gyu mcps before midterm 2

Question 1

Which of the following is false?

a) The income yield of a security that has a $3 cash flow during a period, with a beginning price of $15, is 20 percent.
b) The arithmetic mean is always less than the geometric mean of a series of returns.
c) The geometric mean of 50 percent and −50 percent is −13.4 percent.
d) The greater the dispersion of a distribution, the greater the spread between the geometric mean and the arithmetic mean.

Answer 1

b) The arithmetic mean is always less than the geometric mean of a series of returns.

Question 2

Which of the following is false?

a) The expected return of a portfolio is always the weighted average of the expected return of each asset in the portfolio.
b) Covariance measures the co-movement between the returns of individual securities.
c) The standard deviation of a portfolio is always the weighted average of the standard deviations of individual assets in the portfolio.
d) Standard deviation is easier to interpret than variance as a measure of risk.

Answer 2

c) The standard deviation of a portfolio is always the weighted average of the standard deviations of individual assets in the portfolio.

Question 3

Which of the following is false?

a) The standard deviation of a portfolio that contains two individual securities is the weighted average of individual standard deviations only when the correlation coefficient is equal to +1.
b) It is impossible to eliminate all the risk for a two-security portfolio.
c) There are n(n − 1)/2 co-movement terms and n variance terms for an n-security portfolio.
d) The more securities added, the lower the marginal risk reduction per security added.

Answer 3

b) It is impossible to eliminate all the risk for a two-security portfolio.

Question 4

Which of the following statements is correct?

a) The new efficient frontier is a curved line similar to the original efficient frontier.
b) All the portfolios along the new efficient frontier dominate those along the original efficient frontier including the tangency portfolio.
c) The weight of the risk-free asset is positive in calculating expected return when investors buy stocks on margin.
d) Investors who are more risk averse invest to the left of the tangent portfolio.

Answer 4

d) Investors who are more risk averse invest to the left of the tangent portfolio.

Question 5

All of the following are differences between the CML and SML, except

a) the slope.
b) the risk measurement.
c) the y-intercept.
d) the application to the required return on individual securities.

Answer 5

c) the y-intercept.

Question 6

Which of the following statements are true:

i) The excess return on an investment (over and above the risk free rate) is equal to its Beta (β) multiplied by the market risk premium according to the Capital Asset Pricing Model (CAPM).
ii) The security market line (SML) is a graph of the expected return of a security as a function of systematic risk (Beta).
iii) The equity (or market) risk premium can be estimated by calculating historical average excess returns of the market portfolio above the prevailing risk-free rate.
a) i only
b) i and ii
c) ii and iii
d) all of the statements

Answer 6

d) all of the statements

Question 7

which of the following statements is false?

a) Systematic risk cannot be diversified away.
b) The market portfolio includes all risky assets including stocks, bonds, real estate, derivatives, and so on.
c) The market portfolio is observable.
d) The y-intercept of both the SML and the CML is RF

Answer 7

c) The market portfolio is observable

Question 8

Systematic risk (beta)

a) is also called unique risk.
b) equals total risk divided by non-systematic risk.
c) estimates do not change through time.
d) measures of portfolios are more stable than those of individual assets

Answer 8

d) measures of portfolios are more stable than those of individual assets

Question 9

what is the beta of the market?

Answer 9

one

Question 10

If a security’s total risk (variance) increases, does that mean the beta must have increased?

Explain

Answer 10

No, the total risk has two components – systematic (or market) and unique (non-systematic)

If the total has increased, it doesn’t mean that the market risk (measured by beta) component has necessarily increased

Question 11

What would motivate an investor to invest in a stock whose beta is negative, implying its expected return is less than the risk-free rate?

why?

Answer 11

A savvy investor recognizes that negative beta stocks can only occur if the security is negatively correlated with the overall market, which is uncommon

By investing in this stock, they would likely be able to reduce the overall risk of their portfolio

because beta is correlation of the market and security

Question 12

Which of the following statements about an efficient market is false?

a) Prices fully and accurately reflect all available information.
b) Prices reflect information about a firm’s future plans.
c) Prices are always correct.
d) Price changes are independent of one another.

Answer 12

c) Prices are always correct.

Question 13

Which of the following is not a component of market efficiency?

a) Allocational efficiency
b) Informational efficiency
c) Managerial efficiency
d) Operational efficiency

Answer 13

c) Managerial efficiency

Question 14

Which of the following is useful in attempting to identify mispriced securities if the semi-strong form of EMH is assumed?

a) Past stock price changes
b) Earnings expectations
c) Past and current published trading volumes
d) Relevant insider information

Answer 14

d) Relevant insider information

Question 15

Which of the following conclusions is false?

a) Evidence strongly supports the weak form of EMH.
b) Evidence strongly supports the semi-strong form of EMH, with more contradictory evidence than for the weak form.
c) Evidence strongly supports the strong form of EMH.
d) Evidence does not support the strong form of EMH.

Answer 15

c) Evidence strongly supports the strong form of EMH.

Question 16

In an efficient market,

a) security prices react quickly to new information.
b) security analysts will not enable investors to realize superior returns consistently.
c) one cannot make money.
d) a and b are both correct

Answer 16

d) a and b are both correct

Question 17

Which of the following statements about strong form EMH is false?

a) It encompasses both the weak and semi-strong EMH.
b) It is the most flexible form of market efficiency.
c) It states that prices reflect both public and private information.
d) It implies that no investor can take advantage of insider information.

Answer 17

b) It is the most flexible form of market efficiency.

Question 18

Proponents of the efficient market hypothesis think technical analysts

a) should focus on relative strength.
b) should focus on resistance levels.
c) should focus on support levels.
d) are wasting their time.

Answer 18

d) are wasting their time.

Question 19

According to proponents of the efficient market hypothesis, the best strategy for a small investor with a portfolio worth $25,000 is probably to

a) perform fundamental analysis.
b) invest in individual stocks.
c) invest in derivative securities.
d) invest in mutual funds.

Answer 19

d) invest in mutual funds.

Question 20

Explain whether each of the following is an example of informational efficiency.

Every time my broker tells me to buy, the stock price subsequently goes down. Every time my broker tells me to sell, the stock price subsequently goes up.

Answer 20

Yes. All I have to do to consistently beat the market is do the opposite of what my broker advises

Question 21

Explain whether each of the following is an example of informational efficiency.

I use a simple trading rule: if the stock has risen for the past three days—sell; if the stock has fallen for the past three days—buy. I usually make money

Answer 21

Yes. I’m trading based on past price behaviour. If the market is weak form efficient, I should not be able to consistently make money (on a risk-adjusted basis)

Question 22

Explain whether each of the following is an example of informational efficiency.

I carefully examine the financial statements of the firm, the industry prospects, and general economic conditions. Because of my skill, I am able to complete this analysis within five minutes of the financial statement disclosure. I usually make money

Answer 22

No. The fact that a skillful analysis was completed before anyone else does not suggest that the market is semi-strong form inefficient. Rather, the money I make is a fair compensation for my skill and speed

Question 23

Parker Investments Inc. has just completed an investigation of strong form efficiency in the Canadian stock market and has concluded that its evidence is statistically significant but not economically significant. Explain to your client how this is possible

Answer 23

Statistical significance simply asks whether or not the observations are likely under the null hypothesis proposed for the situation

Economic significance, in contrast, asks if the observed relationship is large enough that you can make money from it

Question 24

Which type of analyst, buy side or sell side, is more likely to “sell” their recommendation to the public?

Answer 24

A sell-side analyst works for the investment banks and brokerage houses who are trying to “sell” the securities; consequently, they are most likely to offer their recommendations to the public

In contrast, the buy-side analyst works for an investor (usually a large institution) and will want to keep their recommendations private

Question 25

State four important implications of the EMH for investors

Answer 25

technical and fundamental analysis both tend to be futile since weak form and semi-strong form of efficiency are both well-supported

Active trading strategies are unlikely to outperform “passive” portfolio management strategies on a consistent basis

Investors should focus on diversifying their portfolios and defining expected returns and acceptable risk levels

Question 26

state. two two implications for corporate officers

Answer 26

it is unimportant to time security issues and repurchases

Moreover, they should monitor the market price of the firm’s security, which reflects market opinion of the company’s outlook

Question 27

how to test the weak form of market efficiency?

Answer 27

runs test which classifies each price change by its sign, and tests if there are any “runs” in the series of signs

to test if price changes are independent of each other

the serial correlations test, which measures the correlation between successive price changes for various lags

Question 28

how to test the semi strong form of market efficiency?

Answer 28

to test the speed of adjustment of stock prices to a new information announcement, using an event study

to examine the performance of investors to see if they consistently generate abnormal risk-adjusted returns by using publicly available information

Question 29

Elvira, the CEO of AT Pharmaceutical Ltd., has hired Dome Financial Inc. to advise her on issuing new stock. Her company will need to issue more stock soon to finance the development of a new product—Hair Growth formula. Elvira has noticed that, on average, the stock price of pharmaceutical companies is higher in the spring than the rest of the year.

She would like to issue the Hair Growth stock in the spring to obtain the highest price possible.

Given your understanding of the efficiency of the Canadian market, what advice do you have for Elvira regarding the timing of the new stock issue?

Answer 29

“On average” does not mean always. There is still likely to be considerable variation in the performance of pharmaceutical company stocks in the spring.

The general evidence indicates that trying to “time” the market is not successful.

What will be the impact on the new product if she waits to raise the capital? For example, possible leaks of information?

Question 30

Assume that the information system is so advanced that the market, as confirmed by numerous unbiased studies, is efficient

Investment firms therefore decide to retire all portfolio managers and financial analysts and let random choice govern the security selection process. What impact will this action have on market efficiency?

Answer 30

The efficiency of the market is based upon the continuing services of the analysts and portfolio managers to actively scout the market

If these players are removed from the market, the prices will cease to reflect all the available information

This will consequently lead to markets becoming inefficient

Question 31

Which of the following statements is false?

a) Systematic risk cannot be diversified away.
b) The market portfolio is observable.
c) The market portfolio includes all risky assets including stocks, bonds, real estate, derivatives, and so on.
d) The y-intercept of both the SML and the CML is RF.

Answer 31

b) The market portfolio is observable.

Question 32

Which of the following is a TRUE statement?

a) The new (or super) efficient frontier represents the portfolios composed of the risk-free rate and the tangent portfolio that offers the highest expected rate of return for any given level or risk.
b) The tangent portfolio is the risky portfolio on the efficient frontier whose tangent line cuts the horizontal axis at the risk-free rate.
c) The market portfolio is a portfolio that contains some risky securities in the market.

d9 The separation theorem states that the investment decision, (how to construct the portfolio of risky assets), is not separate from the financing decision, (how much should be invested or borrowed in the risk-free asset).

Answer 32

a) The new (or super) efficient frontier represents the portfolios composed of the risk-free rate and the tangent portfolio that offers the highest expected rate of return for any given level or risk.

Question 33

If markets were weak form efficient, which of the following situations would NOT yield abnormal returns?

a) Analyzing a company’s earnings report
b) Identifying a pattern in a company’s stock price
c) Obtaining insider information
d) All of the above would yield abnormal returns

Answer 33

b) Identifying a pattern in a company’s stock price

Question 34

If assets are _______ the portfolio risk will equal the weighted average of its constituent securities.

a) perfectly positively correlated
b) uncorrelated
c) correlated
d) perfectly negatively correlated

Answer 34

a) perfectly positively correlated