Investment Planning Flashcards
An investor who would like to know how a portfolio manager performed relative to how the manager was expected to perform on a risk-adjusted basis would use which one of the following indicators?
A.Sharpe index.
B.Jensen index.
C.Treynor index.
D.Sharpe and Treynor.
Solution: The correct answer is B.
To compare a portfolio manager’s performance to that of the market using Sharpe or Treynor models, one must calculate the results of both of these models on other portfolios or on a market being used as a benchmark, as well as the portfolio in question.
Kimberly Thurman is a private investor who researches individual stock purchases thoroughly. She studies company annual reports and 10k reports, computes comparative financial ratios from the reports, and compares company financial information to industry statistics to find undervalued stocks. Kim believes in:
A.The weak form of the efficient market hypothesis.
B.The neglected firm effect.
C.The random walk hypothesis.
D.The semi-strong form of the efficient market hypothesis.
Solution: The correct answer is A.
Kimberly believes fundamental analysis will help her achieve above average market returns. The weak form of the EMH states that “the current price of a security reflects all historical information available on that security and does not reject fundamental analysis.”
A client has bought a stock for $40 per share. At the end of the first year, she purchases another share at $43 per share. At the end of the second year with the share price of $48, she sells her shares. Along the way, at the end of each year, she received a $2 per share dividend. What is the time-weighted return on her investment?
A.9.53%
B.13.5%
C.14.3%
D.16.6%
Solution: The correct answer is C.
This is simply an uneven cash flow problem.
CF0 = <$40>
CF1 = $2
CF2 = $50
IRR = 14.33%
Note: Since this is a time weighted return, we are only concerned about the security’s cash flow. Therefore, we ignore the second purchase at $43 per share.
After examining several funds and calculating the correlation coefficient relative to the client’s existing portfolio, when do diversification benefits begin?
A.When correlation < 1.
B.When correlation = 0.
C.When correlation = -1.
D.When correlation = 1.
Solution: The correct answer is A.
Diversification benefits begin anytime correlation is something less than 1.
The Federal Reserve is currently tightening the money supply. As the treasurer and CFO of your company, which of the following best describes the hedge position that you should undertake and the reason for taking it to protect your company’s long-term bond inventory.
A.A short position to hedge against increases in bond prices.
B.A long position to hedge against increases in bond prices.
C.A short position to hedge against decreases in bond prices.
D.A long position to hedge against decreases in bond prices.
Solution: The correct answer is C.
You own a long position on the bonds. A tightening of money will cause a rise in the interest rates, thus exposing your bonds to a loss in value when bond prices decrease as a result. You should undertake a short (sell) position in interest rate futures to protect your position.
asmine has a large paper profit in her Amalgamated Corporation shares, currently at $46 per share. She is happy with the stock, but realizes that a good thing CANNOT go on forever. She bought the stock so inexpensively that she is not worried about the downside. If she is willing to sell at $50, what strategy could you recommend to her?
A.Buy $50 call options.
B.Sell $50 call options.
C.Buy $50 put options.
D.Sell $50 put options.
Solution: The correct answer is B.
She gains the premium from selling the call, and if the price rises, at or above the strike price of $50, her stock will be called away at $50. “C” would be a good choice, but she is not worried about the downside risk.
What is the standard deviation of a stock with the following returns?
Year Return
1 5.75%
2 12.23%
3 11.16%
4 <3.94%>
5 9.37%
A.6.55%
B.6.91%
C.9.37%
D.10.16%
Solution: The correct answer is A.
6.5476
You have to input the info into data, then hit the stat button and scroll until you see Sx
Which of the following best describes the fees charged based on the average daily fund assets and used principally to meet marketing expenses are called:
A.Front-end load.
B.12b-1 fees.
C.Back-end load.
D.Deferred sales charge.
Solution: The correct answer is B.
The above statement describes 12b-1 fees.
You are faced with several fixed income investment options. Which of these bonds has the greatest interest rate risk?
A.A U.S. Treasury bond with an 11.625% coupon, due in five years with a price of $1,225.39 and a yield to maturity of 6.3%.
B.A U.S. Treasury strip bond (zero-coupon) due in five years with a price of $735.12 and a yield to maturity of 6.25%.
C.A corporate B-rated bond with a 9.75% coupon, due in five years with a price of $1,038.18 and a yield to maturity of 8.79%.
D.A U.S. T-bill selling for $950 due in six months.
Solution: The correct answer is B.
With the term being equal, the bond with the lowest coupon will have the biggest duration. The longer the duration, the more sensitive the bond price is to interest rate changes. Bond B has the lowest coupon, zero.
To immunize a bond portfolio over a specific investment horizon, an investor would do which of the following?
A.Match the maturity of each bond to the investment horizon.
B.Match the duration of each bond to the investment horizon.
C.Match the average weighted maturity of the portfolio to the investment horizon.
D.Match the average weighted duration of the bond portfolio to the investment horizon.
Solution: The correct answer is D.
Duration, not maturity is used to immunize a portfolio. The average weighted duration rather than the duration of each specific bond is used for successful portfolio immunization.
An investor with a required rate of return of 12.5% is looking at a stock that pays a $3.75 dividend per share, has a growth rate of 6%, and is selling in the market for $60 per share. What would you recommend?
A.Buy; it meets the buyer’s return requirements and is underpriced.
B.Buy; does not meet the buyer’s return requirements, but it is underpriced.
C.Do not buy; it does not meet the buyer’s return requirements and is overpriced.
D.Do not buy; it meets the buyer’s return requirements, but is overpriced.
Solution: The correct answer is A.
Use the intrinsic value formula and the expected rate of return formula to arrive at the correct solution for this problem.
(3.75 × 1.06) ÷ (.125-.06)
V = 3.975 ÷ .065
V = $61.1538; therefore, the stock is undervalued since it is trading at $60.
Rate of Return
3.975 ÷ 60 = .066
.066 + .06 = 12.6 > 12.5
Your client, Bill McGill, has asked you to help him to better understand the inner workings of three very different bonds that he owns by helping him to run some calculations with him. The descriptions of the three bonds are as follows:
Bond A: Price = $1,025; Par value = $1,000; Coupon rate = 8.75%; Years to Maturity = 5
Bond B: Price =$985; Par value = $1,000; Coupon rate = 7.95%; Years to Maturity = 4
Bond C: Price = $1,040; Par value = $1,000; Coupon rate = 9.15%; Years to Maturity = 3
Bill has asked you to please help him calculate the yield to maturity of each of his bonds. You have done this and arrived at the following:
A.Bond A = 8.08%; Bond B = 8.29%; Bond C = 7.51%
B.Bond A = 7.63%; Bond B = 8.78%; Bond C = 6.31%
C.Bond A = 8.13%; Bond B = 8.40%; Bond C = 7.64%
D.Bond A = 8.75%; Bond B = 7.95%; Bond C = 9.15%
Given the following diversified mutual fund performance data, which fund had the best risk-adjusted performance if the risk-free rate of return is 5.7%?
Fund A: Average rate of return = .0782, Standard deviation of annual return = .0760 and Beta = 0.950
Fund B: Average annual return = .1287, Standard deviation of annual return = .1575 and Beta = 1.250
Fund C: Average annual return = .1034, Standard deviation of annual return = .1874 and Beta = 0.857
Fund D: Average annual return = .0750, Standard deviation of annual return = .0810 and Beta = 0.300
A.Fund B, because the annual return is highest.
B.Fund C, because the Sharpe ratio is lowest.
C.Fund D, because the Treynor ratio is highest.
D.Fund A, because the Treynor ratio is lowest.
Solution: The correct answer is C.
Fund D .060
If a fund is diversified, use the Treynor model.
(Return - Risk free) / Beta
If it is a single stock, use the Sharpe model.
(Return - Risk free) / SD
The higher calculation is always better because it means more return for a given risk
Tip: to save time, start with funds with high returns and small values to divide by
What is the standard deviation of a portfolio invested 60% in stock “A” with a 15% return and a standard deviation of 17.5%, and the balance in stock “B” with an 18% return and a 16.75% standard deviation. There is a .29 correlation between the two securities.
A.16.2%
B.14.0%
C.13.05%
D.4.69%
Solution: The correct answer is B.
Step 1
(.6 * .6 * 17.5 * 17.5) sto in mem 1
Step 2
(.4 * .4 * 16.75 * 16.75) sto in mem 2
Step 3
(2 * .6 * .4 * 17.5 * 16.75 * .29) sto in mem 3
Step 4
mem 1 + mem 2 + mem 3
Step 4
Square root it √
= 13.99%
The ideal correlation for portfolio construction is:
A.+1
B.-1
C.0
D.+.17
Solution: The correct answer is B.
Graphically depicted, a correlation of negative one (-1) means that any two investments move exactly opposite from one another.
As a measure for risk, the Capital Market Line (CML) uses the:
A.Risk free rate of return.
B.Beta of the market.
C.Standard deviation of the market.
D.Portfolio weighted beta.
Solution: The correct answer is C.
The CML (Capital Market Line) uses standard deviation, while the SML (Security Market Line) uses the beta as its “risk” measurement.
Mutual fund XYZ has a beta of 1.5, standard deviation of 12% and a correlation to the S&P 500 of .80. How much return of fund XYZ is due to the S&P 500?
A.20%.
B.64%.
C.80%.
D.100%.
Solution: The correct answer is B.
.8 * .8 = .64
Correlation is .80, therefore r-squared is .64 (R-squared = correlation coefficient squared). Therefore 64% of mutual fund’s return is due to the S&P 500. Remember, r-squared measures the percentage of return due to the market.
Commercial Paper with a maturity greater than 270 days is prohibited under SEC regulations.
A.True
B.False
Solution: The correct answer is B.
Commercial paper is generally issued with maturities of 270 days or less. There are costly registration procedures required for securities over 270 days, but they are not prohibited.
Michael has an investment with the following annual returns for four years:
Year 1: 12%
Year 2: -5%
Year 3: 8%
Year 4: 18%
What is the arithmetic mean (AM) and what is the geometric mean (GM)?
A.AM = 8.25%, GM = 7.91%
B.AM = 8.25%, GM = 10.64%
C.AM = 10.75%, GM = 7.91%
D.AM = 10.75%, GM = 10.64%
Solution: The correct answer is A.
AM = (.12 -.05 + .08 + .18) / 4 = .0825 = 8.25%
GM = (1.12 × .95 × 1.08 × 1.18) ^ (1/4) - 1 × 100
GM = (1.356) ^ (1/4) - 1 × 100
GM = 7.91%
Tip: GM is always lower than AM so you can quickly eliminate some answers!!!!!
The type of risk which measures the extent to which a firm uses debt securities and other forms of debt in its capital structure to finance is known as:
A.Business risk
B.Systematic risk
C.Default risk
D.Financial risk
Solution: The correct answer is D.
Financial risk has to do with the amount of leveraging or use of borrowed funds a firm utilizes to structure its investment and finance its assets.
Sylvia has two assets in her portfolio, asset A and asset B. Asset A has a standard deviation of 40% and asset B has a standard deviation of 20%. 50% of her portfolio is invested in asset A and 50% is invested in asset B. The correlation for asset A and asset B is .90. What is the standard deviation of her portfolio?
A.Greater than 30%.
B.Less than 30%.
C.Equal to 30%.
D.Not enough information to determine.
Solution: The correct answer is B.
It’s not necessary to use the standard deviation of a two asset portfolio formula to answer this question. Since there’s a 50/50 weighting for each asset, simply take a simple average of the standard deviations (.40 + .20) / 2 = .30. Since the correlation is less than 1, the standard deviation for the portfolio will be less than the simple average. If correlation was equal to 1, then the standard deviation would be equal to 30%.
This is to help to understand the concept of standard deviation of a two asset portfolio. It is not simply the weighted average, but how those assets move in relation to one another (correlation).
To obtain the maximum reduction in risk, an investor should combine assets that
A.are negatively correlated.
B.are uncorrelated.
C.have a correlation coefficient of positive one.
D.have a correlation coefficient of negative one.
Solution: The correct answer is D.
Uncorrelated assets have a correlation equal to 0. Perfect negatively correlated assets will have a correlation equal to -1 and achieve the more diversification.
Investment A produced annual rates of return of 4%, 8%, 14% and 6% respectively over the past four years. Investment B produced annual rates of return of 5%, 12%, 8% and 11% respectively over the past four years. Which investment was more risky over the past 4 years?
A.A
B.B
C.Both A & B
D.Neither A nor B
Solution: The correct answer is A.
Standard Deviation for A=4.3%, B=3.2%; therefore, A is more risky.
Combining uncorrelated assets should
A.increase the overall risk level of a portfolio.
B.decrease the overall risk level of a portfolio.
C.not change the overall risk level of a portfolio.
D.cause the other assets in the portfolio to become positively related.
Solution: The correct answer is B.
Uncorrelated assets have a correlation equal to 0. Negatively correlated assets will have a correlation equal to -1 and achieve the more diversification.
Joe purchased 1 share of XO for $80. One year later the stock paid a dividend of $2 and Joe purchased an additional share for $95. Joe sold the stock 1 year later for $110. What is the dollar weighted return?
A.35.6%
B.17.60%
C.18.50%
D.53.0%
Solution: The correct answer is B.
CF0 = <80>
CF1 = <93> (2 - 95)
CF2 = 220 (110 x 2)
IRR = 17.60%
Beta is the slope of the best fit line for the points with coordinates representing the _______ and the _______ for each one of several years.
A.rate of return; level of risk for an individual security
B.rate of inflation; rate of return for an individual security
C.risk level of a stock; market rate of return
D.market rate of return; security’s rate of return
Solution: The correct answer is D.
Beta is really the slope of the line the represents the return of a security relative to the return of the market.
Which of the following is not a diversifiable risk?
A.Business Risk
B.Financial Risk
C.Interest Rate Risk
D.Default Risk
Solution: The correct answer is C.
Diversifiable risks are unsystematic risks which include: A, B, C, D, E, F, G. Accounting, Business, Country, Default, Executive, Financial, and Government.
Solution:
Sharpe Only: A sector mutual fund with a r-squared (to the S&P 500) of .59
Sharpe and Treynor: Relative risk adjusted performance measures
Treynor and Alpha: A well diversified mutual fund with a r-squared (to the S&P 500) of .88
Alpha Only: Absolute risk adjusted performance measures
The following data has been gathered concerning a particular investment and conditions in the market.
Risk-free rate 3.0%
Market return 10%
Beta of investment 1.5
According to the Capital Asset Pricing Model, the required return for this investment is
A.8.8%
B.12.9%
C.13.5%
D.14.9%
Solution: The correct answer is C.
ER = Rf + B (Rm – Rf)
= .03 + 1.5 (.10 - .03)
= 13.5
Asset selection can be achieved through one of four fundamental means. Which of the following is not one of the four means?
A.Discounted cash flow techniques
B.Relative valuation with multipliers
C.Fundamental Analysis
D.Indexing
Solution: The correct answer is C.
Choices A, B, and D are 3 of the four fundamental means to achieve asset allocation. The fourth option is technical analysis (not listed as an answer choice). Technical analysis uses the historical pricing and volume data to make asset decisions. Both discount cash flow and relative valuation methods are part of fundamental analysis.
Which of the following forms of the efficient market hypothesis supports technical analysis?
A.Weak Form
B.Semi-Strong Form
C.Strong Form
D.None of the choices
Solution: The correct answer is D.
None of the above.
Even the weak form holds that technical analysis is of no particular value.
Which of the following forms of the efficient market hypothesis supports fundamental analysis?
A.Weak Form
B.Semi-Strong Form
C.Strong Form
D.None of the choices
Solution: The correct answer is A.
Only the weak form accepts Fundamental Analysis as a viable investment approach.
The efficient market hypothesis asserts that stocks follow:
A.Predictable pattern
B.Random walk
C.Both choices
D.Neither choice
Solution: The correct answer is B.
Random Walk is a common nickname for the EMH.
Holly bought a stock at the margin requirement, when the stock was trading at $10. The stock paid quarterly dividends of $.25. Holly held the stock for one year and sold the stock when it was trading at $11. What was Holly’s holding period return?
A.10%
B.20%
C.30%
D.40%
Solution: The correct answer is D.
The first key to this question is knowing that the margin requirement is 50%, which is established by the Federal Reserve. So, Holly is required to pay $10 × .50 = $5 in cash and borrow the other $5 per share to make the investment. The question does not reference any margin interest, so it’s excluded from the calculation. The second key to this problem is that the Purchase Price in the numerator reflects both the equity contribution of $5 per share and the $5 per share that must be repaid to the broker. The Purchase Price in the denominator only needs to reflect the $5 in equity paid.
HPR = (SP - PP +/- CF) / PP
HPR = ((11 - 10) + (.25 × 4)) / (10 × .5)
HPR = 40%
Large blocks of stocks trade without brokers in the …
A.Primary Market
B.Secondary Market
C.Third Market
D.Fourth Market
Solution D
Jill places a stop limit order with a stop price to sell at $27 per share and a limit sell price at $25 per share on a stock currently trading at $30 per share. The share price ended the day at $29 per share, never going below that. If, overnight, the price fell to $23 per share, what would be Jill’s recognized loss per share in this scenario?
A.$0
B.$3
C.$5
D.$7
Solution: The correct answer is A.
The benefit of the stop-limit order is to ensure you sell (or buy) at prices you’d like, while also ensuring that the trade does not get executed if the price falls (or rises) too high during market gaps (e.g., overnight activity). In this case, since the limit price was set at $25 per share, the trade doesn’t get executed (and won’t until the price of the stock rises to at least $25, which would result in a recognized $5 loss per share). Thus, no transactions occur and she has no recognized gains or losses. Had she placed a stop order, then the trade would have been immediately executed the next morning at $23 per share, resulting in a $7 recognized loss per share.
Monie purchases one share of Coffee Dreams, Inc. for $58. Monie uses a margin account with a 50 percent initial margin for the purchase and is concerned about receiving a margin call. If the maintenance margin equals 35 percent, at what price would Monie receive a margin call?
A. $20.30
B. $37.70
C. $44.62
D. $53.34
Jill places a stop limit order to sell at $27 per share on a stock currently trading at $30 per share. What price per share was her trade executed at if the price quickly falls to $23 per share?
A.$23
B.$27
C.$30
D.Her trade was not executed
Solution: The correct answer is D.
A stop limit order is a limit order at $27. Since the stock quickly falls to $23, Jill is likely to still own the stock. The order would have been activated at 27, but it would then be a limit order at $27.
Which of the following have been repurchased by the corporation?
A.Unissued shares.
B.Repurchased shares.
C.Authorized shares.
D.Treasury shares.
Solution: The correct answer is D.
Unissued shares have never been held by investors to be repurchased. There is no such thing as “repurchased” shares. Authorized shares may be unissued or outstanding shares, but not necessarily Treasury shares (which are those the company has repurchased.)
American depository receipts (ADRs) are for the following purpose(s):
Finance foreign exports.
Eliminate currency risk.
Sell U.S. Securities in overseas markets.
Trade foreign securities in U.S. markets.
A.I and III only.
B.I and IV only.
C.II and IV only.
D.IV only.
Solution: The correct answer is D.
ADRs provide an opportunity for Americans to purchase foreign securities.
Which one of the following statements best describes a firm commitment?
A.The investment banker agrees to purchase the entire issue and resell the securities to the public.
B.The SEC registration process for an underwriting is NOT as extensive as for an initial public offering.
C.The investment banker agrees to sell a minimum number of shares before the offering closing date.
D.The corporation issuing shares bears the risks associated with a failure to market the entire issue.
Solution: The correct answer is A.
C desrcibes a best-effort underwriting
Assume Mike’s stock that he bought at $40 per share falls to $20. How much equity would he be required to contribute per share, if the maintenance margin is 35% and the initial margin was 60%?
A.$3
B.$4
C.$5
D.$6
Solution: The correct answer is A.
(current price) $20 − (initial equity)$16 = 4
Required Equity: $20 × .35 = $7.00
Margin Call= 7 − 4 = 3
- The stock was purchased for $40 on margin. They needed to pay for 60% of that amount, or $24. $40 - $24 paid, leaves $16 of debt.
The current equity is $20 per share, minus the debt of $16.
Treasury stock can be used to do which of the following?
pay for an acquisition
pay the company employees
pay stock dividends
cover employee stock option plan contributions
A.I and III only
B.II and IV only
C.III and IV only
D.I, III and IV only
Solution: The correct answer is D.
Stocks whose prices are expected to remain stable, or even prosper, when economic activity is slowing down are known
A.defensive stocks.
B.cyclical stocks.
C.reversible stocks.
D.speculative stocks.
Solution: The correct answer is A.
Engines, Inc. declares a 2-for-5 reverse stock split. The stock currently sells for $3 a share. A shareholder who owned 100 shares of stock prior to the split will now own
A.40 shares valued at about $7.50 a share.
B.40 shares valued at about $1.20 a share.
C.250 shares valued at about $7.50 a share.
D.250 shares valued at about $1.20 a share.
Solution: The correct answer is A.
100 shares × 2/5 = 40 shares; $3 × 5/2 = $7.50
A company has 2 million shares of common stock outstanding. Annual sales are $26 million. The net profit margin is 8% and the dividend payout ratio is 40%. Currently the stock trades at $17.68 per share. Given this information, the company has a P/E ratio of
A.17 and a dividend yield of 3.20%.
B.17 and a dividend yield of 2.35%.
C.16 and a dividend yield of 3.20%.
D.16 and a dividend yield of 2.35%.
Solution: The correct answer is B.
$26M
x .08
$2.08M
EPS: 2.08 M / 2 M outstanding = 1.04 EPS
P/E: 17.68 / 1.04 = 17
Dividend Yield: 1.04 x .40 = .4160 / 17.68 = .0235 * 100 = 2.35%
The current annual dividend of ABC Corporation is $2.00 per share. Five years ago the dividend was $1.36 per share. The firm expects dividends to grow in the future at the same compound annual rate as they grew during the past five years. The required rate of return on the firm’s common stock is 12%. The expected return on the market portfolio is 14%. What is the value of a share of common stock of ABC Corporation using the constant dividend growth model (round to the nearest dollar)? (CFP® Certification Examination - Released 3/95)
A.$11
B.$17
C.$25
D.$36
E.$54
Solution: The correct answer is E.
Step 1: Growth rate
N = 5
i = ? = .08
PV = <1.36>
PMT = 0
FV = 2
Step 2: current year dividend
2 × (1 + .08) = 2.16
Step 3: Share value
= 2.16 ÷ (.12 - .08) = 54
Answer is $54
Using the constant growth dividend valuation model, calculate the intrinsic value of a stock that pays a dividend this year of $2.00 and is expected to grow at 6%. The beta for this stock is 1.5, the risk free rate of return is 3% and the market return is 12%.
A.$48.27
B.$35.33
C.$28.75
D.$20.19
Solution: The correct answer is D.
Use the constant growth dividend model to solve for intrinsic value. The question does not provide the required rate of return, however the capital asset pricing model can be used solve for required rate of return.
CAPM: .12 - .03 = .09 * 1.5 = .135 + .03 = .165
= 2 (1.06)/(.165 - .06)
= 20.19
Jim and Anne Taylor are baby boomers who would like to add an equity investment to their portfolio. They require a 12% rate of return and are considering the purchase of one of the following two common stocks:
Stock 1: dividends currently are $1.50 annually and are expected to increase 8% annually; market price = $35
Stock 2: dividends currently are $2.25 annually and are expected to increase 7% annually; market price = $50
Using the dividend growth model, determine which stock would be more appropriate for the Taylors’ to purchase at this time:
A.Stock 2, because the stock is undervalued.
B.Stock 2, because the return on investment is greater than the Taylor’s required rate of return.
C.Stock 1, because its dividend growth rate is greater than Stock 2’s growth rate.
D.Stock 1, because the expected return on investment is greater than the Taylor’s required rate of return.
Solution: The correct answer is D.
The correct answer choice is the application of the following calculation. If a stock is calculated as undervalued using the required rate of return in the constant growth model, it will also exceed the client’s required rate of return.
Stock 1: v = (1.50 × 1.08) ÷ (.12 - .08), v = $40.50 vs Market Price of $35, therefore this stock is undervalued.
You can use the rate of return based on current price formula to double check your calculation:
[(1.50 x 1.08)/35] + .08 = 12.62%. This exceeds the expected return of 12%.
Bristol-Buyers Company has a market price of $36.00 per share with earnings of $3.00 per share, a beta of 1.1 and a dividend of $1.20, which means a dividend payout ratio of 40%. Earnings for next year are projected to increase by 25%, and the retention ratio is projected to remain at 60%. Using the price/earnings multiplier, to what level might your client expect to see market prices move in a year?
A.$39.60
B.$45.00
C.$50.40
D.$57.60
Solution: The correct answer is B.
The $36.00 per share price is divided by the $3.00 earnings per share resulting in a price/earnings multiplier of 12. The increase of earnings by 25% results in a projected $3.75 earnings next year. Stock Price = 12 × $3.75 = $45.00
Shares are purchased and sold at end of day net asset value.
A.Exchange traded funds
B.Closed end funds
C.Unit investment trust
D.Open end funds
Solution: The correct answer is D.
There is not a fixed number of shares, so the open end mutual fund determines the value of the end of the day based on redeemed and sold shares.
After the initial offering, purchases and sales occur via exchanges.
A.Exchange traded funds
B.Closed end funds
C.Unit investment trust
D.Open end funds
Solution: The correct answer is B.
Passively managed, with individual proportionate ownership.
A.Exchange traded funds
B.Closed end funds
C.Unit investment trust
D.Open end funds
Solution: The correct answer is C.
A portfolio has a total return of 10.5%, a beta of 0.72 and a standard deviation of 6.3%. The risk free rate is 3.8%, the market return is 12.4%. Jensen’s measure of this portfolio’s performance is
A.0.5%
B.4.3%
C.7.9%
D.9.3%
Solution: The correct answer is A.
ER = .038 + .72 (.124 − .038) = .0999
A = Actual Return – Er = .105 − .0999 = .005
ER = Rf + B (Rm − Rf)
Which of the following would not be an investment holding in a Money Market Mutual Fund?
A.Treasury Bills
B.Bank Certificates of Deposit
C.Bankers’ Acceptances
D.Repurchase Agreements
Solution: The correct answer is B.
Money Market Mutual Funds will invest in jumbo CDs (aka Negotiable Certificates of Deposit), but not Bank CDs. Jumbo CDs are typically offered through a brokerage firm and are in amounts of $100,000 or greater. Bank CDs are non-negotiable and are in smaller amounts.
The Real Rate of Return component of a bond’s yield includes the effect of the term-to-maturity.
A.True
B.False
Solution: The correct answer is B.
The Real Rate of Return is the return after accounting for inflation, and it does not include the effect of term-to-maturity.
Mature from two to ten years from original issue.
A.Treasury Notes
B.TIPS
C.I Bonds
D.All Treasuries
Solution: The correct answer is A.
U.S. Treasury Securities Maturity Ranges:
Treasury Bills (T-Bills) → Up to 1 year (short-term)
Treasury Notes (T-Notes) → 2 to 10 years (medium-term)
Treasury Bonds (T-Bonds) → More than 10 years (typically 30 years)
Interest rate adjusts to protect investor from inflation.
A.Treasury Notes
B.TIPS
C.I Bonds
D.All Treasuries
Solution: The correct answer is C.
I Bonds (Series I Savings Bonds) are U.S. government savings bonds designed to protect against inflation by offering a variable interest rate tied to inflation.
TIPS increase the principle with inflation
Private Activity Revenue bonds are not Federally tax exempt because they benefit private projects.
A.True
B.False
Solution: The correct answer is B.
While most Private Activity Bonds (PABs) are taxable, some are federally tax-exempt if they finance qualified projects that serve a public purpose.
An airline is considering issuing bonds to finance eight new airplanes that will be delivered in six months. Which type of bond will the airline issue?
A.Income bond.
B.Debenture.
C.High-yield bond.
D.Equipment trust certificate.
Solution: The correct answer is D.
Income bonds are high risk bonds, usually issued by financially troubled firms. Debentures are unsecured debt. High-yield bonds are lower quality than investment grade and cost the issuer more in interest payments. The airplanes would serve as collateral on the Equipment Trust Certificates.
David has $20,000 that is earmarked for a down payment on a house in two years. If David is in the 28% tax bracket, what should he invest the $20,000 in?
A.A 4% tax free money market mutual fund.
B.A 5.4% corporate bond.
C.A well diversified growth mutual fund.
D.An intermediate muni-bond fund paying 4.5%.
Solution: The correct answer is A.
The taxable equivalent yield for the tax free money market fund is 5.56%
.04 ÷ (1 - .28)
The taxable equivalent yield is greater than the taxable corporate bond paying 5.4%. The mutual fund and intermediate muni-bond fund are not appropriate given the investor’s time horizon.
If the yield curve is inverted and you believe inflation will be coming down, you should buy long term bonds.
A.True
B.False
Solution: The correct answer is A.
If you buy long-term bonds when yields are high, you benefit from price appreciation when rates drop.
Short-term bonds will mature too quickly, requiring reinvestment at lower future yields.
A bond’s compound annual return assuming coupons are reinvested at the market rate.
A.Current Yield
B.Semi-annual
C.Yield to Maturity
D.Yield to Call
Solution: The correct answer is C.
Which of the following bonds could initially immunize a bond portfolio if the investor’s time horizon is 8 years?
A.30 Year Zero Coupon Bond
B.Series of T-Bills
C.8 Year Coupon Bond
D.10 Year Coupon Bond
Solution: The correct answer is D.
Coupon bonds have lower duration than their maturity because they pay periodic interest (which reduces sensitivity to interest rates).
A 10-year coupon bond’s duration is typically around 7-9 years, making it a better match for an 8-year horizon than an 8-year coupon bond, which might have a duration of only ~6-7 years.
Bond A has a 6% annual coupon and is due in 2 years. Its value in today’s market is $900. Bond B has a 10% annual coupon and is due in 4 years. It is priced to yield 12%. Bond C is a zero-coupon bond priced to yield 11% in 8 years.
The yield to maturity of Bond A is closest to:
A.9.90%
B.10.45%
C.10.95%
D.11.91%
Solution: The correct answer is D.
N=2
i=?
PV =<900>
PMT=60
FV=1,000
Note-This is an annual bond so it’s not necessary to adjust N, i or PMT.
Your client has asked you to assist her in examining possible additions to her bond portfolio. She has expressed a desire to minimize risk at this stage in her planning process, and to assure income beginning at the point of her retirement, and lasting throughout. She has a tentative retirement date in seven years at age 65. She has an eighteen year life expectancy in retirement. Which of the following is an appropriate addition to her current portfolio?
25-year AAA-rated corporate bonds with a seven-year maturity.
20 year AAA-rated municipal bonds with a seven-year duration.
25-year AAA-rated corporate zeroes with a seven-year duration.
20-year US Treasury zeroes with a seven-year maturity.
25-year AAA-rated corporate bonds with a seven-year duration.
A.I, III and V only.
B.II, III and V only.
C.III and IV only.
D.V only.
Solution: The correct answer is D.
The client is looking for income to begin in 7 years. Therefore anything maturing in 7 years will not provide that income. Zeroes provide no income. She wants something out 25 years, not 20 years. Thus, option “V” is the only one left.
Hannah Latham, a client of yours, recently bought an orange grove. She has asked you about locking in the future price of her crop to assure adequate funds to meet expenses for the coming year. You explain futures contracts to her and advise that she take the following position:
A.Set aside enough money to cover expenses and hope for the best.
B.Since she is short the commodity, she should take a long position in a futures contract.
C.Since she is long the commodity, she should take a short position in a futures contract.
D.None of the above.
Solution: The correct answer is C.
The farming and produce business are far too risky to be left to chance. And since she has the oranges in the trees, she should be long the commodity and sell a contract (or “short” the contract.).
You purchase one call contract and pay a $3 premium that allows you to buy the stock at $50. The stock is currently trading at $48. What is the intrinsic value of the situation you’re in?
A.-$5
B.-$2
C.$0
D.$2
Solution: The correct answer is C.
Intrinsic Value of Call = Stock Price - Strike Price, therefore IV = 48 - 50 = -2, however intrinsic value cannot be negative.
With the same dollar investment, which of the following strategies can cause an investor to experience the greatest loss?
A.Selling a naked put option.
B.Selling a naked call option.
C.Writing a covered call.
D.Buying a call option.
Solution: The correct answer is B.
Naked call writing (selling) is the most dangerous position in the described selection. If the market price of a stock moves against a put writer, it can fall to zero and that’s the end of it. If it moves against a call writer, the sky is the limit as to how high the price could go.
What is the yield-to-maturity of a $1,000, 6% semi-annual coupon bond that matures in 5 years and currently sells for $900?
A.4.24%
B.7.09%
C.8.50%
D.9.00%
Solution: The correct answer is C.
N = 5 × 2 =10
I = ? 4.25 × 2 = 8.5%
PV = <900>
PMT = (1,000 × .06) = 60/2 = 30
FV = 1,000
Tip: Don’t forget to convert the answer back to per year
According to the expectations hypothesis, investors’ expectations of decreasing inflation will result in
A.a downward-sloping yield curve.
B.an upward-sloping yield curve.
C.a flat yield curve.
D.a humped yield curve.
Solution: The correct answer is A.
The expectations hypothesis explains the shape of the yield curve based on inflation expectations. If inflation is expected to be lower in the future, then the yield curve is sloping downward.
Inflation rise = rate rise = curve rise
A convertible bond has a par value of $1,000, a market value of $1,200, and a conversion price of $20. What is the conversion ratio?
A.20
B.50
C.55
D.60
Solution: The correct answer is B.
Conversion ratio = $1,000/$20 = 50
Always use the bond’s par value, NOT market value, when calculating the conversion ratio.
The conversion ratio is fixed so using the market value wouldn’t make sense because it changes based on stock price
What is the intrinsic value of a put with a strike price of $20 and the underlying stock is trading at $25?
A.-5
B.0
C.$5
D.Need more info
Solution: The correct answer is B.
Put Intrinsic Value = Strike – Stock
20 – 25
Intrinsic Value cannot = less than zero.
Intrinsic Value is only from the perspective of the buyer, not the seller
Negative intrinsic value makes no sense because no one would exercise an option at a loss
Barbara Reed owns an LMN, Inc. bond with a par value of $1,000. LMN is a AA-rated bond that matures in seven years. Barbara receives $55 of interest income from LMN semiannually. Comparable debt, i.e., is AA-rated, 7-year maturity, yields 12%. The bond’s duration is five years. What is the intrinsic value of the bond?
a) $703.36
b) $880.80
c) $953.53
d) $954.36
The correct answer is “C.”
The intrinsic value of a bond is its calculated present value. N = 7 x 2, i = 12 / 2, PV = ?, PMT =55, FV = 1,000
John Henry has requested information regarding the risk involved in his overseas investments. He has given you the following information: Monrovia Investment: Standard deviation of 17.5%, Rate of return = 16.3% and Weight in portfolio of 60%. Zimba-bwe Investment: Standard deviation of 24.9%, Rate of return = 32.1% and Weight in portfolio of 40%. Harry wants to know what the portfolio risk (as measured by portfolio deviation) is if the correlation coefficient of these two investments is negative .35.
a) 11.6%
b) 9.7%
c) 5.8%
d) 2.1%
Solution: A
What is the return that your client should expect from a security that last year returned 11.7% with a standard deviation of .146, a beta of 1.2, when the overall market return has been 10.93%, and U.S. Treasury issues are currently delivering around 3.56%?
a) 14.6%
b) 13.3%
c) 12.4%
d) 11.7%
The correct answer is “C.”
Using the CAPM one can calculate this answer.
Standard deviation and last years return are merely distractors.
ER = Rf + B (Rm - Rf) ER = .0356 + 1.2 (.1093 - .0356) ER = .0356 + .0884 ER = .1240 = 12.4%
Dawn’s mutual fund returned 15% last year, with a beta of 1.75. The risk-free rate of return was 2.5%, the market return was 7%. The standard deviation is 16%. What would you tell Dawn regarding the performance of her mutual fund?
a) The standard deviation was too low; therefore, Dawn was undercompensated for the risk of her fund.
b) The Treynor ratio is .9, which means Dawn earned an adequate risk-adjusted return.
c) The Sharpe ratio is 1, which means Dawn earned a return less than was required on a risk-adjusted basis.
d) The alpha is 4.6%, which means the fund manager returned a higher rate of return than was expected on a risk-adjusted basis.
Answer: D
Standard deviation is a measure of volatility and variability. Standard deviation by itself is not a risk-adjusted performance indicator. For Sharpe and Treynor to be meaningful, one Sharpe ratio needs to be compared to another Sharpe ratio and one Treynor ratio must be compared to another Treynor ratio. The Alpha ratio is calculated below:
p = 0.15 - [0.025 + 1.75(0.07 - 0.025)] 0.15 - 0.1038 0.0462 or 4.62%
Julie Quatsoe owns an LMN, Inc. bond with a par value of $1,000. LMN is a AA-rated bond that matures in seven years. Julie receives $55 of interest income from LMN semiannually. Comparable debt, i.e., is AA-rated, 7-year maturity, yields 12%. The bond’s duration is five years. Assume the Federal Reserve is concerned about inflation and increases the discount rate. As a consequence, market interest rates on 7-year AA-rated bonds change from 12% to 13%. How will the price of Julie’s bond change?
a) The price will increase by approximately 5%.
b) The price will increase by approximately 7%.
c) The price will decrease by approximately 7%.
d) The price will decrease by approximately 5%.
The correct answer is “D.”
You may use the “rule of thumb”, that is, multiply the percent increase (or decrease) by the years of duration and this will give you the percent change in price of the bond. It is best, however, to calculate this with the appropriate change of the price of a bond’s formula.
Change in Price = -5 [1 (1 + .12)] = -4.5
Dodson Skipworth has a 20% required rate of return. He is considering investing in XYZ, Inc., which pays an annual dividend of $.64 and is projected to increase its earnings and dividends by 17% annually. The current market price is $36.50. Based on the data, what is the intrinsic value of XYZ, Inc. stock per share? a) $24.96
b) $28.62
c) $30.00
d) $32.74
The correct answer is “A.”
Use the intrinsic value formula to determine the correct dollar amount of this stock currently.
V =D1 (r - g) = (.64 x 1.17) (.20 - .17)
Using the following information, what is the duration of the bond being described? - Maturity is 11 years. - Par value is $1,000. - The coupon rate is 8.25%. - The bond is currently selling in the market at $1,094. - The bond pays interest annually.
a) 12.4 years.
b) 11 years.
c) 9.3 years.
d) 7.8 years.
The correct answer is D
If the bond has a high coupon (above YTM), expect lower duration (~50-60% of maturity).
If the bond has a low coupon (below YTM), expect higher duration (~70-80% of maturity).
Laureen owns a rental property that generates rental income of $500,000 annually. Her expenses are $300,000 per year, which include depreciation of $25,000. Her mortgage payment is $30,000 per year, which includes $20,000 of interest expense. What is her net operating income?
a) $200,000
b) $225,000
c) $245,000
d) $255,000
Answer: C
Rent $500,000 - Expenses <$300,000> = Net Income $200,000
+ Interest Expense $20,000
+ Depreciation Expense $25,000
Net Operating Income $245,000
Net Operating Income (NOI) is BEFORE interest & depreciation.
Net Income is AFTER these expenses, so you must add them back.
Mortgage principal payments are NEVER included in NOI calculations
Lisa expects a potential rental property investment to have gross revenue of $1,400,000 annually. She anticipates $150,000 in maintenance expense, $300,000 in salaries, $100,000 in utilities, $200,000 in depreciation and a mortgage payment of $150,000. Her principal payment would be $50,000 and interest expense would be $100,000. How much should Lisa pay for the rental property if her required rate of return is 8%?
A.$6,250,000
B.$8,125,000
C.$10,625,000
D.$17,500,000
Solution: The correct answer is C.
Lisa’s expenses would be $150,000 in maintenance, $300,000 in salaries, $100,00 in utilities, $200,000 in depreciation and $150,000 in mortgage payments where $100,000 is interest expense and $50,000 is principal.
$1,400,000 -$150,000 (maintenance) - $300,000 (salaries) - $100,000 (utilities) = $850,000 in Net Income
NOI/Capitalization Rate = $850,000/.08
=$10,625,000
Which of the following statements regarding a Real Estate Investment Trust (REIT) is true?
A.REITs are an example of a well diversified portfolio.
B.REITs are exempt from tax at the entity level if it derives a minimum of 75 percent of its income from real estate.
C.REITs are exempt from tax at the entity level if it distributes at least 90 percent of its income on an annual basis.
D.Both B and C must be true to be exempt from tax at the entity level.
Solution: The correct answer is D.
REITs pay no income tax as long as 75% of the REITs income comes from real estate and it pays out 90 percent of its taxable income to shareholders.
Choice A is incorrect. REITs are not a well diversified portfolio. REITs are considered a sector exposure and would not be a diversified portfolio.
Which one of the following actions would be the most appropriate hedge to protect the value of your long position in a stock if you’re planning a future major purchase with that money??
A.sale of a call
B.purchase of a call
C.sale of a put
D.purchase of a put
Solution: The correct answer is D.
To hedge a long position to preserve your liquidation value, the investor needs a strategy that take advantage of a bear market. Purchasing a put is a bearish strategy.
Which of the following statements are NOT characteristics of short selling?
A.borrowing shares of stock from a brokerage firm or other investors
B.selling shares of stock that you do not own
C.betting the stock price will decrease
D.limiting losses per share to the price at which the stock was sold
Solution: The correct answer is D.
Investors sell on the front end and buy back at a later time which exposed the investor to increases in the price which can have unlimited loss depending on the time and purchase price of the stock.
Choices, A, B and C are characteristics of short selling.
Which of the following statements regarding REIT’s is false.
A.A REIT is a company that earns income from real estate through financing, operating, or owning properties.
B.REITS allows the investor to participate in the management of properties at a lower investment amount than directly investing.
C.REITS do not pay income tax on dividends if at least 90% of its taxable income is paid to shareholders.
D.Some of the risks of investing in REITS / real estate include, market, environmental, political, and liquidity.
Solution: The correct answer is B.
REITS do not allow the investor to participate in the management of properties at a lower investment amount than directly investing, investing in a REIT is considered a passive activity.
Choices A, C and D are true statements.
Which of the following are functions of the primary market?
I. Capital is provided by investors in exchange for a repayment promise from the borrower.
II Provide liquidity for current stockholders.
III Provide continuous pricing of securities.
IV Allows businesses to access capital.
A.I and II only
B.II and IV only
C.I and III only
D.I and IV only
Solution: The correct answer is D.
Statements II and III describe the secondary market.
For 1, think of the government issuing debt.
The random walk hypothesis
A.implies that security analysis is able to predict future market behavior.
B.suggests that random patterns appear but only over long periods of time.
C.has been disproved based on recent computer simulations.
D.supports the notion that random price movements are indicative of efficient markets.
Solution: The correct answer is D.
Solution: The correct answer is D.
The random walk hypothesis supports the notion that random price movements are indicative of efficient markets.
Choice A is incorrect. A true statement would read…implies that security analysis is unable to predict future market behavior.
Choice B is incorrect. A true statement would read…suggests that random patterns appear over periods of time.
Choice C is incorrect. A true statement would read… has not been disproved based on recent computer simulations.
Under which bond provision does a bond issuer purchase bonds from the holder and then issues new bonds at a lower coupon rate, thereby reducing the cost of its debt.
A.call feature
B.sinking fund feature
C.subordinate clause
D.refunding provision
Solution: The correct answer is D.
A refunding provision allows the bond issuer to call the bonds from the holder and then issue new bonds at a lower coupon rate, thereby reducing the cost of its debt.
Choice A is incorrect. A call feature allows the issuer to redeem the bond issue prior to its scheduled maturity
Choice B is incorrect. In a sinking fund, the issuer is required to retire portions of the bond issue prior to maturity.
Choice C is incorrect. A subordinate clause states that if additional bonds are issues, the original bondholders will receive payment before the issuer pay debt issued afterwards.
Which of the following does not describe a unit investment trust
A.offers a diversified portfolio of securities.
B.is a portfolio of securities that have a secondary market.
C.is passively managed and self liquidating.
D.engages in short-term trading within a particular sector.
Solution: The correct answer is D.
UITs are typically unmanaged or passively managed.
Choices A, B, and C are characteristics of UITs.
Which of the following characteristics does not apply to closed-end mutual funds?
A.limited number of outstanding shares
B.transactions between shareholders
C.fund repurchase of shares at any time
D.market prices in excess of NAV
Solution: The correct answer is C.
Closed end funds trade on exchanges with the help of a broker so are not repurchased by the investment company.
Choices A, B, and D describe characteristics of a closed end investment company. Shares may trade at a premium or discount to NAV.
Specific companies are researched and chosen as investments based on their outstanding investment possibilities by analysts who practice:
A.The Dow theory analysis.
B.Top-down analysis.
C.Bottom-up analysis.
D.Random Walk analysis.
Solution: The correct answer is C.
Bottom up analysts are looking for the next big, but as yet, undiscovered stock that will break onto the scene. Bottom up analysts start with the company, then the industry and finally the economic climate. Top-down starts with the economic climate, moves to the industry and then the company.
