Questions Flashcards
The relative strength index for a stock stands at 75. This reading is best
described as an indication that the stock is
A neutral.
B oversold.
C overbought.
C is correct. The relative strength index (RSI) is a momentum oscillator and provides
information on whether or not an asset is overbought or oversold. An RSI greater than 70
indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold. A is incorrect. The relative strength index is a momentum oscillator and provides
information on whether or not an asset is overbought or oversold. An RSI greater than 70
indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold.
B is incorrect. The relative strength index is a momentum oscillator and provides
information on whether or not an asset is overbought or oversold. An RSI greater than 70
indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold.
Which of the following institutional investors is most likely to have a low tolerance
for investment risk and relatively high liquidity needs?
A Insurance company
B Defined-benefit
pension plan
C Charitable foundation
A is correct. Insurance companies need to be relatively conservative and liquid, given
the necessity of paying claims when due.
B is incorrect because defined-benefit
pension plans tend to have quite high risk
tolerances and quite low liquidity needs.
C is incorrect because endowments/foundations typically have high risk tolerances
and quite low liquidity needs.
The risk-free
rate is 5%, and the market risk premium is 8%. If the beta of TRL
Corp. is 1.5, based on the capital asset pricing model (CAPM), the expected
return of TRL’s stock is closest to:
A 17.0%.
B 9.5%.
C 15.5%.
A is correct. Using the CAPM relationship of E(Ri ) = Rf + [E(Rm ) – Rf ]β i , we can estimate
the expected return as: E(Ri ) = 0.05 + (0.08)(1.5) = 17.0%.
B is incorrect because the expected return is computed as 0.05 + (0.08 – 0.05)(1.5)
= 9.5%.
C is incorrect because the expected return is computed as 0.08 + (0.05)(1.5) = 15.5%.
An investment policy statement’s risk objective states that over a 12-month
period, with a probability of 95%, the client’s portfolio must not lose more than
5% of its value. This statement is most likely a(n):
A total risk objective.
B relative risk objective.
C absolute risk objective.
C is correct. The statement is an absolute risk objective because it expresses a maximum
loss in value with an associated probability of loss.
A is incorrect because this is an absolute (not total) risk objective because it expresses
a maximum loss in value with an associated probability of loss.
B is incorrect because this is an absolute (not relative) risk objective because it expresses
a maximum loss in value with an associated probability of loss.
Two investors have utility functions that differ only with regard to the coefficient
of risk aversion. Relative to the investor with a higher coefficient of risk
aversion, the optimal portfolio for the investor with a lower coefficient of risk
aversion will most likely have:
A a lower level of risk and return.
B a higher level of risk and return.
C the same level of risk and return.
B is correct. A less risk-averse
investor’s highest utility curve, given the lower coefficient of
risk aversion, is likely to touch the capital allocation line at a point that would represent
a portfolio with higher risk and more expected return.
A is incorrect because for a high coefficient of risk aversion, the investor will seek a
lot of return for a bit of extra risk and will have an optimal portfolio that is tangential to
the capital allocation line at a lower level of risk and return relative to the investor with
a lower coefficient of risk aversion.
C is incorrect because only investors with identical coefficients of risk aversion would
select the same optimal portfolio.
Within a risk management framework, risk tolerance:
A and risk exposure should be kept in alignment.
B includes the qualitative assessment and evaluation of risk.
C is determined as a result of establishing how and where risk is taken.
A is correct. The process of risk monitoring, mitigation, and management is the most
obvious facet of the risk management framework and requires recognizing when risk
exposure is not aligned with risk tolerance.
B is incorrect. Risk identification and measurement include the qualitative assessment
and evaluation of risk.
C is incorrect. Risk tolerance can provide guidance on risk budgeting, which is how
and where risk is taken. Risk budgeting is a result of determining risk tolerance.
Which of the following statements best describes a potential concern for clients
using robo-advisers?
Robo-advisers:
A must be established as registered investment advisers.
B do not seem to incorporate the full range of investment information into
their recommendations.
C are likely to be held to a similar code of conduct as other investment professionals
in the given region.
B is correct. Initial research has shown that robo-advisers
do not seem to incorporate
the full range of investment information into their recommendations, meaning that
important points may be missing in investment decisions.
A is incorrect. It is an advantage to clients that robo-advisers
must be registered as
investment advisers, because they are subject to guidance from the securities regulator
of their country.
C is incorrect. It is an advantage to clients that robo-advisers
must be held to a similar
code of conduct as other investment professionals in the given region.
When a security that was in an upward trend falls 1% below its trendline, a
technical analyst will most likely determine that:
A a downward trend is beginning.
B the upward trend is ending.
C the trendline needs an adjustment.
C is correct. When a security’s price drops through the trendline by a significant amount
(at least 5% to 10%), this decline signals that the uptrend has ended and further decline
may follow. Minor breakthroughs simply call for the trendline to be moderately adjusted
over time. A security falling 1% below its trendline is considered a minor breakthrough.
A is incorrect. The amount the price falls below the trendline would need to be at
least 5% before it would be considered a signal that the uptrend is ending and may
signal a further decline in price.
B is incorrect. The amount the price falls below the trendline would need to be at
least 5% before it would be considered a signal that the uptrend is ending.
Security analysis is most likely a part of which step in the portfolio management process? A The feedback step B The execution step C The planning step
B is correct. The execution step of the portfolio management process has three parts:
asset allocation, security analysis, and portfolio construction.
A is incorrect because under the planning step, there are two parts: understating the
client’s needs and preparation of an investment policy statement.
C is incorrect because under the feedback step, there are two parts: portfolio monitoring
and rebalancing and performance measurement and reporting.
Which of the following is most likely associated with an investor’s ability to take
risk rather than the investor’s willingness to take risk?
A The investor has a long investment time horizon.
B The investor believes earning excess returns on stocks is a matter of luck.
C Safety of principal is very important to the investor.
A is correct. Investment time horizon is an objective factor that measures the investor’s
ability to take risk.
B is incorrect because luck is a subjective factor that measures willingness to take risk.
C is incorrect because safety of principal is a subjective factor that measures willingness
to take risk.
An investment has a 50% probability of returning 12% and a 50% probability of
returning 6%. An investor prefers this uncertain investment over a guaranteed
return of 10%. This preference most likely indicates that the investor is risk:
A seeking.
B averse.
C neutral.
A is correct. The expected value of the uncertain investment is 9%, which is less than
the guaranteed return of 10%. Only a risk-seeking
person would be willing to accept
this investment.
B is incorrect. A risk-averse
person would prefer the guaranteed outcome of 10%.
C is incorrect. A risk-neutral
person would prefer the guaranteed outcome of 10%.
John Smith is given two investment options. Option A is a payment with a 50%
chance of getting $100 and a 50% chance of getting $0. Option B is a guaranteed
payment of $50. If Smith chooses Option A over Option B, his risk preference is
best described as risk:
A seeking.
B averse.
C neutral.
A is correct. Both options have the same expected return of $50. Option A, however, has
a higher risk (standard deviation) than Option B. Therefore, John Smith’s risk preference
is that of risk seeking.
B is incorrect because a risk-averse
person would prefer a lower risk profile given the
same expected return.
C is incorrect because a risk-neutral
person would be indifferent about the risk profile
of the outcome.
Risk management is a process that can most likely be best described as:
A minimizing risks while attempting to maximize returns.
B forecasting the level of risk that can meet a defined required return.
C defining a level of risk to be taken with the goal of maximizing the portfolio’s
value.
C is correct. Risk management is the process by which an organization or individual
defines the level of risk to be taken, measures the level of risk being taken, and adjusts
the latter toward the former, with the goal of maximizing the company’s or portfolio’s
value or the individual’s overall satisfaction or utility.
A is incorrect. Risk management is actively understanding how to best balance the
achievement of goals with an acceptable chance of failure.
B is incorrect. Risk management is not about predicting risks.
Fintech” is best described as:
A technology-driven
innovation in the financial service industry.
B the collection of large quantities of financial data from a variety of sources
in multiple formats.
C the use of technical models to describe patterns in financial markets and
make trading decisions.
A is correct. In its broadest sense, the term “fintech” generally refers to technology-driven
innovation occurring in the financial service industry.
B is incorrect. The collection of large quantities of data from a variety of sources in
multiple formats is the description of big data.
C is incorrect. The use of technical models to describe patterns in financial markets
and make trading decisions is the description of technical analysis.
Which of the following is least likely to be a constraint for an investment trust that has been
established for an infant for the strict use of buying their first home?
A. Liquidity
B. Tax concerns
C. Unique circumstances
Answer: A
This is correct. It is unlikely that the infant will be drawing funds from the trust for a lengthy
period of time and hence the trust might not have any liquidity constraints whatsoever.
Which of the following statements is least correct? Bond index construction can be more difficult
than equity index construction because:
A. there are more equity issues.
B. the bond price discovery process is less effective.
C. specific bonds are likely to move between different indexes.
Answer: A
This is incorrect as the universe and types of bonds is much broader than that of equities.
Furthermore, specific bonds mature and are replaced constantly.
Which of the following statements is most correct? Exchange-traded funds (ETFs) differ from
index mutual funds as:
A. ETFs are more tax-effective.
B. mutual funds have lower fees.
C. mutual funds pay out all dividends received.
Answer: A
This is correct. ETFs are generally considered to have a tax advantage over index mutual funds,
as the latter is generally required to pass on capital gains tax as gains are realized through trading.
Good risk governance practices in an organization should:
(i) focus on enterprise risk management.
(ii) provide for the appointment of a chief risk officer.
(iii) provide for a risk management committee.
(iv) give clear guidance to management.
A. Only (i), (ii), and (iv) are correct.
B. Only (ii), (iii), and (iv) are correct.
C. (i), (ii), (iii), and (iv) are all correct.
Answer: A
This is correct. Good risk governance should focus on the business as a whole (enterprise risk
management), and should provide for governance structures, such as the appointment of a CRO
and a risk forum of some kind. A good risk governance framework will also give clear guidance
to management, while at the same time leaving another flexibility in the execution of business
strategy.
Ingrid Jolley, CFA, has put together a constrained efficient frontier (no short sales) of five risky
assets based on expected returns, volatility, and correlations of the risky assets. Asset E has the
highest expected return and standard deviation of returns of 13.5% p.a. and 16.2% p.a. However,
Jolley wishes to put together a portfolio with an expected return greater than 13.5% p.a. but with
an expected volatility of no more than 13.5% p.a. This objective might best be achieved by:
A. borrowing and investing in Asset E.
B. including a long position in the risk-free asset.
C. borrowing and investing in a portfolio of the risk assets.
Answer: C
This statement is correct. As Asset E is the highest returning asset, it would sit on the right-hand
extreme of a constrained efficient frontier. The only way to achieve a portfolio that is above the
efficient frontier is to combine the optimal risky portfolio with the risk-free asset; in this case,
borrowing the risk-free asset and leveraging into the optimal risky portfolio.
Which of the following markets is most likely to exhibit semi-strong form efficiency?
A. Stock market in a country with no laws against insider trading
B. Corporate bond market where all issuers are required to have a credit rating
C. Commodity futures market where most trading is based on technical analysis
Answer: B
This is correct. A bond market where issuers are required to have a credit rating would likely lead
to prices based on public information. This is a semi-strong form efficient market.
Which of the following statements is most correct? In technical analysis, the change in polarity
principle might refer to:
A. a price trend changing direction.
B. a resistance level becoming a support level.
C. a price movement between support and resistance levels.
Answer: B
The change in polarity principle asserts that once the price rises (falls) through the resistance
(support) level, this then becomes the new support (resistance) level.
Growth in adoption of robo-advisory services is least likely driven by:
A. desire for lower fees.
B. demand from younger investors.
C. high barriers to entering the industry.
Answer: C
New entrants into the market are finding it easy to develop solutions to compete against
incumbent wealth managers.
Which of the following would most likely be a “social issue” considered within a sustainable investing policy? A. Data protection B. Energy efficiency C. Board composition
Answer: A
Data protection would be considered a social issue as it relates to corporate responsibility
regarding the sensitive information of customer and stakeholder information.
1 Investors should use a portfolio approach to:
A reduce risk.
B monitor risk.
C eliminate risk
1 A is correct. Combining assets into a portfolio should reduce the portfolio’s volatility. Specifically, “individuals and institutions should hold portfolios to reduce
risk.” As illustrated in the reading, however, risk reduction may not be as great
during a period of dramatic economic change.