Final Exam Review Flashcards
A person whose entire portfolio is comprised of bonds is generally most susceptible to which type of risk?
I Interest rate risk
II Reinvestment rate risk
III Market risk
IV. Purchasing power risk
D. I, II, III, IV
Interest rate fluctuations cause market risk in bonds. Fixed coupons are exposed to inflation risk. Coupon interest payments must be reinvested. Bonds are affected by DRIP.
Input variables needed to create portfolios under the Markowitz model do not include which of the following?
A.Covariance
B.Correlation coefficient
C.Standard deviation
D.Return
E. Beta
E. Beta
The Markowitz Model uses standard deviation as a risk measurement (covariance, correlation coefficient, and return). It does not factor Beta.
Sam is interested in buying XYZ common stock at $25. Considering the following information on XYZ and the market.
Dividends are $1.40 currently and growing at 8%
Beta of XYZ is 1.34. Standard Deviation of XYZ is 12.5
Standard deviation of market is 14
Yield on Treasury bills is 7.4%
Market is expected to earn 12%
What should a CFP® professional most likely suggest Sam do?
A.Sam should buy the stock because it is overvalued.
B.Should buy the stock based on the data given.
C.The intrinsic value of the stock is $27.17 with a current market price of $25, and the stock should be purchased.
D.The valuation of the stock is $15.25, and the stock should not be purchased. It is overvalued.
The correct answer is C.
The stock is undervalued. Sam should buy it at $25 now.
Required rate (r) = .074+ (.12 - .074) (1.34)=13.564%
Intrinsic value=1.40 (1 + .08)=27.17 (buy at $25)
.13564 - .08
When is a publicly traded corporation most likely to issue new bonds?
I When previously issued bonds are selling at a premium.
II When previously issued bonds are selling at a discount.
III When interest rates are expected to rise.
IV When interest rates have fallen.
I,III,IV
If yield curve YC1 moves upward and becomes YC2, which of the following is true?
A. Duration has increased.
B.Duration has decreased.
C.Interest rates have decreased.
D.Only long-term bonds have increased.
The correct answer is B.
An upward movement in the yield curve shows that interest rates have increased. If interest rates increased, then duration decreased (inverse relationship.)
Time is positively related to duration. Duration increases. Maturity increases. They are positively correlated.
Duration is inversely related to YTM. When interest rates increase then duration decreases.
Duration is inversely related to coupon rate. Coupon and yield are interest rates - inversely related.
Which of the entities shown is most likely to purchase STRIPS?
A.The U.S. government
B.A U.S. corporation
C.A pension plan
D.A trustee for a revocable trust
The correct answer is C.
STRIPS are most often purchased by pension plans because the plan is tax-deferred. For most other types of accounts, taxes are due on the interest, but no interest is actually paid until maturity (phantom income).
In a time of declining interest rates, which of the following debt instruments would be expected to generate the highest total return?
A.A corporate long-term bond
B.A zero-coupon bond
C.A GNMA fund
D.T-bills
The correct answer is A.
Only one bond indicates its maturity (Answer A). The zero-coupon bond choice does not indicate its maturity and produces only phantom income. When interest rates decline, mortgages are normally refinanced (GNMAs). T-bills only last for 1 year (or less). When interest rates decline, the client wants to own longer-term bonds for price appreciation opportunities.
Frances Fashionista feels that a clothing retailer has fallen out of favor. She wants to speculate. Based on her outlook and wish to speculate, which of the following trades makes the most sense for Frances?
A.Buy a call for $300.
B.Buy a put for $300.
C.Write a put for $300.
D.Sell the stock short at $50 per share.
The correct answer is B.
If Frances buys a put for a $300 premium, that’s the maximum she can lose. If she sells the stock short and the stock goes up, she has to buy the stock on the open market to close her position. The stock’s price could rise to infinity (without limit).
Stock Stock Price Earnings Dividend Yield
Company A $50 $2.00 4%
Company B $40 $2.00 5%
Company C $20 $2.00 7%
Company D $30 $2.00 6%
A.Company A
B.Company B
C.Company C
D.Company D
The correct answer is C.
$20 x 7% = $1.40 dividend. The other companies’ dividends equal or are close to equaling the issuer’s earnings.
Who among the following is considered an insider?
a The receptionist at the front lobby desk
b An Officer
c A member of the Board of Directors
d A person who has information about the firm that no one else has access to
b An Officer
c A member of the Board of Directors
d A person who has information about the firm that no one else has access to
Bob, a CFP® practitioner, suggests to his clients that they invest using dollar cost averaging. Why would he most likely suggest the passive approach?
A.To take advantage of rising markets
B.To increase investment returns
C.To outperform lump-sum strategies
D.To teach his clients to be disciplined investors
D.To teach his clients to be disciplined investors
Bond duration is the weighted average maturity of the bonds cash flow on a present value basis. What is the relationship of y,c and t to duration.
y = YTM - inversely related
c = coupon -inversely
t = time YTM positively related
Risk adjusted Return:
Which fund provides an optimum return for an investor.
a. Annual return is 24 % beta 2
b. Annual return is 6% beta .5
c. Annual return is 12% beta 1.2
d. Annual return is 8% beta .8
a and b
standardize mutual funds for risk
Individual Mutual fund return/ Beta coefficient.
One can get a basket of mutual funds standardized for risk.
Higher the return the better. ie 12% is better than 10% - questions say will to take more risk ie beta above 1.0
Which of the following securities exposes the owner to the greatest amount of reinvestment risk?
1. Zero Coupon bond
2. BB 8% - 10 year corporate bond
3. GNMA
4. Strip
- GNMA - more risk because payments are interest and principal. Have both each month.
Zero and STRIPS are essential the same - Neither have reinvestment risk. No coupon payments to invest.
Tom Harmon asks you which portfolio would be a good one to own
A. A perfectly positively correlated set of securities.
B. A portfolio with a correlation coefficient of zero.
C. A portfolio with high covariance.
D. A portfolio with a high coefficient of variation.
B - Most investors would like a portfolio of zero.
Standard deviation would be reduced.
Perfectly positive would have max risk.
Portfolio with high covariance would have a high correlation coefficient.
A portfolio with a high coefficient of variation is risky.
