Exam q's Flashcards
The typical small investor would be unlikely to make a trade in which Market?
1,2,3 or 4
The fourth market is direct trades between investors. Because of the expense of trading in this market, only large institutions trade here.
Maturity and minimum denomination of the following:
Commercial Paper
Negotiable CD’s
Bankers Acceptances
Commercial Paper - maximum maturity is 270 days and the minimum denomination is usually $100,000, it can be lower but most institutional investors prefer to deal in minimums of $1M.
Negotiable CDs - usually short term matuirty used by money markets, banks will sell negotiable CDs with a minimum denomination of $100,000. However, trades in negotiable CDs have a minimum denomination of $1 million.
Bankers Acceptances - Usually trade in multiples of $100,000.
Series EE bonds carry a fixed-rate and are investments that are guaranteed to double in value over ….. years. The newer Series I bonds have both a fixed rate and a variable rate to keep up with …….?
Series EE savings bonds double in 20 years
Series I savings bonds have a fixed and variable rate to keep up with inflation
Mortgage Pass-Throughs
Pass through: In a mortgage pass-through, the issuer of the pass-through security collects the payments
from the borrowers, deducts a service charge, and then distributes the payments to the holders of the pass-through security. FNMA and FHLMC are the agencies that issue these securities.
Collateralized Mortgage Obligations
Collateralized mortgage obligations (CMOs) are similar to a pass-through, with one key difference. The issuer of a CMO sequences the securities. These sequences are called tranches. In a traditional CMO (known as a sequential pay CMO), interest will be paid on all of the tranches as promised, but the initial principal payments are directed to paying off only the first tranche. Once the first tranche has been paid in full, then the principal payments are directed to the owners of the second tranche. The holders of the first tranche
have a relatively short-term, low risk security. The holders of the last tranche own a security that has substantial credit risk and risk as to the timing of payments
With regard to collateralized mortgage obligations, which answer below is correct:
(A) The different tranches are of relatively equal safety.
(B) The maturity is fixed, just as with other bond-like instruments.
(C) The issuer is responsible for servicing these instruments.
(D) The principal received each period is relatively certain, the interest income is not.
The answer is (C). (A) is incorrect because although the first tranche is relatively safe, the later tranches can be quite risky. (B) is incorrect because the maturity is dependent upon when the borrowers pay off their mortgages. (D) is incorrect as interest and principal payments both depend on payments made by the mortgage borrowers, both are uncertain.
If the return on a security is normally distributed with an arithmetic mean of 6 percent and a standard deviation of 3 percent, then the probability of earning more than 12 percent is approximately? (A) 5 percent (B) 2½ percent (C) 1 percent (D) ½ percent
The answer is (B). The 12 percent is two standard deviations above the expected rate of return of 6 percent. The probability of a return more than two standard deviations from the expected return is 5 percent. However, this 5 percent is split equally between the upside and downside.
Approximately 68 percent of the time, the actual return will be within one standard deviation of the expected return
One of the most important things to remember about a normal distribution is that approximately 68 percent of the time, the actual return will be within …… standard deviation of the expected return and about 95 percent of the time the actual return will be within …… standard deviations of the expected return.
One of the most important things to remember about a normal distribution is that approximately 68 percent of the time, the actual return will be within one standard deviation of the expected return and about 95 percent of the time the actual return will be within two standard deviations of the expected return.
If the return on a security is normally distributed with an arithmetic mean of 6 percent and a standard deviation of 3 percent, then the probability of earning more than 12 percent is approximately (A) 5 percent (B) 2½ percent (C) 1 percent (D) ½ percent
The answer is (B). The 12 percent is two standard deviations above the expected rate of return of 6 percent. The probability of a return more than two standard deviations from the expected return is 5 percent. However, this 5 percent is split equally between the upside and downside.
You just bought a bond for 105 ($1,050). The bond will pay $70 in coupon payments annually. You plan to hold it to maturity in 10 years, and you believe you will be able to reinvest the coupons at a 5 percent rate of return. What would be your realized compound yield to maturity? (A) 5 percent (B) 5.5 percent (C) 6 percent (D) 6.5 percent
The answer is (C). The keystrokes for the realized compound yield to maturity are: SHIFT, C ALL; 10, N; 5, I/YR; 70, PMT; FV {Display: –880.45}; SHIFT, C ALL; 10, N; 1050, +/-, PV; 1880.45, FV; I/YR {Display: 6.00}
For a bond that pays $35 interest annually, trades at a price of 85 (i.e., $850), has a par value of $1,000, and a term to maturity of 8 years, the yield to maturity is
The answer is (B). The keystrokes for the yield to maturity are: SHIFT, C ALL; 8, N; 850, +/-, PV; 35, PMT; 1000, FV; I/YR {Display 5.91%}
Which of the following is correct with respect to what are known as alternative investments?
(A) a problem with trading collectibles is that there are no price indexes to get a sense of their change in value
(B) the depletion allowance for growing timber is an attractive tax incentive for investors
(C) the prices of collectibles are primarily a function of the demand curve
(D) gold jewelry is a good alternative investment as its value will move with the price of gold
The answer is (C). (A) is incorrect because both Barron’s and Forbes report the Sotheby index for prices of certain collectibles. (B) is incorrect because the depletion allowance applies to mineral rights, not timber. (D) is incorrect because although the price of jewelry will reflect, to some extent, the content of any precious metal such as gold, the price is mainly a function of the exquisiteness of the design and the currency of the style.
Suppose stocks X and Y have standard deviations of 5 percent and 10 percent and a covariance of 0. If 40 percent of a portfolio is invested in X and 60 percent in Y, what is the standard deviation of this two-security portfolio? (A) 6.3 percent (B) 7.5 percent (C) 8.0 percent (D) 40.0 percent
The answer is (A). The answer is calculated as follows:
Variance = (.402 x 52) + (.602 x 102) + (2 x .40 x .60 x 0) = 4 + 36 + 0 = 40
Standard deviation = Square root of 40 or 6.3 percent
Keystrokes: SHIFT, C ALL; .4, x, .4, x, 5, x, 5, =, M+; .6, x, .6, x, 10, x, 10, =, M+; 2, x, .4, x, .6, x, 0, =, M+; RM; SHIFT, yx, .5, = {Display: 6.3}
Which of the following statements concerning betas is correct?
(A) Stocks with negative betas have the least amount of risk.
(B) A stock with a beta equal to 1 has no risk.
(C) A stock with a beta of 0 is expected to provide a rate of return equal to the market portfolio.
(D) A stock with a beta greater than 1 is expected to be more volatile than the market portfolio.
The answer is (D). (A) is incorrect because a stock with a negative beta only means it moves opposite to the general market, not that it has the least risk. (B) is incorrect because a stock with a beta of 1 should move about the same as the overall market. (C) is incorrect because a stock with a beta of 0 would provide a rate of return about the same as the risk-free rate.
What is Modern Portfolio Theory and why is it important to understand?
Modern portfolio theory (MPT) is a theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward. According to the theory, it’s possible to construct an “efficient frontier” of optimal portfolios offering the maximum possible expected return for a given level of risk.
It is important to understand because it is the basis for how most professionals think about the market.
Which of the following is a feature of the S&P 500 Index?
(A) it is the most commonly quoted index
(B) the index includes common stocks, preferred stocks, and warrants, but not rights
(C) the adjustment for dividends paid in shares of stock (i.e., stock dividends) is always complicated
(D) it is a value-weighted index
The answer is (D). (A) is incorrect because the most commonly quoted index is the Dow Jones Industrial Average. (B) is incorrect because the index includes only common stocks. (C) is incorrect because, as a value-weighted index, dividends paid in shares of stock do not alter the market capitalization’s of any of the companies.
Market capitalization is
Market capitalization is equal to the share price multiplied by the number of shares outstanding.
The volatility of a bond’s price when interest rates change is greater
(A) when the term to maturity is shorter.
(B) when the coupon rate is higher.
(C) when its duration statistic is smaller.
(D) when the yield to maturity is lower.
The answer is (D). (A), (B) and (C) are associated with reduced volatility in a bond’s price when interest rates change.
Which of the following is a violation of the wash sale rule?
(A) You sell 27 shares of an S&P 500 index fund at a loss. Then, 15 days later, you buy 42 shares of a Russell 3000 index fund.
(B) You have brokerage accounts at two firms. At the first firm you buy 100 shares of PQR stock. Then, 22 days later, you sell 100 shares of PQR stock, bought the prior year, for a loss in your account at the other firm.
(C) Your spouse buys 200 shares of UK stock. Then, 31 days later, you sell 100 shares of the same stock, bought 43 days earlier, at a slight loss.
(D) You sell 100 shares of UK stock at a slight gain. Then, 4 days later, your spouse buys 200 shares of the same stock.
The answer is (B). (A) is incorrect because the two indices are sufficiently different. (C) is incorrect because the purchase is more than 30 days prior to the sale. (D) is incorrect because the stock is sold at a gain.
Growth investing in stocks typically means investing in which of the following?
(A) above-average-P/E stocks
(B) below-average-P/E stocks
(C) stocks with recent large jumps in their dividend payments
(D) stocks with large recent price increases
The answer is (A). (B) is incorrect because it is the definition of value investing. (C) and (D) are incorrect because they are meaningless as descriptions of investment styles.
Which statement best describes the relationship between the overall economy and the stock market?
(A) There is no discernible relationship between the two.
(B) The stock market typically leads the overall economy.
(C) The stock market typically moves with the overall economy.
(D) The stock market typically lags behind the overall economy.
The answer is (B). The stock market is one of the leading indicators identified by the National Bureau of Economic Research (NBER).
Which of the following is correct with regard to measuring a company’s profitability?
(A) a firm with a weak ROA could still have an average or better ROE if its equity multiplier is large enough
(B) ROE indicates the profits earned relative to the amount of total assets owned by the firm
(C) if two firms in the same industry have the same ROE, then it really doesn’t matter what their ROA ratios are
(D) the equity multiplier is one of the more effective profitability ratios
The answer is (A). (B) is incorrect because ROE is profits relative to equity, not total assets. (C) is incorrect because as ROE = ROA x Equity Multiplier, which means a firm with a weak ROA that uses extensive debt financing (and this has a large equity multiplier), is much weaker than a firm with a strong ROA and little use of debt financing. (D) is incorrect because the equity multiplier is a financial leverage ratio, not a profitability ratio.
Which of the following statements regarding duration is correct?
(A) The higher the coupon rate, the larger the duration statistic.
(B) The duration of a zero-coupon bond equals its term to maturity.
(C) Usually, the longer the term to maturity, the shorter the duration statistic.
(D) The higher the yield to maturity, the larger the duration statistic.
The answer is (B). (A) and (D) are incorrect because duration is inversely related to the coupon rate and yield to maturity. (C) is incorrect because duration is normally directly related to term to maturity.
Duration: It is analogous to the beta statistic for a stock, wherein the higher the beta, the more volatile
the price of the asset for a given change in the market portfolio.
If a standard call on MM stock with a strike price of $20 is purchased for $3 per share, the buyer exercises at the close of trading on the expiration date, and the stock closes at $30 per share, then what is the buyer's profit before taxes and commissions (A) $700 (B) $1,000 (C) $2,000 (D) $2,300
The answer is (A). A standard call option is for 100 shares. If the stock closes at $30 and the strike price is $20, the buyer of the call has a gain of $10 per share, or $1,000 on the stock itself. However, the buyer paid $300 for the option, so the buyer’s net gain is $700 ($1,000 – $300).