Module 2 Quiz

Question 1

Which one of the following is not an objective of an investment policy?

A) To provide a performance evaluation

B) To provide a basis for review

C) To select individual securities

D) To provide a foundation of goals, time horizons, and

Answer 1

C) To select individual securities

The investment policy does not ordain which individual securities will be selected.

Question 2

Which one of the following is not an appropriate element of an investment policy?

A) The portfolio should produce $10,000 in income annually.

B) All equity assets must be in listed securities.

C) Bonds must be investment grade.

D) The portfolio should maximize return and minimize risk.

Answer 2

D) The portfolio should maximize return and minimize risk.

A requirement that the portfolio “maximize return and minimize risk” is unclear and immeasurable.

Question 3

Which one of the following is not one of the steps in the asset allocation process?

A) Review portfolio performance and the investment climate

B) Select individual securities

C) Determine representative asset classes

D) Establish guidelines for reaching goals

Answer 3

D) Establish guidelines for reaching goals

The asset allocation process includes determining the representative asset classes in addition to reviewing the portfolio, selecting securities, and determining asset weights. Establishing guidelines for reaching goals is part of an investment policy.

Question 4

An investor has a 6%, 10,000 par value bond that matures in 15 years. The yield to maturity on similar bonds currently is 5.5%. What is the price of this bond?

A) $5,779.16

B) $9,509.99

C) $1,050.62

D) $10,506.23

Answer 4

D) $10,506.23

The answer is $10,506.23. For a $10,000 par value bond, set the calculator to the END mode, 2 P/YR, FV = 10,000, PMT = 300 (6% x $10,000 = $600 annually ÷ 2), N = 30, Shift, N, I/YR = 5.5, then PV = -$10,506.23. For the TI BA II+: FV = 10,000, PMT = 300 (6% x $10,000 = $600 annually ÷ 2), N = 30, 2ND, xP/Y, N I/Y = 5.5, then CPT, PV = -$10,506.23

Question 5

The Sharpe ratio measures

A) total risk as measured by beta.

B) total risk as measured by alpha.

C) unsystematic risk as measured by standard deviation.

D) total risk as measured by standard deviation.

Answer 5

D) total risk as measured by standard deviation.

The Sharpe ratio measures total risk as measured by standard deviation.

Question 6

Growth stocks are characterized by

A) low P/E ratios.

B) low market-to-book ratios.

C) low profit margins.

D) high P/E ratios.

Answer 6

D) high P/E ratios.

Value stocks are characterized by low market-to-book ratios and low P/E ratios. Growth stocks are characterized by high market-to-book ratios and high P/E ratios. Growth stocks usually have high profit margins.

Question 7

Which one of the following is not a strategy associated with the practice of tactical asset allocation?

A) All of these

B) Sector rotation

C) Momentum investing

D) Buying and holding an S&P 500 Index fund

Answer 7

D) Buying and holding an S&P 500 Index fund

Buying and holding an S&P 500 Index fund is not a strategy associated with tactical asset allocation. Tactical asset allocation is an active approach that moves money to those areas deemed to be the most promising. Sector rotation and momentum investing are strategies used with tactical asset allocation.

Question 8

Assume the standard deviation for a stock is 10 and its mean return is 14%. What is the range of returns you would expect 68% of the time?

A) -6% and 34%

B) 4% and 24%

C) -4% and 24%

D) -18% and 34%

Answer 8

B) 4% and 24%

The 68% of the time refers to one standard deviation so (14% - 10%) and (14% + 10%) are the ranges.

Question 9

Stock A has an expected return of 15% and a standard deviation of 7.5%. Stock B has an expected return of 18% and a standard deviation of 9%. Based on the coefficient of variation, which stock has more relative risk?

A) Stock A

B) The two stocks cannot be compared.

C) Both have the same relative risk.

D) Stock B

Answer 9

C) Both have the same relative risk.

Although Stock A has a lower absolute risk, it has the same relative risk as measured by its coefficient of variation (CVA = 7.5%/15% = 0.50) as Stock B (CVB = 9%/18% = 0.50). The coefficient of variation formula can be used to compare two stocks.

Question 10

Stock B has a beta of 1.2. If the market rises by 10%, Stock B can be expected to

A) fall by 10%.

B) fall by 12%.

C) rise by 10%.

D) rise by 12%.

Answer 10

D) rise by 12%.

It can be expected that Stock B would rise by 12% (10% times 1.2).

Question 11

As an investor, you are optimistic about the near-term prospects of the market. To enhance portfolio returns you would

A) choose securities with betas of 1.0.

B) choose securities with betas less than 1.0.

C) buy Treasury bills.

D) choose securities with betas greater than 1.0.

Answer 11

D) choose securities with betas greater than 1.0.

Securities with betas higher than the market beta of 1.0 should show greater upward price movement as the market rises.

Question 12

A bond has a duration of eight years. If market interest rates rise by 1%, the percentage price change of the bond is approximately

A) a 1% increase.

B) an 8% increase.

C) an 8% decline.

D) a 1% decline.

Answer 12

C) an 8% decline.

A bond has a duration of eight years. If market interest rates rise by 1%, the percentage price change of the bond is approximately

Question 13

Dollar cost averaging is

A) purchasing variable quantities of shares to maintain a targeted invested position.

B) none of the above.

C) the arithmetic average of quoted share prices during the period.

D) purchasing shares with equal, periodic contributions.

Answer 13

D) purchasing shares with equal, periodic contributions.

Dollar cost averaging is the purchase of shares with equal, periodic contributions. The number of shares purchased depends on the purchase price, but the total periodic amount invested remains the same.

Question 14

Graham recommended that nonprofessional investors apply which one of the following rules of thumb?

A) The dividend yield should be no less than twice the AAA bond yield.

B) Buy stocks for two-thirds or less of their net current assets

C) The earnings-price ratio (earnings yield) should be half of the current AAA bond yield.

D) Buy stocks for two-thirds or more of their net current assets.

Answer 14

B) Buy stocks for two-thirds or less of their net current assets

Graham recommended buying stocks for two-thirds or less of their net current assets, the earnings-price ratio should be twice the current AAA bond yield, and the dividend yield should be no less than two-thirds of the AAA bond yield.

Question 15

Which one of the following apply to systematic risk?

A) It is risk that can be nearly eliminated after acquiring 20+ unrelated stocks.

B) It is risk that is associated with owning a particular security.

C) It is risk that can be nearly eliminated after acquiring 12-18 unrelated stocks.

D) It is a risk that is common to an asset class.

Answer 15

D) It is a risk that is common to an asset class.

Unsystematic risk is the risk associated with owning a particular security and can be nearly eliminated after acquiring 12-18 unrelated stocks. Systematic risk is common to an asset class.

Question 16

Cash equivalents include all of the following EXCEPT

A) commercial paper.

B) Treasury notes.

C) Treasury bills.

D) bankers’ acceptances.

Answer 16

B) Treasury notes.

Cash equivalents include bank deposits (such as checking accounts, savings accounts, and money market accounts) and debt instruments issued with maturities of one year or less, called money market instruments. These include Treasury bills, negotiable certificates of deposit, commercial paper, and bankers’ acceptances. Treasury notes mature in 1-10 years. They are not considered money market or cash equivalents.

Question 17

Portfolio rebalancing involves

A) selling low-performing assets and reinvesting in higher-performing assets.

B) changing your asset allocation over time.

C) diversifying your portfolio.

D) selling those assets that have appreciated significantly and reinvesting in assets that have not performed well in order to get back to your original asset allocation.

Answer 17

D) selling those assets that have appreciated significantly and reinvesting in assets that have not performed well in order to get back to your original asset allocation.

The concept of portfolio rebalancing centers on selling those assets that have appreciated significantly and reinvesting in assets that have not performed well.

Question 18

Strategic asset allocation is

A) a totally passive strategy

B) a timing strategy.

C) a “target allocation” approach to investing.

D) a contrarian strategy.

Answer 18

C) a “target allocation” approach to investing.

Strategic asset allocation establishes a target allocation for a given asset class (such as 60% to common stocks) and rebalances the portfolio when necessary to maintain that target allocation.

Question 19

Unsystematic risk

A) increases during periods of volatile interest rates.

B) is increased through diversification.

C) is reduced when markets fluctuate less.

D) is affected by the nature of how a firm finances its operations.

Answer 19

D) is affected by the nature of how a firm finances its operations.

Financial risk is one of the types of unsystematic risk.

Question 20

Which one of the following can be used to measure a mutual fund’s risk-adjusted return as measured by total risk?

A) the funds correlation coefficient

B) the fund’s alpha

C) the fund’s beta

D) the fund’s standard deviation

Answer 20

D) the fund’s standard deviation

The Sharpe ratio measures total risk, as measured by standard deviation.

Question 21

Sources of risk include which of the following?

A) All of these

B) Higher interest rates

C) A loss of purchasing power

D) Fluctuating exchange rates

Answer 21

A) All of these

Fluctuating exchange rates, higher interest rates, and loss of purchasing power are all considered sources of risk.

Question 22

A measurement of total risk is

A) systematic risk.

B) standard deviation.

C) beta.

D) unsystematic risk.

Answer 22

B) standard deviation.

Standard deviation is a measure of total risk; that is, both systematic and unsystematic risk. Beta measures systematic risk only.

Question 23

Investors who want to bear the least amount of risk should acquire stocks with beta coefficients

A) less than 0.5.

B) less than 1.0.

C) greater than 1.0.

D) greater than 1.5.

Answer 23

A) less than 0.5.

When seeking investments that have the least amount of risk, the lowest beta should be selected.

Question 24

Assume Stock IJK has a mean of 5% and a standard deviation of 3.42%. From this information, what can you conclude regarding the stock’s expected future returns?

A) There is a 99% chance that returns will fall within two standard deviations on either side of the mean.

B) There is a 68% chance that returns will fall between positive 1.58% and positive 8.42%.

C) There is a 95% chance that the return will fall within three standard deviations on either side of the mean.

D) There is a 68% chance that returns will fall between negative 1.58% and positive 8.42%.

Answer 24

B) There is a 68% chance that returns will fall between positive 1.58% and positive 8.42%.

There is a 68% chance that returns will fall between positive 1.58% (5% - 3.42%) and positive 8.42% (5% + 3.42%). There is a 99% chance that returns will fall within three standard deviations on either side of the mean.

Question 25

Contrarian strategy uses such indicators as

A) specialist’s sentiment.

B) short selling.

C) all of these.

D) put-call ratio.

Answer 25

C) all of these.

Short selling is a contrarian indicator, as are specialist’s sentiment and the put-call ratio.

Question 26

A bond portfolio strategy that splits the portfolio between _____________ bonds is referred to as a barbell strategy.

A) highly rated and low rated

B) high-priced and low-priced

C) short-term and long-term

D) high yield to maturity and low yield to maturity

Answer 26

C) short-term and long-term

A barbell strategy splits the bond portion of a portfolio between short-term and long-term bonds. Both ends may then stagger maturities similar to the ladder strategy. For example, the short-term end may be constructed with bonds of maturities five years or less and the long-term end may be constructed with bonds of maturities greater than 10 years.

Question 27

Under value averaging, if an investor desired to increase his or her investment by $1,000 per month and the asset value had declined by $250 from the previous month, the investor would invest ______ the next month, assuming the price of the investment did not change.

A) $250

B) $1,000

C) $750

D) $1,250

Answer 27

D) $1,250

To increase the value by $1,000 per month, the loss from the previous month must be made up in addition to the following month’s contribution: $250 + $1,000 = $1,250.

Question 28

__________ is a coherent set of guidelines for managing financial assets according to the client’s goals and the realities of the investment market.

A) Contrarian strategy

B) Investment policy

C) Asset allocation

D) Client suitability

Answer 28

B) Investment policy

The investment policy statement is a blueprint for the financial management process that is aligned with the goals of the client but also in line with market reality.

Question 29

The lower the coupon rate,

A) the lower the total return of a bond.

B) the greater the price volatility of a bond.

C) the greater the total return of a bond.

D) the lower the price volatility of a bond.

Answer 29

Total return cannot be determined without knowing the purchase price. The coupon rate is inversely related to the bond’s price volatility.

Question 30

Small firm investors

A) acquire shares when larger percentages of the company’s shares become owned by institutional investors.

B) typically have confidence in the efficient market hypothesis.

C) are risk averse.

D) should have a long time horizon.

Answer 30

D) should have a long time horizon.

The small firm effect is an anomaly to the efficient market hypothesis since greater returns over time have been realized commensurate with the associated risk. Small firm investors sell when 40% of the company’s shares become owned by institutional investors. Small firm investors should have a long time horizon due to the increased risk/volatility associated with this investment strategy.