Quiz1

Question 1

Assume that a company has total assets of $3.0 million, total liabilities of $1.2 million, preferred stock of $0.5 million and 5,000 shares of common stock. The book value per share of common stock is

A. $130
B. $180
C. $220
D. $260

Answer 1

D. $260

Total book value= assets- liabilities – preferred stock. Here, total book value= $3.0M- $1.2M- $0.5M= $1.3M. On a per share basis, book value per share is $1.3M/5,000= $260.

Question 2

The advantages of investing in common stock include:

A. Low volatility of investment returns.
B. Guaranteed higher returns than short-term bonds
C. Guaranteed regular cash flows via dividends.
D. Participation in the growth of the issuing company

Answer 2

D. Participation in the growth of the issuing company

An advantage of owning common stock is the participation in the growth of the firm via dividends or capital gains. Common stocks generally exhibit higher volatility than other types of investments, but are not guaranteed higher returns or regular cash flows via dividends. A stock can have negative returns and suspend dividend payments.

Question 3

Preferred stocks with cumulative fixed dividends:

A. Must pay the missed dividends before common shareholders can be paid dividends.
B. Are taxed on accumulated dividends.
C. Are required to pay dividends each quarter.
D. All of the above are true.

Answer 3

A. Must pay the missed dividends before common shareholders can be paid dividends.

Cumulative preferred stocks must pay missed dividends before common shareholders can be paid dividends. The other statements are not true. These types of preferred stocks are not required to pay dividends each quarter nor are taxed on accumulated dividends.

Question 4

Which one of the following best describes a debenture?

A. A long-term corporate promissory note
B. An investment in the debt of another corporate party
C. A long-term corporate debt obligation with a claim against securities rather than against physical assets
D. A corporate debt obligation that allows the holder to repurchase the security at specified dates before maturity
E. Unsecured corporate debt

Answer 4

E. Unsecured corporate debt

A debenture has no specific assets pledged as collateral. Answer A is incorrect as it does not specify whether there is any collateral underlying the note. Answer B is simply a description of a corporate bond, and does not specify whether there is any collateral underlying the bond. Answer D is a description of a callable bond, which may or may not be a debenture.

Question 5

Risk factors faced by corporate bond investors include all of the following EXCEPT:

A. liquidity risk
B. interest rate risk
C. default risk
D. derivative risk
E. purchasing power (inflation) risk

Answer 5

D. derivative risk

This is not a legitimate risk affecting corporate fixed income issues. All other risks listed above are risks affecting corporate bond investors.

Question 6

Andrew wants to purchase a government-backed investment that adjusts the interest rate for inflation every six months. Which of the following investments should Andrew purchase?

A. Series EE bonds
B. Series HH bonds
C. Series I bonds
D. Treasury inflation-protected securities (TIPS)

Answer 6

C. Series I bonds

Series I bonds is the answer. The government adjusts the interest rate paid on Series I bonds every six months. The principal amount is the item adjusted on TIPS. Series EE bonds adjust the interest rate every six months, but it is not necessarily tied to inflation. Series HH bonds are no longer being issued as of August 2004.

Question 7

Each of the following four corporate bonds is currently selling at a discount:

         Bond                  Coupon              Maturity              Bond Rating       Yield to Maturity
             A                        5.2%                   5 years                     AA                       6.0%
             B                        5.2%                  10 years                     B                        7.0%
             C                        5.0%                  15 years                    AA                       6.0%
             D                        4.8%                   5 years                    AAA                     5.8%         

Amber is considering investing in corporate bonds, but she is concerned about maintaining her principal over her 5-year time horizon. The income from these bonds is another important consideration for her. She anticipates market interest rates to increase over the next several years. Choose the best bond for Amber to invest in.

A. Bond A
B. Bond B
C. Bond C
D. Bond D

Answer 7

A. Bond A

If rates increase, bond prices will decrease causing the longer-term bonds (Bonds B and C) to be sold in 5 years for less than their current market price. Since Amber is concerned about her principal, she should not invest in these two bonds. Both Bonds A and D match Amber’s time horizon. Since the bonds are selling for a discount, she will receive a capital gain if she holds the bonds to maturity. Even though Bond A has a slightly lower rating (AA versus AAA), the probability of default is not significantly increased. Bond A also has a higher coupon providing for a larger cash inflow that can be reinvested at the anticipated higher rates.

Question 8

All of the following statements concerning investment companies are correct EXCEPT:

A. Both closed-end and open-end companies will, upon request, redeem their outstanding shares at NAV at any time
B. A closed-end investment company doesn’t make any additional share offerings after its initial public offering.
C. An open-end investment company must redeem any outstanding shares owned by investors.
D. An open-end investment company may sell new shares after the initial offering of shares to investors.

Answer 8

A. Both closed-end and open-end companies will, upon request, redeem their outstanding shares at NAV at any time

A closed-end company does not normally redeem any of its outstanding shares. Only open-end investment companies promise to redeem its shares at any time.

Question 9

Rank the following types of funds from lowest risk to highest risk:

A. Sector funds, growth funds, balanced funds, money market funds, hedge funds
B. Money market funds, balanced funds, sector funds, hedge funds, growth funds
C. Balanced funds, money market funds, hedge funds, sector funds, growth funds
D. Money market funds, balanced funds, growth funds, sector funds, hedge funds

Answer 9

D. Money market funds, balanced funds, growth funds, sector funds, hedge funds

Money market funds are the least risky funds listed, as they invest in short-term money market instruments. Balanced funds are conservative. They usually invest in a mix of bonds and stocks. Sector funds are more risky than growth funds as they give up diversification to invest in a certain sector of the market. Hedge funds use leverage, making them the most risky funds in this group.

Question 10

Orion mutual fund has a portfolio of 300 stocks with a total market value of $700 million. The fund also has $30 million in liabilities. If the mutual fund has 15 million shares outstanding, what is the net asset value (NAV)?

A. $33.67
B. $37.56
C. $41.25
D. $44.67

Answer 10

D. $44.67

NAV= (market value of portfolio- liability)/shares = (700-30)/15 = $44.67

Question 11

Revenue municipal bonds are subject to which of the following investment risks?
(1) Default risk
(2) Unsystematic risk
(3) Reinvestment rate risk
(4) Sovereign risk

A. (1) and (2) only
B. (1), (2) and (4) only
C. (1), (2) and (3) only
D. (1), (2), (3) and (4)

Answer 11

C. (1), (2) and (3) only

All municipal bonds are subject to reinvestment rate risk because the coupon payments must be reinvested at the same rate in order to maintain the yield-to-maturity. Defaults can happen with revenue municipal bonds. Because there are specific attributes related to the revenue structure that is backing these types of bonds, there is unsystematic risk.

Question 12

If the mean return for Sarconics, Inc. is 16% and the standard deviation is 4%, what will the range of returns be within two standard deviations?

A. Between 4% and 16%
B. Between 8% and 16%
C. Between 8% and 24%
D. Between 8% and 30%

Answer 12

C. Between 8% and 24%

At two standard deviations, approximately 95% of the outcomes will fall between [16%-(2x4%)] = 8%, and [16%+(2x4)]= 24%

Question 13

What is the standard deviation of returns given returns of 9%, 6%, 2%, -5%?

A. 4.2%
B. 5.1%
C. 6.1%
D. 7.8%

Answer 13

C. 6.1%

The average return is : (9 + 6 +2-5)/4 = 12/4 = 3%. The variance is [(9-3)2 + (6-3)2 + (2-3)2 + (-5-3)2]/(4-1)= [36+9+1+64]/3= 110/3= 36.67. The standard deviation is 36.67 squared= 6.06%

Question 14

A bell curve whose left side tail is longer than the right side is an example of:

A. Positive skewness
B. Negative skewness
C. Abnormal distribution
D. Low kurtosis

Answer 14

B. Negative skewness

This is the definition of negative skewness.

Question 15

Your client purchased 100 shares of XYZ Corporation stock at $40 per share and deposited 50% of the purchase price for initial margin requirement. If the maintenance margin is 35%, at what price will your client receive a margin call?

A. $29.63
B. $13.00
C. $32.57
D. $30.77

Answer 15

D. $30.77

Price at which a margin call is initiated.
[(1- Initial Margin Percentage)/(1- Maintenance Margin)] x Stock Purchase Price = [(1- 0.50)/(1- 0.35)] x ($40)= (0.5/0.65) x ($40)= $30.77

Question 16

Your client purchased 100 shares of XYZ Corporation stock at $40 per share and deposited 50% of the purchase price for initial margin requirement. If the maintenance margin is 30%, the client will receive a margin call of $28.57. Assume the client enters into the margin loan agreement and buys XYZ stock. If the price drops to $28, how much money will the client have to put up to satisfy the margin agreement?

A. $40.00
B. $85.00
C. $240.00
D. $500.00

Answer 16

A. $40.00

If the price drops to $28, then the total value= $2,800, and the net equity is ($2,800-$2,000)/$2,800= 28.6% equity, less than the 30% maintenance margin required. The additional dollars needed to meet the maintenance margin requirement: 0.30*$2,800= $840-$800= $40

Question 17

A client desires to purchase 500 shares of a stock only when the price gets to a certain level, and is worried about a sudden stock movement once the price is near that level. The most appropriate market order for this client would be:

A. Market Order
B. Stop-Limit Order
C. Limit Order
D. Good until cancelled order

Answer 17

B. Stop-Limit Order

This type of order combines the benefits of a market order and a limit order to constrain the price of execution.

Question 18

Smith invests in a limited partnership which requires an outlay of $9,200 today . At the end of years 1 through 5, he will receive the after-tax cash flows shown below. The partnership will be liquidated at the end of the fifth year. Smith is in the 28% tax bracket.
YEARS CASH FLOWS
0 ($9,200) CFo
1 $600 CF1
2 $2,300 CF2
3 $2,200 CF3
4 $6,800 CF4
5 $9,500 CF5.
Which of the following statements is/are correct?
(1) The IRR is the discount rate which equates the present value of an investment’s expected costs to the present value of the expected cash inflows.
(2) The IRR is 24.18% and the present value of the investment’s expected cash flows is $9,200.
(3) The IRR is 24.18%. For Smith to actually realize this rate of return, the investment’s cash flows will have to be reinvested at the IRR.
(4) If the cost of capital for this investment is 9%, the investment should be rejected because its net present value will be negative.

A. (2) and (4) only
B. (2) and (3) only
C. (1), (2) and (3) only
D. (1) only
E. (1) and (4) only

Answer 18

C. (1), (2) and (3) only

(1) is correct, by definition, since the IRR is the rate that equates the present value of the project’s inflows with the present value of its outflows, thereby producing a new present value of zero. (2) is correct, by definition of the internal rate of return. That is, if the inflows are discounted at a 24.18% rate of interest, they will produce a present value that is equal to the present value of the one outflow of $9,200. (3) is correct. It is an assumption of the IRR methodology that any cash flows spun off by an investment are reinvested at the internal rate of return of that investment. (4) is incorrect. Compute the net present value. It is a positive $5,976.77.

Question 19

Smith invests in a limited partnership which requires an outlay of $9,200 today . At the end of years 1 through 5, he will receive the after-tax cash flows shown below. The partnership will be liquidated at the end of the fifth year. Smith is in the 28% tax bracket.
YEARS CASH FLOWS
0 ($9,200) CFo
1 $600 CF1
2 $2,300 CF2
3 $2,200 CF3
4 $6,800 CF4
5 $9,500 CF5
The after-tax IRR of this investment is

A. 17.41%
B. 19.20%
C. 24.18%
D. 28%
E. 33.58%

Answer 19

C. 24.18%

On the financial calculator, enter a negative $9,200 as the initial cash flow. Then, enter the remaining positive cash flows at the end of years 1,2,3,4 and 5, as indicated in the problem. The internal rate of return is 24.18%. Note that the fact that Smith is in the 28% tax bracket is irrelevant to this answer since the cash flows are identified in the question as being after-tax flows.

Question 20

Stock XYZ has a standard deviation of 3% and an expected return of 12%, and Stock ABC has a standard deviation of 5% and an expected return of 16%. Which of the following is true?

A. Stock XYZ has substantially more risk per unit than Stock ABC.
B. Stock ABC has substantially more risk per unit than Stock XYZ.
C. Both investments have the same amount of risk per unit of investment.
D. None of the above statements are true.

Answer 20

B. Stock ABC has substantially more risk per unit than Stock XYZ.

The coefficient of variation is found by dividing the standard deviation by the expected return. For Stock XYZ, the coefficient of variation is 3%/12%= 0.25. For Stock ABC, the coefficient of variation is 5%/16%= 0.31. Stock ABC carries more risk per unit of return.

Question 21

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 9% zero-coupon bond priced to yield 11% in 8 years.
The yield to maturity of Bond A is closest to

A. 9.90%
B. 10.40%
C. 10.90%
D. 11.40%
E. 11.90%

Answer 21

E. 11.90%

To find the yield to maturity of Bond A, on your financial calculator enter $1,000 as the FV, $900 +/- as the PV, $60 as the end-of-period PMT, and 2 as the value of n. Solve for i, which is 11.90%

Question 22

JKL portfolio has a realized return of 15% over the last several years and a beta of 1.10. The 3-month Treasury bill is currently yielding 4%. The S&P Index has a realized return of 12% and a beta of 1.00. If the tracking error is 0.015, what is the information ratio of portfolio JKL?

A. 1.5
B. 2
C. 2.45
D. 3.25

Answer 22

B. 2

The information ratio is found as follows:
Return of portfolio- Return of benchmark/Tracking error
= (0.15- 0.12)/(0.015)= (0.03/0.015)= 2.0

Question 23

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.

Answer 23

D. Match the average weighted duration of the bond portfolio to the investment horizon.

This is, by definition, the immunization of a portfolio.

Question 24

An immunization strategy protects a portfolio from:

A. Prepayment risk
B. Liquidity risk
C. Interest Rate Risk
D. Default Risk

Answer 24

C. Interest Rate Risk

Immunization protects an interest rate sensitive portfolio from losing value given unexpected rate changes. An immunization strategy must be monitored and adjusted over time.

Question 25

A client has a cash need at the end of seven years. Which of the following investments might initially immunize the portfolio?
(1) a 9-year maturity coupon bond
(2) a 7-year maturity coupon Treasury note
(3) a series of Treasury bills

A. (1), (2) and (3) only
B. (1) only
C. (2) only
D. (2) and (3) only

Answer 25

B. (1) only

Immunization of a portfolio involves matching the portfolio’s duration with the duration of the investor’s cash needs. A 7-year maturity coupon Treasury note would have a duration of less than seven years. Similarly, a series of Treasury bills would have a very short duration. A 9-year maturity coupon bond, on the other hand, will have a duration of less than nine years, perhaps something in the neighborhood of seven years.

Question 26

Which of the following is the benchmark line that corresponds to the graphic display of the Treynor index?

A. Security Market Line (SML)
B. Capital Market Line(CML)
C. Efficient Frontier
D. All of the above

Answer 26

A. Security Market Line (SML)

The Treynor index measures uses beta as the measure of risk and graphically displays the risk/return tradeoff. The CML uses the standard deviation, not beta, in estimating expected return and risk displays.

Question 27

The internal rate of return (IRR):

A. Is influenced by the timing of contributions and withdrawals that may be beyond the control of an investment manager.
B. Is always equal to the time-weighted annual return.
C. Is the discount rate that equates the present value of cash inflows to the present value of cash outflows.
D. All of the above are true.
E. “A and C are true, but B is not true”

Answer 27

E. “A and C are true, but B is not true”

The internal rate of return is the same as the dollar-weighted annual return, but is not equal to the time-weighted annual return. The time-weighted return is equal to the geometric average.

Question 28

A project should be rejected under the internal rate of return (IRR) criteria if:

A. IRR<0
B. IRR>0
C. IRR>1.0
D. IRR> required return
E. IRR< required return

Answer 28

E. IRR< required return

If the internal rate of return is less than the required return, the project should be rejected.

Question 29

The strategy that involves an assortment of bonds or CDs with staggered maturities is called:

A. Immunization
B. Bullet Strategy
C. Duration Strategy
D. Ladder portfolio

Answer 29

D. Ladder portfolio

The strategy described here is a ladder strategy in which individual issues are staggered in a way that integrates interest rate projections.

Question 30

In contrast with passive investing, an active investing strategy:

A. Focuses on individual security selection.
B. Has lower trading costs than a passive approach.
C. Has lower research costs than a passive approach.
D. Assumes that markets are efficient.

Answer 30

A. Focuses on individual security selection.

Active management assumes that markets are not totally efficient, and, by using research, investors are able to outperform a passive strategy. Typically, there is more trading under active management, which results in higher trading and research costs.