Ch 12 Portfolio Management and Investment Risk Part IV Flashcards
Define reinvestment risk.
The risk that an investor will not be able to reinvest her principal at the same interest rate.
What is the formula for determining an asset’s total return?
(Ending Value - Beginning Value + Dividends/Interest) ÷ Beginning Value
Define negative financial leverage.
It is when the return achieved is less than the cost of borrowing.
A client notices that a thinly traded stock has had few daily trades effected. To what risk is it most susceptible?
Liquidity risk
Business, regulatory, political, and liquidity risk are all types of ____________ risk.
unsystematic risk.
Highly regulated companies, such as utilities, are subject to __________ risk.
regulatory risk.
12 years ago, Tina invested $25,000 which has now grown to $100,000. What is the annual growth rate of her investment?
In 12 years, the money doubled twice (every six years). Using the Rule of 72, 72 divided six years = 12%.
Both the Dow Jones Industrial Average and the S&P 500 Index are _____-cap indexes.
large-cap indexes.
__________ value is the dollar amount to be invested today to meet a specific dollar objective at a set future point.
Present
True or False: The interest rate on TIPS is fixed, but the principal may be adjusted.
True
_________ stock pays higher than average dividends.
Income stock
In a declining market, is a high beta security expected to outperform or underperform the market as a whole?
Underperform
What is the use of the Capital Asset Pricing Model (CAPM)?
To find an investor’s optimal portfolio by comparing expected risk with expected rates of return
If an investor is short stock, a buy stop order can be used to limit _________ risk.
upside risk.
What is the efficient frontier?
The line representing portfolios (excluding risk-free alternatives) showing the lowest risk for a given level of return
What is a Perpetuity?
An annuity that pays out forever.
Identify the acronym: MPT
Modern Portfolio Theory
A company with more debt than equity outstanding is considered ____________.
leveraged.
___________________ is the balancing of investment classes according to an investor’s investment objectives.
Asset allocation
The difference between an investment’s total return and the risk-free rate is the risk _______.
premium.
What is commonly used to measure an asset’s risk-free rate of return?
The interest rate on a U.S. T-bill
What is the risk of having an excessive portion of a portfolio invested in one particular security or asset class?
Concentration risk
Do stop orders guarantee a specific price when buying or selling?
No, stop orders execute at the market price (which is uncertain) once they are activated.
Stop orders become _________ orders once they are triggered/activated.
market orders
Define expected return.
The possible return of an asset multiplied by the likelihood of occurrence
A ____________ is an annuity that never stops paying money.
perpetuity
The Russell 2000 Index is a _____-cap index.
small-cap index.
Bond A yields 7.5% when inflation is 3%. Bond B yields 8% when inflation is 4%. Which has a higher real interest rate?
Bond A. Bond A’s real interest rate is 4.5% (7.5% - 3%) and Bond B’s real interest rate is 4% (8% - 4%).
True or False: Strategic asset allocation is considered an active asset allocation approach.
False. Strategic asset allocation is considered a passive approach.
Identify the acronym: CAPM
Capital Asset Pricing Model
Over the last three months, a stock rose from $50 to $51 and paid a $.25 dividend. What is its annualized return?
The three-month return is 2.5% ($1.25 ÷ $50). A quarterly return is annualized by multiplying by four (2.5% x 4 = 10%).
If an investor is long stock, a sell stop order can be used to limit ___________ risk.
downside risk.
True or False: A buy-and-hold strategy is considered an active/tactical investment strategy.
False. A buy-and-hold strategy is considered a passive/strategic investment strategy.
What is required to make the dollar weighted return and the time weighted return equal?
Remove or subtract any deposits into and/or withdrawals out of the portfolio
Which return measures investment performance by including all cash inflows and outflows?
Dollar-weighted return
Which would have the least risk—large-, mid-, or small-cap companies?
Large cap stocks have the least risk.
What uses computer simulations to present random outcomes of an investment strategy?
Monte Carlo Simulation
What strategy involves moving a client’s funds from one industry to another during defined periods?
Sector rotation
Name the three forms of market efficiency.
Strong-, Semi-Strong and Weak-Form
______ is the measure of an asset’s volatility compared to the market as a whole.
Beta
What is the present value of an annuity that pays $2,000 per year and earns 5% per year?
$40,000 = $2,000/.05
List some forms of business risk that apply when investing in individual equity securities.
Poor management, obsolete products, changing market conditions
What method of investing is characterized by regularly investing a set amount of money, regardless of share prices?
Dollar Cost Averaging
What is used as the basic measure of risk for an investment?
Standard deviation
If two investments go in opposite directions from one another, this is referred to as ___________ correlation.
negative correlation.
What is the formula for the Sharpe Ratio?
(Return on Investment - Risk-Free Return) ÷ Standard Deviation
True or False: In a weak-form efficient market, technical analysis will be useful.
False. In a weak-form efficient market, only fundamental analysis will be useful.
_______ investors look for stocks of companies that are intrinsically undervalued.
Value
What is the formula for calculating the risk premium?
Risk premium = total return - risk-free rate
Identify the range from the following set of numbers: 10, 12, 5, 1, 7, 7, 8, 4
- Range is calcuated by starting with the largest value (12) and then subtracting the smallest value (1).
For a person with a diversified portfolio of large-cap stocks, what type of risk may be reduced by using index options?
Systematic risk
What are the three main concepts underlying the Modern Portfolio Theory?
Expected return, standard deviation, and correlation
____________ risk is the inability to sell an investment easily.
Liquidity risk
The ________ rate of return is used to calculate the anticipated return for a portfolio of securities.
expected
Describe a value investor.
One seeking stocks that are undervalued in relation to their earnings and have low P/E ratios
Which form of market efficiency declares that only insiders can regularly beat the market?
Semi-strong
The principal value of TIPS may be adjusted based on changes to the __________________________.
Consumer Price Index (CPI).
If two investments closely track one another, this is referred to as ___________ correlation.
positive correlation.
What ratio tests a company’s ability to pay its current liabilities with its current assets, but excludes inventory?
The Quick Asset Ratio (the Acid Test)
