Chapter 03 - How Securities Are Traded

Computational Finance Question Bank Chapter 03 How Securities Are Traded

Multiple Choice Questions

1. The trading of that was previously issued takes place A. in the . B. in the . C. usually with the assistance of an investment banker. D. A and B. E. B and C.

2. A purchase of a new issue of stock takes place A. in the secondary market. B. in the primary market. C. usually with the assistance of an investment banker. D. A and B. E. B and C.

3. Firms raise capital by issuing stock A. in the secondary market. B. in the primary market. C. to unwary . D. only on days when the market is up. E. C and D.

4. The following statements regarding the specialist are true: A. Specialists maintain a book outstanding unexecuted limit orders. B. Specialists earn income from commissions and spreads in stock prices. C. Specialists stand ready to trade at quoted bid and ask prices. D. Specialists cannot trade in their own accounts. E. A, B, and C are all true.

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5. Investment bankers A. act as intermediaries between issuers of and investors. B. act as advisors to companies in helping them analyze their financial needs and find buyers for newly issued securities. C. accept deposits from savers and lend them out to companies. D. A and B. E. A, B, and C.

6. In a "firm commitment" A. the investment banker buys the stock from the company and resells the issue to the public. B. the investment banker agrees to help the firm sell the stock at a favorable price. C. the investment banker finds the best marketing arrangement for the investment banking firm. D. B and C. E. A and B.

7. The secondary market consists of A. transactions on the AMEX. B. transactions in the OTC market. C. transactions through the investment banker. D. A and B. E. A, B, and C.

8. Initial requirements are determined by A. the Securities and Exchange Commission. B. the Federal Reserve System. C. the New York . D. B and C. E. A and B

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9. You purchased JNJ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a ______A. stop-buy order B. limit-buy order C. market order D. limit-sell order E. none of the above.

10. You sold JCP stock at $80 per share. Your losses could be minimized by placing a ______: A. limit-sell order B. limit-buy order C. stop-buy order D. day-order E. none of the above.

11. Which one of the following statements regarding orders is false? A. A market order is simply an order to buy or sell a stock immediately at the prevailing market price. B. A limit sell order is where investors specify prices at which they are willing to sell a security. C. If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and when the share price falls below $45. D. A market order is an order to buy or sell a stock on a specific exchange (market). E. None of the above.

12. Restrictions on trading involving insider information apply to the following except A. corporate officers. B. corporate directors. C. major stockholders. D. All of the above are subject to insider trading restrictions. E. None of the above is subject to insider trading restrictions.

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13. The cost of buying and selling a stock consists of ______. A. broker's commissions B. dealer's bid-asked spread C. a price concession an may be forced to make. D. A and B. E. A, B, and C.

14. Assume you purchased 200 shares of GE on margin at $70 per share from your broker. If the initial margin is 55%, how much did you borrow from the broker? A. $6,000 B. $4,000 C. $7,700 D. $7,000 E. $6,300

15. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was A. $4,800. B. $12,000. C. $5,600. D. $7,200. E. none of the above.

16. You purchased 100 shares of IBM common stock on margin at $70 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no ; ignore interest on margin. A. $21 B. $50 C. $49 D. $80 E. none of the above

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17. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin. A. 0.33 B. 0.55 C. 0.43 D. 0.23 E. 0.25

18. You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60% and the stock pays no dividend. What would your be if you sell the stock at $45 per share? Ignore interest on margin. A. 25.00% B. -33.33% C. 44.31% D. -41.67% E. -54.22%

19. Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $40/share? The stock paid no during the period, and you did not remove any money from the account before making the offsetting transaction. A. 20.03% B. 25.67% C. 22.22% D. 77.46% E. none of the above

20. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a margin call if the maintenance margin is 35%? A. $51.00 B. $65.18 C. $35.22 D. $40.36 E. none of the above

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21. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would be the maintenance margin if a margin call is made at a stock price of $60? A. 40% B. 33% C. 35% D. 25% E. none of the above

22. Specialists on stock exchanges perform the following functions A. Act as dealers in their own accounts. B. Analyze the securities in which they specialize. C. Provide liquidity to the market. D. A and B. E. A and C.

23. Shares for short transactions A. are usually borrowed from other brokers. B. are typically shares held by the short seller's broker in street name. C. are borrowed from commercial banks. D. B and C. E. none of the above.

24. Which of the following orders is most useful to short sellers who want to limit their potential losses? A. Limit order B. Discretionary order C. Limit-loss order D. Stop-buy order E. None of the above

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25. Which of the following orders instructs the broker to buy at the current market price? A. Limit order B. Discretionary order C. Limit-loss order D. Stop-buy order E. Market order

26. Which of the following orders instructs the broker to buy at or below a specified price? A. Limit-loss order B. Discretionary order C. Limit-buy order D. Stop-buy order E. Market order

27. Which of the following orders instructs the broker to sell at or below a specified price? A. Limit-sell order B. Stop-loss C. Limit-buy order D. Stop-buy order E. Market order

28. Which of the following orders instructs the broker to sell at or above a specified price? A. Limit-buy order B. Discretionary order C. Limit-sell order D. Stop-buy order E. Market order

29. Which of the following orders instructs the broker to buy at or above a specified price? A. Limit-buy order B. Discretionary order C. Limit-sell order D. Stop-buy order E. Market order

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30. Shelf registration A. is a way of placing issues in the primary market. B. allows firms to register securities for sale over a two-year period. C. increases transaction costs to the issuing firm. D. A and B. E. A and C.

31. Block transactions are transactions for more than ______shares and they account for about _____ percent of all trading on the NYSE. A. 1,000; 5 B. 500: 10 C. 100,000; 50 D. 10,000; 30 E. 5,000; 23

32. A program trade is A. a trade of 10,000 (or more) shares of a stock. B. a trade of many shares of one stock for one other stock. C. a trade of analytic programs between financial analysts. D. a coordinated purchase or sale of an entire portfolio of stocks. E. not feasible with current technology but is expected to be popular in the near future.

33. When stocks are held in street name A. the investor receives a stock certificate with the owner's street address. B. the investor receives a stock certificate without the owner's street address. C. the investor does not receive a stock certificate. D. the broker holds the stock in the brokerage firms' name on behalf of the client. E. C and D.

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34. subscriber levels A. permit those with the highest level, 3, to "make a market" in the security. B. permit those with a level 2 subscription to receive all bid and ask quotes, but not to enter their own quotes. C. permit level 1 subscribers to receive general information about prices. D. include all OTC stocks. E. A, B, and C.

35. You want to buy 100 shares of Hotstock Inc. at the best possible price as quickly as possible. You would most likely place a A. stop-loss order B. stop-buy order C. market order D. limit-sell order E. limit-buy order

36. You want to purchase XON stock at $60 from your broker using as little of your own money as possible. If initial margin is 50% and you have $3000 to invest, how many shares can you buy? A. 100 shares B. 200 shares C. 50 shares D. 500 shares E. 25 shares

37. A sale by IBM of new stock to the public would be a(n) A. short sale. B. seasoned equity offering. C. private placement. D. secondary market transaction. E. initial .

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38. The finalized registration statement for new securities approved by the SEC is called A. a red herring B. the preliminary statement C. the prospectus D. a best-efforts agreement E. a firm commitment

39. The minimum market value required for an initial listing on the is A. $2,000,000 B. $2,500,000 C. $1,100,000 D. $60,000,000 E. 100,000,000

40. In 2005, the price of a seat on the NYSE reached a high of A. $1,000,000 B. $4,000,000 C. $1,750,000 D. $2,225,000 E. $3,000,000

41. You sell short 100 shares of Loser Co. at a market price of $45 per share. Your maximum possible loss is A. $4500 B. unlimited C. zero D. $9000 E. cannot tell from the information given

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42. You buy 300 shares of Qualitycorp for $30 per share and deposit initial margin of 50%. The next day Qualitycorp's price drops to $25 per share. What is your actual margin? A. 50% B. 40% C. 33% D. 60% E. 25%

43. When a firm markets new securities, a preliminary registration statement must be filed with A. the exchange on which the security will be listed. B. the Securities and Exchange Commission. C. the Federal Reserve. D. all other companies in the same line of business. E. the Federal Deposit Insurance Corporation.

44. In a typical underwriting arrangement the investment banking firm I) sells shares to the public via an underwriting syndicate. II) purchases the securities from the issuing company. III) assumes the full risk that the shares may not be sold at the offering price. IV) agrees to help the firm sell the issue to the public but does not actually purchase the securities. A. I, II, and III B. I, III, and IV C. I and IV D. II and III E. I and II

45. Which of the following is true regarding private placements of primary security offerings? A. Extensive and costly registration statements are required by the SEC. B. For very large issues, they are better suited than public offerings. C. They trade in secondary markets. D. The shares are sold directly to a small group of institutional or wealthy investors. E. They have greater liquidity than public offerings.

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46. A specialist on the AMEX Stock Exchange is offering to buy a security for $37.50. A broker in Oklahoma City wants to sell the security for his client. The Intermarket Trading System shows a bid price of $37.375 on the NYSE. What should the broker do? A. Route the order to the AMEX Stock Exchange. B. Route the order to the NYSE. C. Call the client to see if she has a preference. D. Route half of the order to AMEX and the other half to the NYSE. E. It doesn't matter - he should flip a coin and go with it.

47. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. Your initial investment was A. $4,800. B. $12,000. C. $2,250. D. $7,200. E. none of the above.

48. You sold short 150 shares of common stock at $27 per share. The initial margin is 45%. Your initial investment was A. $4,800.60. B. $12,000.25. C. $2,250.75. D. $1,822.50. E. none of the above.

49. You purchased 100 shares of XON common stock on margin at $60 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore interest on margin. A. $42.86 B. $50.75 C. $49.67 D. $80.34 E. none of the above

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50. You purchased 1000 shares of CSCO common stock on margin at $19 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore interest on margin A. $12.86 B. $15.75 C. $19.67 D. $13.57 E. none of the above

51. You purchased 100 shares of common stock on margin at $40 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $25? Ignore interest on margin. A. 0.33 B. 0.55 C. 0.20 D. 0.23 E. 0.25

52. You purchased 1000 shares of common stock on margin at $30 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $24? Ignore interest on margin. A. 0.33 B. 0.375 C. 0.20 D. 0.23 E. 0.25

53. You purchased 100 shares of common stock on margin for $50 per share. The initial margin is 50% and the stock pays no dividend. What would your rate of return be if you sell the stock at $56 per share? Ignore interest on margin. A. 28% B. 33% C. 14% D. 42% E. 24%

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54. You purchased 100 shares of common stock on margin for $35 per share. The initial margin is 50% and the stock pays no dividend. What would your rate of return be if you sell the stock at $42 per share? Ignore interest on margin. A. 28% B. 33% C. 14% D. 40% E. 24%

55. Assume you sell short 1000 shares of common stock at $35 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $25/share? The stock paid no dividends during the period, and you did not remove any money from the account before making the offsetting transaction. A. 20.47% B. 25.63% C. 57.14% D. 77.23% E. none of the above

56. Assume you sell short 100 shares of common stock at $30 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $35/share? The stock paid no dividends during the period, and you did not remove any money from the account before making the offsetting transaction. A. -33.33% B. -25.63% C. -57.14% D. -77.23% E. none of the above

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57. You want to purchase GM stock at $40 from your broker using as little of your own money as possible. If initial margin is 50% and you have $4000 to invest, how many shares can you buy? A. 100 shares B. 200 shares C. 50 shares D. 500 shares E. 25 shares

58. You want to purchase IBM stock at $80 from your broker using as little of your own money as possible. If initial margin is 50% and you have $2000 to invest, how many shares can you buy? A. 100 shares B. 200 shares C. 50 shares D. 500 shares E. 25 shares

59. Assume you sold short 100 shares of common stock at $40 per share. The initial margin is 50%. What would be the maintenance margin if a margin call is made at a stock price of $50? A. 40% B. 20% C. 35% D. 25% E. none of the above

60. Assume you sold short 100 shares of common stock at $70 per share. The initial margin is 50%. What would be the maintenance margin if a margin call is made at a stock price of $85? A. 40.5% B. 20.5% C. 35.5% D. 23.5% E. none of the above

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61. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. At what stock price would you receive a margin call if the maintenance margin is 35%? A. $50 B. $65 C. $35 D. $40 E. none of the above

62. You sold short 100 shares of common stock at $75 per share. The initial margin is 50%. At what stock price would you receive a margin call if the maintenance margin is 30%? A. $90.23 B. $88.52 C. $86.54 D. $87.12 E. none of the above

63. Despite large first-day IPO returns, average first-year returns in the US are approximately ______percent. A. 7.2 B. 18.2 C. 26.4 D. 4.8 E. 9.1

64. Average second-year IPO returns in the US are approximately ______percent. A. 6.7 B. 18.2 C. 26.4 D. 7.0 E. 9.1

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65. Average third-year IPO returns in the US are approximately ______percent. A. 6.7 B. 18.2 C. 26.4 D. 5.3 E. 10.4

66. The preliminary prospectus is referred to as a ______. A. red herring B. indenture C. green mail D. tombstone E. headstone

67. The minimum revenue required for an initial listing on the New York Stock Exchange is A. $2,000,000 B. $25,000,000 C. $50,000,000 D. $75,000,000 E. 100,000,000

68. The minimum annual pretax income in the previous two years required for an initial listing on the New York Stock Exchange is A. $2,000,000 B. $25,000,000 C. $50,000,000 D. $75,000,000 E. 100,000,000

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69. The average daily number of shares traded on the NYSE in 2008 was approximately ______dollars. A. over 3 billion B. 1.8 trillion C. 12 billion D. 4 trillion E. none of the above

70. The securities act of 1933 ______. I) requires full disclosure of relevant information relating to the issue of new securities II) requires registration of new securities III) requires issuance of a prospectus detailing financial prospects of the firm IV) established the SEC V) requires periodic disclosure of relevant financial information VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers A. I, II and III B. I, II, III, IV, V, and VI C. I, II and V D. I, II and IV E. IV only

71. The securities act of 1934 ______. I) requires full disclosure of relevant information relating to the issue of new securities II) requires registration of new securities III) requires issuance of a prospectus detailing financial prospects of the firm IV) established the SEC V) requires periodic disclosure of relevant financial information VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers A. I, II and III B. I, II, III, IV, V, and VI C. I, II and V D. I, II and IV E. IV, V, and VI

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72. Which of the following is not required under the CFA Institute Standards of Professional Conduct? A. knowledge of all applicable laws, rules and regulations B. disclosure of all personal investments whether or not they may conflict with a client's investments C. disclosure of all conflicts to clients and prospects D. reasonable inquiry into a client's financial situation E. All of the above are required under the CFA Institute standards.

73. According to the CFA Institute Standards of Professional Conduct, CFA Institute members have responsibilities to all of the following except: A. the government B. the profession C. the public D. the employer E. clients and prospective clients

Short Answer Questions

74. Discuss margin buying of common stocks. Include in your discussion the advantages and disadvantages, the types of margin requirements, how these requirements are met, and who determines these requirements.

75. List three factors that are listing requirements for the New York Stock Exchange. Why does the exchange have such requirements?

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Chapter 05 Introduction to Risk, Return, and the Historical Record

Multiple Choice Questions

1. Over the past year you earned a nominal rate of interest of 10 percent on your money. The inflation rate was 5 percent over the same period. The exact actual growth rate of your purchasing power was A. 15.5%. B. 10.0%. C. 5.0%. D. 4.8%. E. 15.0%.

2. Over the past year you earned a nominal rate of interest of 8 percent on your money. The inflation rate was 4 percent over the same period. The exact actual growth rate of your purchasing power was A. 15.5%. B. 10.0%. C. 3.8%. D. 4.8%. E. 15.0%.

3. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 7%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year? A. 4%. B. 10%. C. 7%. D. 3%. E. 6%.

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4. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year? A. 1.5%. B. 10%. C. 7%. D. 3%. E. 1%.

5. If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately A. 1%. B. 9%. C. 20%. D. 15%. E. 7%.

6. If the annual real rate of interest is 2.5% and the expected inflation rate is 3.7%, the nominal rate of interest would be approximately A. 3.7%. B. 6.2%. C. 2.5%. D. -1.2%. E. 4.3%.

7. You purchased a share of stock for $20. One year later you received $1 as a dividend and sold the share for $29. What was your holding-period return? A. 45% B. 50% C. 5% D. 40% E. 32%

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8. You purchased a share of stock for $30. One year later you received $1.50 as a dividend and sold the share for $32.25. What was your holding-period return? A. 12.5% B. 12.0% C. 13.6% D. 11.8% E. 14.1%

9. Which of the following determine(s) the level of real interest rates? I) The supply of savings by households and business firms II) The demand for investment funds III) The government's net supply and/or demand for funds A. I only B. II only C. I and II only D. I, II, and III E. III only

10. Which of the following statement(s) is (are) true? I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation. A. I and II only. B. I and III only. C. III and IV only. D. II and III only. E. I, II, III, and IV only.

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11. Which of the following statements is true A. Inflation has no effect on the nominal rate of interest. B. The realized nominal rate of interest is always greater than the real rate of interest. C. Certificates of deposit offer a guaranteed real rate of interest. D. Certificates of deposit offer a guaranteed nominal rate of interest. E. Inflation has no effect on the nominal rate of interest, the realized nominal rate of interest is always greater than the real rate of interest, and certificates of deposit offer a guaranteed real rate of interest

12. Other things equal, an increase in the government budget deficit A. drives the interest rate down. B. drives the interest rate up. C. might not have any effect on interest rates. D. always increases business prospects. E. never increases business prospects.

13. Ceteris paribus, a decrease in the demand for loanable funds A. drives the interest rate down. B. drives the interest rate up. C. might not have any effect on interest rates. D. results from an increase in business prospects and a decrease in the level of savings. E. results from an increase in business prospects and a increase in the level of savings.

14. The holding-period return (HPR) on a share of stock is equal to A. the capital gain during the period, plus the inflation rate. B. the capital gain yield during the period, plus the . C. the current yield, plus the dividend yield. D. the dividend yield, plus the risk premium. E. the change in stock price.

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15. Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2009 show that A. stocks offered investors greater rates of return than bonds and bills. B. stock returns were less volatile than those of bonds and bills. C. bonds offered investors greater rates of return than stocks and bills. D. bills outperformed stocks and bonds. E. treasury bills always offered a rate of return greater than inflation.

16. If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation: A. borrowers gain and savers lose. B. savers gain and borrowers lose. C. both borrowers and savers lose. D. neither borrowers nor savers gain or lose. E. both borrowers and savers gain.

You have been given this probability distribution for the holding-period return for KMP stock:

17. What is the expected holding-period return for KMP stock? A. 10.40% B. 9.32% C. 11.63% D. 11.54% E. 10.88%

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18. What is the expected standard deviation for KMP stock? A. 6.91% B. 8.13% C. 7.79% D. 7.25% E. 8.85%

19. What is the expected variance for KMP stock? A. 66.04% B. 69.96% C. 77.04% D. 63.72% E. 78.45%

20. If the nominal return is constant, the after-tax real rate of return A. declines as the inflation rate increases. B. increases as the inflation rate increases. C. declines as the inflation rate declines. D. increases as the inflation rate decreases. E. declines as the inflation rate increases and increases as the inflation rate decreases.

21. The risk premium for common stocks A. cannot be zero, for investors would be unwilling to invest in common stocks. B. must always be positive, in theory. C. is negative, as common stocks are risky. D. cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory. E. cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks are risky.

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22. If a portfolio had a return of 15%, the risk free asset return was 3%, and the standard deviation of the portfolio's excess returns was 34%, the risk premium would be _____. A. 31% B. 18% C. 49% D. 12% E. 29%

23. You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding-period return? A. 4.44% B. 2.22% C. 3.33% D. 5.56% E. 5.91%

24. Toyota stock has the following probability distribution of expected prices one year from now:

If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding-period return on Toyota? A. 17.72% B. 18.89% C. 17.91% D. 18.18% E. 16.83%

25. Which of the following factors would not be expected to affect the nominal interest rate? A. The supply of loanable funds B. The demand for loanable funds C. The coupon rate on previously issued government bonds D. The expected rate of inflation E. Government spending and borrowing

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Chapter 06 Risk Aversion and Capital Allocation to Risky Assets

Multiple Choice Questions

1. Which of the following statements regarding risk-averse investors is true? A. They only care about the rate of return. B. They accept investments that are fair games. C. They only accept risky investments that offer risk premiums over the risk-free rate. D. They are willing to accept lower returns and high risk. E. They only care about the rate of return and accept investments that are fair games.

2. Which of the following statements is (are) true? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. II, III, and IV only

3. Which of the following statements is (are) false? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only C. I and II only D. II and III only E. III, and IV only

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4. In the mean-standard deviation graph an indifference curve has a ______slope. A. negative B. zero C. positive D. northeast E. cannot be determined

5. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor? A. It is the locus of portfolios that have the same expected rates of return and different standard deviations. B. It is the locus of portfolios that have the same standard deviations and different rates of return. C. It is the locus of portfolios that offer the same utility according to returns and standard deviations. D. It connects portfolios that offer increasing utilities according to returns and standard deviations. E. It is irrelevant to making a decision of what portfolio would best suit the investor.

6. In a return-standard deviation space, which of the following statements is (are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return- axis and the standard deviation-axis, respectively.) I) An investor's own indifference curves might intersect. II) Indifference curves have negative slopes. III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect. A. I and II only B. II and III only C. I and IV only D. III and IV only E. II and IV only

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7. Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore, A. for the same risk, David requires a higher rate of return than Elias. B. for the same return, Elias tolerates higher risk than David. C. for the same risk, Elias requires a lower rate of return than David. D. for the same return, David tolerates higher risk than Elias. E. cannot be determined.

8. When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least likely to assess? A. The investor's prior investing experience B. The investor's degree of financial security C. The investor's tendency to make risky or conservative choices D. The level of return the investor prefers E. The investor's feelings about loss

Assume an investor with the following utility function: U = E(r) - 3/2(s2).

9. To maximize her expected utility, she would choose the asset with an expected rate of return of ______and a standard deviation of ______, respectively. A. 12%; 20% B. 10%; 15% C. 10%; 10% D. 8%; 10% E. 10%; 12%

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10. To maximize her expected utility, which one of the following investment alternatives would she choose? A. A portfolio that pays 10 percent with a 60 percent probability or 5 percent with 40 percent probability. B. A portfolio that pays 10 percent with 40 percent probability or 5 percent with a 60 percent probability. C. A portfolio that pays 12 percent with 60 percent probability or 5 percent with 40 percent probability. D. A portfolio that pays 12 percent with 40 percent probability or 5 percent with 60 percent probability. E. A portfolio that pays 12 percent with 20 percent probability or 2 percent with 80 percent probability.

11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6 percent. An investor has the following utility function: U = E(r) - (A/2)s2. Which value of A makes this investor indifferent between the risky portfolio and the risk-free asset? A. 5 B. 6 C. 7 D. 8 E. 1

12. According to the mean-variance criterion, which one of the following investments dominates all others? A. E(r) = 0.15; Variance = 0.20 B. E(r) = 0.10; Variance = 0.20 C. E(r) = 0.10; Variance = 0.25 D. E(r) = 0.15; Variance = 0.25 E. E(r) = 0.12; Variance = 0.35

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13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation of 0.15, that lies on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve? A. E(r) = 0.15; Standard deviation = 0.20 B. E(r) = 0.15; Standard deviation = 0.10 C. E(r) = 0.10; Standard deviation = 0.10 D. E(r) = 0.20; Standard deviation = 0.15 E. E(r) = 0.10; Standard deviation = 0.20

U = E(r) - (A/2)s2, where A = 4.0.

14. Based on the utility function above, which investment would you select? A. 1 B. 2 C. 3 D. 4 E. cannot tell from the information given

15. Which investment would you select if you were risk neutral? A. 1 B. 2 C. 3 D. 4 E. cannot tell from the information given

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16. The variable (A) in the utility function represents the: A. investor's return requirement. B. investor's aversion to risk. C. certainty-equivalent rate of the portfolio. D. minimum required utility of the portfolio. E. the security's variance.

17. The exact indifference curves of different investors A. cannot be known with perfect certainty. B. can be calculated precisely with the use of advanced calculus. C. allow the advisor to create more suitable portfolios for the client. D. cannot be known with perfect certainty but they do allow the advisor to create more suitable portfolios for the client. E. None of these is correct.

18. The riskiness of individual assets A. should be considered for the asset in isolation. B. should be considered in the context of the effect on overall portfolio . C. should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio. D. should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio. E. is irrelevant to the portfolio decision.

19. A fair game A. will not be undertaken by a risk-averse investor. B. is a risky investment with a zero risk premium. C. is a riskless investment. D. will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium. E. will not be undertaken by a risk-averse investor and is a riskless investment.

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20. The presence of risk means that A. investors will lose money. B. more than one outcome is possible. C. the standard deviation of the payoff is larger than its expected value. D. final wealth will be greater than initial wealth. E. terminal wealth will be less than initial wealth.

21. The utility score an investor assigns to a particular portfolio, other things equal, A. will decrease as the rate of return increases. B. will decrease as the standard deviation decreases. C. will decrease as the variance decreases. D. will increase as the variance increases. E. will increase as the rate of return increases.

22. The certainty equivalent rate of a portfolio is A. the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio. B. the rate that the investor must earn for certain to give up the use of his money. C. the minimum rate guaranteed by institutions such as banks. D. the rate that equates "A" in the utility function with the average risk aversion coefficient for all risk-averse investors. E. represented by the scaling factor "-.005" in the utility function.

23. According to the mean-variance criterion, which of the statements below is correct?

A. Investment B dominates Investment A. B. Investment B dominates Investment C. C. Investment D dominates all of the other investments. D. Investment D dominates only Investment B. E. Investment C dominates investment A.

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24. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I) Steve and Edie's indifference curves might intersect. II) Steve's indifference curves will have flatter slopes than Edie's. III) Steve's indifference curves will have steeper slopes than Edie's. IV) Steve and Edie's indifference curves will not intersect. V) Steve's indifference curves will be downward sloping and Edie's will be upward sloping. A. I and V B. I and III C. III and IV D. I and II E. II and IV

25. The can be described as the A. investment opportunity set formed with a risky asset and a risk-free asset. B. investment opportunity set formed with two risky assets. C. line on which lie all portfolios that offer the same utility to a particular investor. D. line on which lie all portfolios with the same expected rate of return and different standard deviations. E. investment opportunity set formed with multiple risky assets.

26. Which of the following statements regarding the Capital Allocation Line (CAL) is false? A. The CAL shows risk-return combinations. B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation. C. The slope of the CAL is also called the reward-to-volatility ratio. D. The CAL is also called the of risky assets in the absence of a risk-free asset. E. The CAL shows risk-return combinations and is also called the efficient frontier of risky assets in the absence of a risk-free asset.

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27. Given the capital allocation line, an investor's optimal portfolio is the portfolio that A. maximizes her expected profit. B. maximizes her risk. C. minimizes both her risk and return. D. maximizes her expected utility. E. minimizes her risk.

28. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. His portfolio's expected return and standard deviation are ______and ______, respectively. A. 0.114; 0.12 B. 0.087; 0.06 C. 0.295; 0.12 D. 0.087; 0.12 E. 0.795; 0.14

Chapter 07 Optimal Risky Portfolios

Multiple Choice Questions

1. Market risk is also referred to as A. , diversifiable risk. B. systematic risk, nondiversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. firm-specific risk.

2. Systematic risk is also referred to as A. market risk, nondiversifiable risk. B. market risk, diversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. firm-specific risk.

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3. Nondiversifiable risk is also referred to as A. systematic risk, unique risk. B. systematic risk, market risk. C. unique risk, market risk. D. unique risk, firm-specific risk. E. systematic risk, firm-specific risk.

4. Diversifiable risk is also referred to as A. systematic risk, unique risk. B. systematic risk, market risk. C. unique risk, market risk. D. unique risk, firm-specific risk. E. systematic risk, firm-specific risk.

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5. Unique risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, firm-specific risk. E. market risk.

6. Firm-specific risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, unique risk. E. nondiversifiable, market risk.

7. Non-systematic risk is also referred to as A. market risk, diversifiable risk. B. firm-specific risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, unique risk. E. nondiversifiable risk, unique risk.

8. The risk that can be diversified away is A. firm-specific risk. B. . C. systematic risk. D. market risk. E. non-systematic risk.

9. The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. non-systematic risk. D. market risk. E. unique risk and non-systematic risk.

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10. The variance of a portfolio of risky securities A. is a weighted sum of the securities' variances. B. is the sum of the securities' variances. C. is the weighted sum of the securities' variances and covariances. D. is the sum of the securities' covariances. E. is the weighted sum of the securities' covariances.

11. The standard deviation of a portfolio of risky securities is A. the square root of the weighted sum of the securities' variances. B. the square root of the sum of the securities' variances. C. the square root of the weighted sum of the securities' variances and covariances. D. the square root of the sum of the securities' covariances. E. is the weighted sum of the securities' covariances.

12. The expected return of a portfolio of risky securities A. is a weighted average of the securities' returns. B. is the sum of the securities' returns. C. is the weighted sum of the securities' variances and covariances. D. is both a weighted average of the securities' returns and a weighted sum of the securities' variances and covariances. E. is the weighted sum of the securities' covariances.

13. Other things equal, diversification is most effective when A. securities' returns are uncorrelated. B. securities' returns are positively correlated. C. securities' returns are high. D. securities' returns are negatively correlated. E. both securities' returns are positively correlated and securities' returns are high.

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14. The efficient frontier of risky assets is A. the portion of the investment opportunity set that lies above the global minimum variance portfolio. B. the portion of the investment opportunity set that represents the highest standard deviations. C. the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation. D. the set of portfolios that have zero standard deviation. E. both the portion of the investment opportunity set that lies above the global minimum variance portfolio and the portion of the investment opportunity set that represents the highest standard deviations.

15. The Capital Allocation Line provided by a risk-free security and N risky securities is A. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities. B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier. C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate. D. the horizontal line drawn from the risk-free rate. E. the line that connects the risk-free rate and the global maximum-variance portfolio of the risky securities.

16. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always A. greater than zero. B. equal to zero. C. equal to the sum of the securities' standard deviations. D. equal to -1. E. between zero and -1.

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17. Which of the following statements is (are) true regarding the variance of a portfolio of two risky securities? A. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. B. There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. D. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and there is a linear relationship between the securities' coefficient of correlation and the portfolio variance. E. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and the degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

18. Which of the following statements is (are) false regarding the variance of a portfolio of two risky securities? A. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. B. There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. D. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and there is a linear relationship between the securities' coefficient of correlation and the portfolio variance. E. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and the degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

19. Efficient portfolios of N risky securities are portfolios that A. are formed with the securities that have the highest rates of return regardless of their standard deviations. B. have the highest rates of return for a given level of risk. C. are selected from those securities with the lowest standard deviations regardless of their returns. D. have the highest risk and rates of return and the highest standard deviations. E. have the lowest standard deviations and the lowest rates of return.

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20. Which of the following statement(s) is (are) true regarding the selection of a portfolio from those that lie on the Capital Allocation Line? A. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. B. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. C. Investors choose the portfolio that maximizes their expected utility. D. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and investors will choose the portfolio that maximizes their expected utility. E. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors and investors will choose the portfolio that maximizes their expected utility.

21. Which of the following statement(s) is (are) false regarding the selection of a portfolio from those that lie on the Capital Allocation Line? A. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. B. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. C. Investors choose the portfolio that maximizes their expected utility. D. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and more risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. E. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and investors choose the portfolio that maximizes their expected utility.

Consider the following probability distribution for stocks A and B:

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22. The expected rates of return of stocks A and B are _____ and _____, respectively. A. 13.2%; 9% B. 14%; 10% C. 13.2%; 7.7% D. 7.7%; 13.2% E. 13.8%; 9.3%

23. The standard deviations of stocks A and B are _____ and _____, respectively. A. 1.5%; 1.9% B. 2.5%; 1.1% C. 3.2%; 2.0% D. 1.5%; 1.1% E. 1.8%; 1.6%

24. The variances of stocks A and B are _____ and _____, respectively. A. 1.5%; 1.9% B. 2.2%; 1.2% C. 3.2%; 2.0% D. 1.5%; 1.1% E. 1.4%; 2.1%

25. The coefficient of correlation between A and B is A. 0.46. B. 0.60. C. 0.58. D. 1.20. E. 0.73.

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26. If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and standard deviation? A. 9.9%; 3% B. 9.9%; 1.1% C. 11%; 1.1% D. 11%; 3% E. 10.6%; 2.1%

27. Let G be the global minimum variance portfolio. The weights of A and B in G are ______and ______, respectively. A. 0.40; 0.60 B. 0.66; 0.34 C. 0.34; 0.66 D. 0.77; 0.23 E. 0.23; 0.77

28. The expected rate of return and standard deviation of the global minimum variance portfolio, G, are ______and ______, respectively. A. 10.07%; 1.05% B. 8.97%; 2.03% C. 10.07%; 3.01% D. 8.97%; 1.05% E. 7.56%; 0.83%

29. Which of the following portfolio(s) is (are) on the efficient frontier? A. The portfolio with 20 percent in A and 80 percent in B. B. The portfolio with 15 percent in A and 85 percent in B. C. The portfolio with 26 percent in A and 74 percent in B. D. The portfolio with 10 percent in A and 90 percent in B. E. The portfolio with 20 percent in A and 80 percent in B, and the portfolio with 15 percent in A and 85 percent in B are both on the efficient frontier.

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Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.

30. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.43; 0.57 E. 0.76; 0.24

Chapter 08 Index Models

Multiple Choice Questions

1. As diversification increases, the total variance of a portfolio approaches ______. A. 0 B. 1 C. the variance of the D. infinity E. -1

2. As diversification increases, the standard deviation of a portfolio approaches ______. A. 0 B. 1 C. infinity D. the standard deviation of the market portfolio E. -1

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3. As diversification increases, the firm-specific risk of a portfolio approaches ______. A. 0 B. 1 C. infinity D. n-1 * n E. -1

4. As diversification increases, the unsystematic risk of a portfolio approaches ______. A. 1 B. 0 C. infinity D. n-1 * n E. -1

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5. As diversification increases, the unique risk of a portfolio approaches ______. A. 1 B. 0 C. infinity D. n-1 * n E. -1

6. The index model was first suggested by ______. A. Graham B. Markowitz C. Miller D. Sharpe E. Jensen

7. A single-index model uses ______as a proxy for the systematic risk factor. A. a market index, such as the S&P 500 B. the current account deficit C. the growth rate in GNP D. the unemployment rate E. the inflation rate

8. Beta books typically rely on the ______most recent monthly observations to calculate regression parameters. A. 12 B. 36 C. 60 D. 120 E. 6

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9. The index model has been estimated for stocks A and B with the following results: RA= 0.03 + 0.7RM+ eA RB= 0.01 + 0.9RM+ eB M= 0.35 (eA) = 0.20 (eB) = 0.10 The covariance between the returns on stocks A and B is ______. A. 0.0384 B. 0.0406 C. 0.1920 D. 0.0772 E. 0.4000

10. According to the index model, covariances among security pairs are A. due to the influence of a single common factor represented by the market index return B. extremely difficult to calculate C. related to industry-specific events D. usually positive E. due to the influence of a single common factor represented by the market index return, and they are usually positive

11. The intercept in the regression equations calculated by beta books is equal to A.  in the CAPM B.  + rf(1 + ) C.  + rf(1 - ) D. 1 -  E. 1

12. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the slope of the regression line is an estimate of ______. A. the  of the asset B. the  of the asset C. the  of the asset D. the  of the asset E. the  of the asset

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13. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the intercept of the regression line is an estimate of ______. A. the  of the asset B. the  of the asset C. the  of the asset D. the  of the asset E. the  of the asset

14. In a factor model, the return on a stock in a particular period will be related to ______. A. firm-specific events B. macroeconomic events C. the error term D. both firm-specific events and macroeconomic events E. neither firm-specific events nor macroeconomic events

15. Rosenberg and Guy found that ______helped to predict a firm's beta. A. the firm's financial characteristics B. the firm's industry group C. firm size D. both the firm's financial characteristics and the firm's industry group E. the firm's financial characteristics, the firm's industry group and firm size

16. If the index model is valid, ______would be helpful in determining the covariance between assets GM and GE. A. GM B. GE C. M D. GM, GE, and M E. GE, and M

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17. If the index model is valid, ______would be helpful in determining the covariance between assets HPQ and KMP. A. HPQ B. KMP C. M D. HPQ, KMP, and M E. HPQ, and KMP

Chapter 09 The Capital Asset Pricing Model

Multiple Choice Questions

1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is A. unique risk. B. beta. C. standard deviation of returns. D. variance of returns. E. skewness.

2. In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is A. unique risk. B. systematic risk. C. standard deviation of returns. D. variance of returns. E. semi-variance.

3. In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is A. unique risk. B. market risk. C. standard deviation of returns. D. variance of returns. E. semi-variance.

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4. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. market risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. interest rate risk.

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5. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. beta risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. interest rate risk.

6. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. systematic risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. interest rate risk.

7. The market portfolio has a beta of A. 0. B. 1. C. -1. D. 0.5. E. 0.75

8. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to. A. 0.06. B. 0.144. C. 0.12. D. 0.132. E. 0.18.

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9. The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to A. 0.142 B. 0.144 C. 0.153 D. 0.134 E. 0.117

10. Which statement is not true regarding the market portfolio? A. It includes all publicly traded financial assets. B. It lies on the efficient frontier. C. All securities in the market portfolio are held in proportion to their market values. D. It is the tangency point between the line and the indifference curve. E. it lies on a line that represents the expected risk-return relationship.

11. Which statement is true regarding the market portfolio? A. It includes all publicly traded financial assets. B. It lies on the efficient frontier. C. All securities in the market portfolio are held in proportion to their market values. D. It is the tangency point between the and the indifference curve. E. It includes all publicly traded financial assets, lies on the efficient frontier, and all securities in the market portfolio are held in proportion to their market values.

12. Which statement is not true regarding the Capital Market Line (CML)? A. The CML is the line from the risk-free rate through the market portfolio. B. The CML is the best attainable capital allocation line. C. The CML is also called the . D. The CML always has a positive slope. E. The risk measure for the CML is standard deviation.

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13. Which statement is true regarding the Capital Market Line (CML)? A. The CML is the line from the risk-free rate through the market portfolio. B. The CML is the best attainable capital allocation line. C. The CML is also called the security market line. D. The CML always has a positive slope. E. The CML is the line from the risk-free rate through the market portfolio, is the best attainable capital allocation line, and it always has a positive slope.

14. The market risk, beta, of a security is equal to A. the covariance between the security's return and the market return divided by the variance of the market's returns. B. the covariance between the security and market returns divided by the standard deviation of the market's returns. C. the variance of the security's returns divided by the covariance between the security and market returns. D. the variance of the security's returns divided by the variance of the market's returns. E. the variance of the security's return divided by the standard deviation of the market's returns.

15. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to A. Rf+  [E(RM)]. B. Rf+  [E(RM) - Rf]. C.  [E(RM) - Rf]. D. E(RM) + Rf. E. Rf-  [E(RM) - Rf].

16. The Security Market Line (SML) is A. the line that describes the expected return-beta relationship for well-diversified portfolios only. B. also called the Capital Allocation Line. C. the line that is tangent to the efficient frontier of all risky assets. D. the line that represents the expected return-beta relationship. E. also called the Capital Market Line.

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17. According to the Capital Asset Pricing Model (CAPM), fairly priced securities A. have positive betas. B. have zero alphas. C. have negative betas. D. have positive alphas. E. have non-zero alphas.

18. According to the Capital Asset Pricing Model (CAPM), underpriced securities A. have positive betas. B. have zero alphas. C. have negative betas. D. have positive alphas. E. have negative alphas.

19. According to the Capital Asset Pricing Model (CAPM), overpriced securities A. have positive betas. B. have zero alphas. C. have negative alphas. D. have positive alphas. E. have negative betas.

20. According to the Capital Asset Pricing Model (CAPM), A. a security with a positive is considered overpriced. B. a security with a zero alpha is considered to be a good buy. C. a security with a negative alpha is considered to be a good buy. D. a security with a positive alpha is considered to be underpriced. E. a security with a positive beta is considered to be underpriced.

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21. According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false? A. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. B. The expected rate of return on a security increases as its beta increases. C. A fairly priced security has an alpha of zero. D. In equilibrium, all securities lie on the security market line. E. All of these are correct.

22. In a well diversified portfolio A. market risk is negligible. B. systematic risk is negligible. C. unsystematic risk is negligible. D. nondiversifiable risk is negligible. E. risk does not exist.

23. Empirical results regarding betas estimated from historical data indicate that A. betas are constant over time. B. betas of all securities are always greater than one. C. betas are always near zero. D. betas appear to regress toward one over time. E. betas are always positive.

24. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. cannot be determined from data provided. E. can either be overpriced or underpriced but not fairly priced.

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25. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should A. buy the stock because it is overpriced. B. sell short the stock because it is overpriced. C. sell the stock short because it is underpriced. D. buy the stock because it is underpriced. E. hold the stock because it is fairly priced.

26. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is A. 1.40 B. 1.00 C. 0.36 D. 1.08 E. 0.80

27. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock is A. 1.7%. B. -1.7%. C. 8.3%. D. 5.5%. E. -5.5%.

28. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced by 3%. B. overpriced. C. fairly priced. D. cannot be determined from data provided. E. underpriced by 5%.

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29. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced by 10%. B. overpriced. C. fairly priced. D. cannot be determined from data provided. E. underpriced by 5%.

30. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced by 10%. C. fairly priced. D. cannot be determined from data provided. E. overpriced by 5%.

Chapter 10 and Multifactor Models of Risk and Return

Multiple Choice Questions

1. ______a relationship between expected return and risk. A. APT stipulates B. CAPM stipulates C. Both CAPM and APT stipulate D. Neither CAPM nor APT stipulate E. No pricing model has found

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2. Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1 and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exit? A. 9.26% B. 3% C. 4% D. 7.75% E. 9.75%

3. In a multi-factor APT model, the coefficients on the macro factors are often called ______. A. systemic risk B. factor sensitivities C. idiosyncratic risk D. factor betas E. both factor sensitivities and factor betas

4. In a multi-factor APT model, the coefficients on the macro factors are often called ______. A. systemic risk B. firm-specific risk C. idiosyncratic risk D. factor betas E. unique risk

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5. In a multi-factor APT model, the coefficients on the macro factors are often called ______. A. systemic risk B. firm-specific risk C. idiosyncratic risk D. factor loadings E. unique risk

6. Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios? A. The CAPM B. The multifactor APT C. Both the CAPM and the multifactor APT D. Neither the CAPM nor the multifactor APT E. No pricing model currently exists that provides guidance concerning the determination of the risk premium on any portfolio.

7. An arbitrage opportunity exists if an investor can construct a ______investment portfolio that will yield a sure profit. A. small positive B. small negative C. zero D. large positive E. large negative

8. The APT was developed in 1976 by ______. A. Lintner B. Modigliani and Miller C. Ross D. Sharpe E. Fama

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9. A ______portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor. A. factor B. market C. index D. factor and market E. factor, market, and index

10. The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called ______. A. arbitrage B. capital asset pricing C. factoring D. E.

11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of A. a common macroeconomic factor B. firm-specific factors C. pricing error D. neither common macroeconomic factors nor firm-specific factors. E. both common macroeconomic factors and firm-specific factors

12. The ______provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the ______implies that this relationship holds for all but perhaps a small number of securities. A. APT, CAPM B. APT, OPM C. CAPM, APT D. CAPM, OPM E. APT and OPM, CAPM

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13. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%. If you wanted to take advantage of an arbitrage opportunity, you should take a short in portfolio ______and a position in portfolio ______. A. A, A B. A, B C. B, A D. B, B E. A, the riskless asset

14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio ______and a long position in portfolio ______. A. A, A B. A, B C. B, A D. B, B E. No arbitrage opportunity exists.

15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a well-diversified portfolio on the factor is 1.1. The variance of returns on the well- diversified portfolio is approximately ______. A. 3.6% B. 6.0% C. 7.3% D. 10.1% E. 8.6%

Chapter 24 Portfolio Performance Evaluation

Multiple Choice Questions

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1. Hedge funds I) are appropriate as a sole investment vehicle for an investor. II) should only be added to an already well-diversified portfolio. III) pose performance evaluation issues due to non-linear factor exposures. IV) have down-market betas that are typically larger than up-market betas. V) have symmetrical betas. A. I only B. II and V C. I, III, and IV D. II, III, and IV E. I, III, and V

2. Mutual funds show ______evidence of serial correlation and hedge funds show ______evidence of serial correlation. A. almost no; almost no B. almost no; substantial C. substantial; substantial D. substantial; almost no E. modest; modest

3. The comparison universe is ______. A. a concept found only in astronomy B. the set of all mutual funds in the world C. the set of all mutual funds in the U. S. D. a set of mutual funds with similar risk characteristics to your mutual fund E. None of these is correct

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4. The comparison universe is not ______. A. a concept found only in astronomy B. the set of all mutual funds in the world C. the set of all mutual funds in the U. S. D. a set of mutual funds with similar risk characteristics to your mutual fund E. a concept found only in astronomy, the set of all mutual funds in the world, and the set of all mutual funds in the U. S.

5. ______did not develop a popular method for risk-adjusted performance evaluation of mutual funds. A. Eugene Fama B. Michael Jensen C. William Sharpe D. Jack Treynor E. Eugene Fama and Michael Jensen

6. ______developed a popular method for risk-adjusted performance evaluation of mutual funds. A. Eugene Fama B. Michael Jensen C. William Sharpe D. Jack Treynor E. Michael Jensen, William Sharpe, and Jack Treynor

7. Henriksson (1984) found that, on average, betas of funds ______during market advances. A. increased very significantly B. increased slightly C. decreased slightly D. decreased very significantly E. did not change

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8. Most professionally managed equity funds generally ______. A. outperform the S&P 500 index on both raw and risk-adjusted return measures B. underperform the S&P 500 index on both raw and risk-adjusted return measures C. outperform the S&P 500 index on raw return measures and underperform the S&P 500 index on risk-adjusted return measures D. underperform the S&P 500 index on raw return measures and outperform the S&P 500 index on risk-adjusted return measures E. match the performance of the S&P 500 index on both raw and risk-adjusted return measures

9. Suppose two portfolios have the same average return, the same standard deviation of returns, but portfolio A has a higher beta than portfolio B. According to the Sharpe measure, the performance of portfolio A ______. A. is better than the performance of portfolio B B. is the same as the performance of portfolio B C. is poorer than the performance of portfolio B D. cannot be measured as there is no data on the alpha of the portfolio E. None of these is correct.

10. Suppose two portfolios have the same average return, the same standard deviation of returns, but portfolio A has a higher beta than portfolio B. According to the Treynor measure, the performance of portfolio A ______. A. is better than the performance of portfolio B B. is the same as the performance of portfolio B C. is poorer than the performance of portfolio B D. cannot be measured as there is no data on the alpha of the portfolio E. None of these is correct.

11. Suppose two portfolios have the same average return, the same standard deviation of returns, but portfolio A has a lower beta than portfolio B. According to the Treynor measure, the performance of portfolio A ______. A. is better than the performance of portfolio B B. is the same as the performance of portfolio B C. is poorer than the performance of portfolio B D. cannot be measured as there is no data on the alpha of the portfolio E. None of these is correct.

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12. Suppose two portfolios have the same average return, the same standard deviation of returns, but Aggie Fund has a higher beta than Raider Fund. According to the Sharpe measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

13. Suppose two portfolios have the same average return, the same standard deviation of returns, but Aggie Fund has a higher beta than Raider Fund. According to the Treynor measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

14. Suppose two portfolios have the same average return, the same standard deviation of returns, but Aggie Fund has a lower beta than Raider Fund. According to the Treynor measure, the performance of Aggie Fund A. is better than the performance of Raider Fund. B. is the same as the performance of Raider Fund. C. is poorer than the performance of Raider Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

15. Suppose two portfolios have the same average return, the same standard deviation of returns, but Buckeye Fund has a higher beta than Gator Fund. According to the Sharpe measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

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16. Suppose two portfolios have the same average return, the same standard deviation of returns, but Buckeye Fund has a lower beta than Gator Fund. According to the Sharpe measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

17. Suppose two portfolios have the same average return, the same standard deviation of returns, but Buckeye Fund has a lower beta than Gator Fund. According to the Treynor measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct.

18. Suppose two portfolios have the same average return, the same standard deviation of returns, but Buckeye Fund has a higher beta than Gator Fund. According to the Treynor measure, the performance of Buckeye Fund A. is better than the performance of Gator Fund. B. is the same as the performance of Gator Fund. C. is poorer than the performance of Gator Fund. D. cannot be measured as there is no data on the alpha of the portfolio. E. None of these is correct is true.

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19. Morningstar's RAR method I) is one of the most widely used performance measures. II) indicates poor performance by placing up to 5 darts next to the fund's name. III) computes fund returns adjusted for loads. IV) computes fund returns adjusted for risk. V) produces ranking results that are the same as those produced with the Sharpe measure. A. I, II, and IV B. I, III, and IV C. I, IV, and V D. I, II, IV, and V E. I, II, III, IV, and V

20. Suppose you purchase 100 shares of GM stock at the beginning of year 1, and purchase another 100 shares at the end of year 1. You sell all 200 shares at the end of year 2. Assume that the price of GM stock is $50 at the beginning of year 1, $55 at the end of year 1, and $65 at the end of year 2. Assume no dividends were paid on GM stock. Your dollar-weighted return on the stock will be ______your time-weighted return on the stock. A. higher than B. the same as C. less than D. exactly proportional to E. more information is necessary to answer this question

21. Suppose the risk-free return is 4%. The beta of a managed portfolio is 1.2, the alpha is 1%, and the average return is 14%. Based on Jensen's measure of portfolio performance, you would calculate the return on the market portfolio as A. 11.5% B. 14% C. 15% D. 16% E. None of these is correct

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22. Suppose the risk-free return is 3%. The beta of a managed portfolio is 1.75, the alpha is 0%, and the average return is 16%. Based on Jensen's measure of portfolio performance, you would calculate the return on the market portfolio as A. 12.3% B. 10.4% C. 15.1% D. 16.7% E. None of these is correct

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