Ch 12 Portfolio Management and Investment Risk Part IV

Question 1

Define reinvestment risk.

Answer 1

The risk that an investor will not be able to reinvest her principal at the same interest rate.

Question 2

What is the formula for determining an asset’s total return?

Answer 2

(Ending Value - Beginning Value + Dividends/Interest) ÷ Beginning Value

Question 3

Define negative financial leverage.

Answer 3

It is when the return achieved is less than the cost of borrowing.

Question 4

A client notices that a thinly traded stock has had few daily trades effected. To what risk is it most susceptible?

Answer 4

Liquidity risk

Question 5

Business, regulatory, political, and liquidity risk are all types of ____________ risk.

Answer 5

unsystematic risk.

Question 6

Highly regulated companies, such as utilities, are subject to __________ risk.

Answer 6

regulatory risk.

Question 7

12 years ago, Tina invested $25,000 which has now grown to $100,000. What is the annual growth rate of her investment?

Answer 7

In 12 years, the money doubled twice (every six years). Using the Rule of 72, 72 divided six years = 12%.

Question 8

Both the Dow Jones Industrial Average and the S&P 500 Index are _____-cap indexes.

Answer 8

large-cap indexes.

Question 9

__________ value is the dollar amount to be invested today to meet a specific dollar objective at a set future point.

Answer 9

Present

Question 10

True or False: The interest rate on TIPS is fixed, but the principal may be adjusted.

Answer 10

True

Question 11

_________ stock pays higher than average dividends.

Answer 11

Income stock

Question 12

In a declining market, is a high beta security expected to outperform or underperform the market as a whole?

Answer 12

Underperform

Question 13

What is the use of the Capital Asset Pricing Model (CAPM)?

Answer 13

To find an investor’s optimal portfolio by comparing expected risk with expected rates of return

Question 14

If an investor is short stock, a buy stop order can be used to limit _________ risk.

Answer 14

upside risk.

Question 15

What is the efficient frontier?

Answer 15

The line representing portfolios (excluding risk-free alternatives) showing the lowest risk for a given level of return

Question 16

What is a Perpetuity?

Answer 16

An annuity that pays out forever.

Question 17

Identify the acronym: MPT

Answer 17

Modern Portfolio Theory

Question 18

A company with more debt than equity outstanding is considered ____________.

Answer 18

leveraged.

Question 19

___________________ is the balancing of investment classes according to an investor’s investment objectives.

Answer 19

Asset allocation

Question 20

The difference between an investment’s total return and the risk-free rate is the risk _______.

Answer 20

premium.

Question 21

What is commonly used to measure an asset’s risk-free rate of return?

Answer 21

The interest rate on a U.S. T-bill

Question 22

What is the risk of having an excessive portion of a portfolio invested in one particular security or asset class?

Answer 22

Concentration risk

Question 23

Do stop orders guarantee a specific price when buying or selling?

Answer 23

No, stop orders execute at the market price (which is uncertain) once they are activated.

Question 24

Stop orders become _________ orders once they are triggered/activated.

Answer 24

market orders

Question 25

Define expected return.

Answer 25

The possible return of an asset multiplied by the likelihood of occurrence

Question 26

A ____________ is an annuity that never stops paying money.

Answer 26

perpetuity

Question 27

The Russell 2000 Index is a _____-cap index.

Answer 27

small-cap index.

Question 28

Bond A yields 7.5% when inflation is 3%. Bond B yields 8% when inflation is 4%. Which has a higher real interest rate?

Answer 28

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%).

Question 29

True or False: Strategic asset allocation is considered an active asset allocation approach.

Answer 29

False. Strategic asset allocation is considered a passive approach.

Question 30

Identify the acronym: CAPM

Answer 30

Capital Asset Pricing Model

Question 31

Over the last three months, a stock rose from $50 to $51 and paid a $.25 dividend. What is its annualized return?

Answer 31

The three-month return is 2.5% ($1.25 ÷ $50). A quarterly return is annualized by multiplying by four (2.5% x 4 = 10%).

Question 32

If an investor is long stock, a sell stop order can be used to limit ___________ risk.

Answer 32

downside risk.

Question 33

True or False: A buy-and-hold strategy is considered an active/tactical investment strategy.

Answer 33

False. A buy-and-hold strategy is considered a passive/strategic investment strategy.

Question 34

What is required to make the dollar weighted return and the time weighted return equal?

Answer 34

Remove or subtract any deposits into and/or withdrawals out of the portfolio

Question 35

Which return measures investment performance by including all cash inflows and outflows?

Answer 35

Dollar-weighted return

Question 36

Which would have the least risk—large-, mid-, or small-cap companies?

Answer 36

Large cap stocks have the least risk.

Question 37

What uses computer simulations to present random outcomes of an investment strategy?

Answer 37

Monte Carlo Simulation

Question 38

What strategy involves moving a client's funds from one industry to another during defined periods?

Answer 38

Sector rotation

Question 39

Name the three forms of market efficiency.

Answer 39

Strong-, Semi-Strong and Weak-Form

Question 40

______ is the measure of an asset's volatility compared to the market as a whole.

Answer 40

Beta

Question 41

What is the present value of an annuity that pays $2,000 per year and earns 5% per year?

Answer 41

$40,000 = $2,000/.05

Question 42

List some forms of business risk that apply when investing in individual equity securities.

Answer 42

Poor management, obsolete products, changing market conditions

Question 43

What method of investing is characterized by regularly investing a set amount of money, regardless of share prices?

Answer 43

Dollar Cost Averaging

Question 44

What is used as the basic measure of risk for an investment?

Answer 44

Standard deviation

Question 45

If two investments go in opposite directions from one another, this is referred to as ___________ correlation.

Answer 45

negative correlation.

Question 46

What is the formula for the Sharpe Ratio?

Answer 46

(Return on Investment - Risk-Free Return) ÷ Standard Deviation

Question 47

True or False: In a weak-form efficient market, technical analysis will be useful.

Answer 47

False. In a weak-form efficient market, only fundamental analysis will be useful.

Question 48

_______ investors look for stocks of companies that are intrinsically undervalued.

Answer 48

Value

Question 49

What is the formula for calculating the risk premium?

Answer 49

Risk premium = total return - risk-free rate

Question 50

Identify the range from the following set of numbers: 10, 12, 5, 1, 7, 7, 8, 4

Answer 50

11. Range is calcuated by starting with the largest value (12) and then subtracting the smallest value (1).

Question 51

For a person with a diversified portfolio of large-cap stocks, what type of risk may be reduced by using index options?

Answer 51

Systematic risk

Question 52

What are the three main concepts underlying the Modern Portfolio Theory?

Answer 52

Expected return, standard deviation, and correlation

Question 53

____________ risk is the inability to sell an investment easily.

Answer 53

Liquidity risk

Question 54

The ________ rate of return is used to calculate the anticipated return for a portfolio of securities.

Answer 54

expected

Question 55

Describe a value investor.

Answer 55

One seeking stocks that are undervalued in relation to their earnings and have low P/E ratios

Question 56

Which form of market efficiency declares that only insiders can regularly beat the market?

Answer 56

Semi-strong

Question 57

The principal value of TIPS may be adjusted based on changes to the __________________________.

Answer 57

Consumer Price Index (CPI).

Question 58

If two investments closely track one another, this is referred to as ___________ correlation.

Answer 58

positive correlation.

Question 59

What ratio tests a company's ability to pay its current liabilities with its current assets, but excludes inventory?

Answer 59

The Quick Asset Ratio (the Acid Test)