Multiple Choice Flashcards
Questions
Jong Mae is optimistic about the long-term growth of her Matsushita stock. However, the stock, currently priced at $128 per share, has made a sharp advance in the last week and she wants to lock in a minimum price in case the shares drop. What should Jong Mae do?
A.Buy $125 call options.
B.Sell $125 call options.
C.Buy $125 put options.
D.Sell $125 put options.
Solution: The correct answer is C.
Buying a put option is like insurance against a drop in price. Remember, from the buyer’s perspective, “Call up” . . . “Put down”!! (This may be a helpful mnemonic device.) The opposite is true for option sellers.
You have recommended a growth mutual fund to a new client. The client considered your recommendation and asked why he shouldn’t invest in another fund that he had been following, which appeared to have a better performance over the past three years. You explained the concept of risk-adjusted performance and obtained the following information about the two funds:
Your fund:
Three-year total return = 13.5%
Average P/E ratio = 20
Standard deviation = 19
Beta = 1.03
Client Fund:
Three-year total return = 14.74%
Average P/E ratio = 24
Standard deviation = 23
Beta = 1.24
Using Treynor, which fund would you recommend if the risk-free return is 3%?
A.Client fund, because its Treynor is higher than your fund.
B.Client fund, because its Treynor is lower than your fund.
C.Your fund, because its Treynor is 10.2% compared with the client’s Treynor of 9.5%.
D.None of the above.
Solution: The correct answer is C.
Your Fund: T = (13.5 - 3.0) ÷ 1.03 = 10.1942
Client Fund T = (14.74 - 3.0) ÷ 1.24 = 9.4677
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 both forward contracts and futures contracts to her and advise that she take the following position:
A.Structure a forward contract with the bank and the juice maker.
B.Take a futures contract position short the commodity and long the contract.
C.Take a futures contract position long the commodity and short the contract.
D.Set aside enough money to cover expenses and hope for the best.
Solution: The correct answer is C.
A forward contract (though very specific) requires a buyer and a seller, and the grower may not know yet to whom the oranges will finally go. 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).
