonly used for evaluating investor performance.