INV ANAL MIDTERM

Question 1
8 out of 8 points
Active trading in markets and competition among securities analysts helps ensure that:
I. Security prices approach informational efficiency
II. Riskier securities are priced to offer higher potential returns
III. Investors are unlikely to be able to consistently find under- or overvalued securities
Selected Answer:
A.
I, II, and III
Answers:
A.
I, II, and III
B.
II and III only
C.
I only
D.
I and II only
Response
Feedback:

If a security is correctly priced, that means a high risk security should have
high expected returns. Active trading and analysts try to make sure every
security is corrected priced.
Question 2
8 out of 8 points
Which of the following is not a money market security?
Selected Answer:
Common stock
Answers:
Bankers' acceptance
Common stock
U.S. Treasury bill
6-month maturity certificate of deposit

Question 3
8 out of 8 points
In a market economy, capital resources are primarily allocated by ____________.
Selected Answer:
A.
financial markets
Answers:
A.
financial markets
B.
investment bankers
C.
governments
D.
the SEC

Question 4
8 out of 8 points
Financial markets allow for all but which one of the following?
Selected Answer:
Answers:
D.
Allow most participants to routinely earn high returns with low risk
A.
Shift consumption through time from higher-income periods to lower
B.
Price securities according to their riskiness
C.
Channel funds from lenders of funds to borrowers of funds
D.
Allow most participants to routinely earn high returns with low risk
Response
Feedback:

Question 5
The foundational role of financial markets is to make sure that only those
who take high risk may get high returns. If one takes little risk, it is only right
for him/her to expect low return.
8 out of 8 points
__________ assets generate net income to the economy, and __________ assets define
allocation of income among investors.
Selected Answer:
C.
Real, financial
Answers:
A.
Financial, real
B.
Real, real
C.
Real, financial
D.
Financial, financial

Question 6
8 out of 8 points
In a ___________ index, changes in the value of the stock with the greatest market value will
move the index value the most, everything else equal.
Selected Answer:
D.
value-weighted index
Answers:
A.
equally weighted index
B.
price-weighted index
C.
bond price index
D.
value-weighted index

Question 7
8 out of 8 points
A benchmark market value index is comprised of three stocks. Yesterday the three stocks
were priced at $12, $20, and $60. The number of outstanding shares for each is 600,000
shares, 500,000 shares, and 200,000 shares, respectively. If the stock prices changed to
$16, $18, and $62 today respectively, what is the 1-day rate of return on the index?
Selected Answer:
C.
6.16%
Answers:
A.
4.35%
B.
7.42%
C.
6.16%
D.
5.78%

Question 8
8 out of 8 points
According to the Flow of Funds Accounts of the United States, the largest financial asset of
U.S. households is ____.
Selected Answer:
B.
pension reserves
Answers:
A.
mutual fund shares
B.
pension reserves
C.
personal trusts
D.
corporate equity

Question 9
8 out of 8 points
A __________ gives its holder the right to buy an asset for a specified exercise price on or
before a specified expiration date.
Selected Answer:
D.
call option
Answers:
A.
futures contract
B.
put option
C.
interest rate swap
D.
call option

Question 10
8 out of 8 points
The Standard & Poor's 500 is __________ weighted index.
Selected Answer:
Answers:
C.
a valueA.
a priceB.
an equally
C.
a valueD.
a share
Question 11
8 out of 8 points
Methods of encouraging managers to act in shareholders' best interest include:
I. Threat of takeover
II. Proxy fights for control of the board of directors
III. Tying managers' compensation to stock price performance
Selected Answer:
B.
I, II, and III
Answers:
A.
II and III only
B.
I, II, and III
C.
I only
D.
I and II only

Question 12
8 out of 8 points
In securities markets, there should be a risk-return trade-off with higherrisk assets having _________ expected returns than lower-risk assets.
Selected Answer:
C.
higher
Answers:
A.
The answer cannot be determined from the information given.
B.
lower
C.
higher
D.
the same

Question 13
8 out of 8 points
Suppose an investor is considering one of two investments that are
identical in all respects except for risk. If the investor anticipates a fair
return for the risk of the security he invests in, he can expect to _____.
Selected Answer:
B.
pay less for the security that has higher risk.
Answers:
A.
earn more if interest rates are lower.
B.
pay less for the security that has higher risk.
C.
pay less for the security that has lower risk.
D.
earn no more than the Treasury-bill rate on either security.

Question 14
8 out of 8 points
__________ portfolio construction starts with selecting attractively priced securities.
Selected Answer:
C.
Bottom-up
Answers:
A.
Side-to-side
B.
Top-down
C.
Bottom-up
D.
Upside-down

Question 1
10 out of 10 points
Kidder provides research for T Rowe Price for nothing. Why they want to do that?
Selected
Answer:
Answers:
B.
Relationship building
A.
Influence T Rowe Price traders to trade in the direction that Kidder
wants.
B.
Relationship building
C.
Use false information or rumors to mislead T Rowe Price traders

Question 2
10 out of 10 points
Why include Tandem in the deal? Wouldn’t that make the deal complicated? In other words,
was it a sweetener (more business to Goldman)? Or something subtler?
Selected
Answer:
Answers:
B.
It is a sweetener. But it is also a way for Greg to hide his price impact in
Avantek because part of the costs are shifted to Tandem.
A.
The only purpose is to help Goldman get more trading business.
B.
It is a sweetener. But it is also a way for Greg to hide his price impact in
Avantek because part of the costs are shifted to Tandem.
C.
It is a sweetener only.
D.
It is not a sweetener.

Question 3
30 out of 30 points
What is the basic problem Greg faces in trying to dispose the block of Avantek shares? What
advice would you give him if he could do it all over again given you have known what he has
done in both Case A and B?

Selected
Answer:
Greg wants to sell the block of Avantek shares which are huge. So he has a pile
of these stocks which has not many selling options. The most basic problem Greg
faces is the restricted pricing pressure of the Avantek shares (he cannot sell it
below $23). Overlooking the overall deal, the advice I would have given to Greg is
to go straight to Michael since he is at top company as Goldman. Goldman will
offer a better overall deal to possess the block of Avantek shares, rather than
calling Steve in which he will be given an unfavorable price. Greg could have also
sold the Avantek shares in smaller lots for a greater price.
Correct
Answer:
[None]
Question 4
10 out of 10 points
Use the fair value from the previous two questions to calculate the follow two questions:
How much transaction cost per share for trading the 35,000 shares of Avantek would Greg
incur relative to the fair value if he sold to Kidder? If Greg later chooses Kidder for trading
the remaining shares in the block of 183,000 shares of Avantek, would his cost per share be
the same as the cost per share for the first 35,000 shares?
Hint: If the true value of the stock is 100 and a trader sells the stock to the market maker at
95, the cost (relative to the fair value) for the trader is 5. Market maker makes a 5-dollar
profit (relative to the fair value).
Selected
Answer:
C.
1/8; His cost per share may become significantly bigger for the remaining
shares.
Answers:
A.
1/8; Cost per share would not increase.
B.
0; Not sure whether his cost per share would increase.
C.
1/8; His cost per share may become significantly bigger for the remaining
shares.

Question 5
10 out of 10 points
How much total transaction cost (note: the cost of all shares) would Greg incur relative to
the fair value if he accepts Michael's terms in CASE B?
Selected Answer:
D.
217,000
Answers:
A.
0
B.
488,000
C.
271,000
D.
217,000

Question 6
10 out of 10 points
How much total direct transaction cost for trading Avantek and Tandem would Greg incur
relative to the fair value if he were to accept Michael's terms in CASE A?
Note: total cost refers to the cost after considering all shares traded. It is not cost per
share.
Selected Answer:
Answers:
D.
309,000
A.
Do not incur cost because Greg actually makes money
B.
271,000
C.
580,000
D.
309,000

Question 7
10 out of 10 points
What would be the most likely fair value for Avantek that would make sense to both Goldman
and Kidder around the time period (say between 11:00 and 11:59) when Greg was
negotiating with Goldman and Kidder?
Hint: Each market maker’s fair value is usually the mid-point of his bid and ask prices.
There are multiple market makers/dealers for a stock on the OTC market. Goldman and
Kidder are market makers. T. Rowe Price is a normal trader.
Suppose a market maker believes the true value of a stock is 100. His bid and ask prices
for the stock can be, e.g., 95 and 105. Traders are going to trade with the market maker
at either 95 (sellers) or 105 (buyers). Other traders in the market are going to see a
sequence of transaction prices of, for example, 95, 105, 95, 105, 105… with 95 and 105
randomly showing up on the computer screen. This is because buyers and sellers
randomly arrive at the market and trade with the market maker. To find market maker’s
bid and ask, as well as the fair value, you need to examine the transaction price history
during the time when T Rowe Price made the phone call. Such information is in the
exhibits at the end of the case.
Selected Answer:
Answers:
D.
24 6/8
A.
24 5/8
B.
23 1/2
C.
24
D.
24 6/8

Question 8
10 out of 10 points
If a block was sold in several small lots in this case, what would be the consequence of doing
that? Could T Rowe do that instead of selling the block entirely to Goldman?
Selected
Answer:
Answers:
A.
No. T Rowe cannot do that because their demand of selling Avantek is
urgent.
A.
No. T Rowe cannot do that because their demand of selling Avantek is
urgent.
B.
Yes. T Rowe can do that because breaking the order into smaller lots and
perhaps trade with both Goldman and Kidder can lower the total transaction
costs.

Question 9
10 out of 10 points
Why Greg went to Kidder first instead of Goldman?
Selected
Answer:
Answers:
B.
Help Kidder grow bigger so that it can become a long-term competitor of
Goldman Sachs.
A.
It is easier to get a better deal from Kidder than from Goldman because
Kidder's bargain power is smaller due to its smaller size.
B.
Help Kidder grow bigger so that it can become a long-term competitor of
Goldman Sachs.
C.
Goldman is a larger market maker. It is easier for Goldman to wait than
Kidder because Goldman has other trading business.
D.
Kidder's terms are better after considering all the Avantek shares that T
Rowe Price wants to trade

Question 10
10 out of 10 points
What would be the most likely fair value during that period for Tandem that would make
sense to Goldman?
Selected Answer:
A.
15
Answers:
A.
15
B.
15 ¼
C.
15 ½
D.
14 7/8

Question 1
12 out of 12 points
You sell short 200 shares of Doggie Treats Inc. that are currently selling at
$25 per share. You post the 50% margin required on the short sale. If your
broker requires a 30% maintenance margin, at what stock price will you
get a margin call? (You earn no interest on the funds in your margin
account, and the firm does not pay any dividends.)
Selected Answer:
B.
$28.85
Answers:
A.
$35.71
B.
$28.85
C.
$31.50
D.
$32.25

Question 2
12 out of 12 points
Assume you purchased 500 shares of XYZ common stock on margin at $40 per share from
your broker. If the initial margin is 60%, the amount you borrowed from the broker is
_________.
Selected Answer:
A.
$8,000
Answers:
A.
$8,000
B.
$20,000
C.
$15,000
D.
$12,000
Response Feedback:

500($40)(.40) = $8,000
Question 3
12 out of 12 points
If you are need to match orders from the public, which prices will be
matched first _______.
Selected Answer:
C.
highest outstanding bid price and lowest outstanding ask price
Answers:
A.
lowest outstanding bid price and highest outstanding ask price
B.
lowest outstanding bid price and lowest outstanding ask price
C.
highest outstanding bid price and lowest outstanding ask price
D.
highest outstanding bid price and highest outstanding ask price
Response
Feedback:

→
highest outstanding bid price and lowest
outstanding ask price
Question 4
12 out of 12 points
The bid price of a stock is _________.
Selected Answer:
A.
the price at which the dealer in the stock is willing to buy
Answers:
A.
the price at which the dealer in the stock is willing to buy
B.
the price at which the dealer in the stock is willing to sell
C.
the price at which an investor can buy the stock
D.
greater than the ask price of the stock expressed in dollar terms
Response
Feedback:
→
the price at which the dealer in the stock is
willing to buy

Question 5
12 out of 12 points
You sell short 300 shares of Microsoft that are currently selling at $30 per share. You
post the 50% margin required on the short sale. If you earn no interest on the funds in
your margin account, what will be your rate of return after 1 year if Microsoft is
selling at $27? (Ignore any dividends.)
Selected Answer:
D.
20%
Answers:
A.
6.67%
B.
15%
C.
10%
D.
20%

Question 6
12 out of 12 points
An order to buy or sell a security at the current price is a ______________.
Selected Answer:
C.
market order
Answers:
A.
limit order
B.
stop-buy order
C.
market order
D.
stop-loss order

Question 7
12 out of 12 points
You purchased 250 shares of common stock on margin for $25 per share. The initial margin
is 65%, and the stock pays no dividend. Your rate of return would be __________ if you sell
the stock at $32 per share. Ignore interest on margin.
Selected Answer:
C.
43%
Answers:
A.
39%
B.
35%
C.
43%
D.
28%

Question 8
12 out of 12 points
The New York Stock Exchange is a good example of _________.
Selected Answer:
C.
an auction market
Answers:
A.
a direct search market
B.
a brokered market
C.
an auction market
D.
a dealer market

Question 9
12 out of 12 points
The complete cost of buying and selling a stock includes:
I. Broker's commissions
II. Dealer's bid-asked spread
III. Price concessions that investors may be forced to make
Selected Answer:
D.
I, II, and III
Answers:
A.
II and III only
B.
I and II only
C.
I and III only
D.
I, II, and III

Question 10
12 out of 12 points
You purchased 200 shares of ABC common stock on margin at $50 per
share. Assume the initial margin is 50% and the maintenance margin is
30%. You will get a margin call if the stock drops below ________. (Assume
the stock pays no dividends, and ignore interest on the margin loan.)
Selected Answer:
D.
$35.71
Answers:
A.
$28.95
B.
$30.77
C.
$26.55
D.
$35.71
Response Feedback:

Equity = 200P - 5,000
Margin = (200P - 5,000)/200P = .30
200P - 5,000 = 60P
140P = 5,000
P = 35.71429
Question 11
12 out of 12 points
You sold short 300 shares of common stock at $30 per share. The initial
margin is 50%. You must put up _________.
Selected Answer:
C.
$4,500
Answers:
A.
$6,000
B.
$9,000
C.
$4,500
D.
$10,000
Response Feedback:

Investment = 300(30)(.50) = 4,500
Question 1
10 out of 10 points
Investors in closed-end funds who wish to liquidate their positions must
Selected Answer:
Answers:
B.
sell their shares through a broker.
A.
sell their shares to the issuer for net asset value.
B.
sell their shares through a broker.
C.
sell their shares to the issuer at a premium to net asset value.
D.
sell their shares to the issuer at a discount to net asset value.
E.
hold their shares to maturity.
Response
Feedback:

Closed-end fund shares are sold on organized exchanges through a
broker.
Question 2
10 out of 10 points
Which one of the following statements regarding open-end mutual funds is false?
Selected
Answer:
Answers:
B.
The funds offer investors a guaranteed rate of return.
A.
The funds redeem shares at net asset value and offer investors
professional management.
B.
The funds offer investors a guaranteed rate of return.
C.
The funds offer investors professional management.
D.
The funds offer investors professional management and a guaranteed rate
of return.
E.
The funds redeem shares at net asset value.
Response Feedback:

Mutual funds do not offer a guaranteed rate of return.
Question 3
10 out of 10 points
Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that
tracks the S&P 500 should choose
Selected Answer:
Answers:
B.
SPY.
A.
IWM.
B.
SPY.
C.
VTI.
D.
DIA.
E.
QQQ.
Response Feedback:

SPY tracks the S&P 500.
Question 4
10 out of 10 points
Differences between hedge funds and mutual funds are that
Selected
Answer:
D.
All of the options
Answers:
A.
hedge funds are commonly structured as private partnerships.
B.
hedge fund managers can pursue strategies not available to mutual funds,
such as short selling, heavy use of derivatives, and leverage.
C.
hedge funds are only subject to minimal SEC regulation.
D.
All of the options
E.
hedge funds are typically open only to wealthy or institutional investors.
Response
Feedback:

Hedge funds are typically open only to wealthy or institutional investors, are
commonly structured as private partnerships, are only subject to minimal
SEC regulation, and can pursue strategies not available to mutual funds,
such as short selling, heavy use of derivatives, and leverage.
Question 5
10 out of 10 points
Which of the following statements about real estate investment trusts is true?
Selected
Answer:
Answers:
C.
REITs invest in real estate or loans secured by real estate and raise capital
by borrowing from banks and issuing mortgages.
A.
REITs raise capital by borrowing from banks and issuing mortgages.
B.
REITs are similar to open-end funds, with shares redeemable at NAV.
C.
REITs invest in real estate or loans secured by real estate and raise capital
by borrowing from banks and issuing mortgages.
D.
All of the options are true.
E.
REITs invest in real estate or loans secured by real estate.
Response
Feedback:

Question 6
Real estate investment trusts invest in real estate or real-estate-secured
loans. They may raise capital from banks and by issuing mortgages. They
are similar to closed-end funds, and shares are typically exchange traded.
10 out of 10 points
Which of the following statements about money market mutual funds is true?
Selected
Answer:
Answers:
E.
They invest in commercial paper, CDs, and repurchase agreements, and
they usually offer check-writing privileges.
A.
They are highly leveraged and risky.
B.
They invest in commercial paper, CDs, and repurchase agreements.
C.
They usually offer check-writing privileges.
D.
All of the options are true.
E.
They invest in commercial paper, CDs, and repurchase agreements, and
they usually offer check-writing privileges.
Response
Feedback:

Money market mutual funds invest in commercial paper, CDs, repurchase
agreements, and other money market securities. They usually offer checkwriting privileges. Their NAV is fixed at $1 per share.
Question 7
10 out of 10 points
Most actively managed mutual funds, when compared to a market index such as the Wilshire
5000,
Selected Answer:
Answers:
A.
do not outperform the market.
A.
do not outperform the market.
B.
beat the market return in all years.
C.
exceed the return on index funds.
D.
beat the market return in most years.
Response
Feedback:

Question 8
Most actively managed mutual funds fail to equal the return earned by
index funds, possibly due to higher transactions costs.
10 out of 10 points
Which of the following functions do investment companies perform for their investors?
Selected Answer:
Answers:
C.
All of the options
A.
Professional management
B.
Record keeping and administration
C.
All of the options
D.
Lower transaction costs
E.
Diversification and divisibility
Response
Feedback:

Investment companies are attractive to investors because they offer all
of the listed services.
Question 9
0 out of 10 points
Which one of the following statements regarding closed-end mutual funds is false?
Selected
Answer:
Answers:
A.
The funds redeem shares at their net asset value.
A.
The funds redeem shares at their net asset value.
B.
The funds always trade at a discount from NAV.
C.
The funds offer investors professional management.
D.
The funds always trade at a discount from NAV and redeem shares at
their net asset value.
E.
None of the options
Response Feedback:

Question 10
Closed-end funds are sold at the prevailing market price.
10 out of 10 points
Multiple Mutual Funds had year-end assets of $457,000,000 and liabilities of $17,000,000.
There were 24,300,000 shares in the fund at year-end. What was Multiple Mutual's net asset
value?
Selected Answer:
Answers:
B.
$18.11
A.
$18.81
B.
$18.11
C.
$69.96
D.
$7.00
E.
$181.07
Response Feedback:

($457,000,000 - 17,000,000)/24,300,000 = $18.11.
Question 11
10 out of 10 points
Which of the following statements about real estate investment trusts is true?
Selected
Answer:
Answers:
D.
All of the options are true.
A.
REITs are usually highly leveraged.
B.
REITs are similar to closed-end funds.
C.
REITs may be equity trusts or mortgage trusts.
D.
All of the options are true.
E.
REITs may be equity trusts or mortgage trusts and are usually highly
leveraged.
Response
Feedback:

Question 1
Real estate investment trusts invest in real estate or real-estate-secured
loans. They may raise capital from banks and by issuing mortgages. They
are similar to closed-end funds and shares are typically exchange traded.
10 out of 10 points
Ignore the fact that DFA tries to actively avoid the lemons problem. If DFA only
offered a small-cap fund and a value fund to their investors (they did this in the
1980s), would this business practice indicates that they were really believers in
market efficiency? Suppose DFA lives in the Fama-French three-factor model world
instead of the CAPM world.
Selected Answer:
B.
No, DFA is not a true believer of market efficiency.
Answers:
A.
Yes, DFA understands the true meaning of market efficiency.
B.
No, DFA is not a true believer of market efficiency.

Question 2
10 out of 10 points
Read textbook chapter 9.1 and answer the following questions: If a stock generates
positive CAPM alpha, it is
Selected Answer:
C.
underpriced in the CAPM world.
Answers:
A.
fairly priced in the CAPM world.
B.
unrelated to whether a stock is mispriced in the CAPM world.
C.
underpriced in the CAPM world.
D.
overpriced in the CAPM world.

Question 3
10 out of 10 points
Read Chapter 11.1 and 11.4 in the textbook and then answer the following question:
DFA’s business practices of trying to avoid the lemons problem while not doing any
fundamental analysis suggest that they believe ___ form of market efficiency but
worried that ___ form of market efficiency might fail.
Selected Answer:
Semi-strong; Strong
Answers:
Semi-strong; Strong
Strong; Semi-strong

Question 4
10 out of 10 points
Read Chapter 11.4 and then answer the following question: Do size and value effects
mean that small stocks outperform large stocks or value stocks outperform growth
stocks in every year/every month?
Selected Answer:
A.
No
Answers:
A.
No
B.
Yes

Question 5
10 out of 10 points
Read textbook chapter 9 and answer the following questions: Small or value stocks
appear underpriced in which models?
Selected Answer:
A.
the CAPM model.
Answers:
A.
the CAPM model.
B.
the Fama-French 3-factor model.
C.
No model suggests that small or value stocks are undervalued.

Question 6
10 out of 10 points
Select all the models that may suggest that small or value stocks are fairly priced?
(choose the best answer)
Selected Answer:
D.
the APT model and the Fama-French 3-factor model
Answers:
A.
No models suggest that small or value stocks are fairly priced.
B.
the Fama-French 3-factor model
C.
the APT model
D.
the APT model and the Fama-French 3-factor model

Question 7
10 out of 10 points
Google is a big stock and LinkedIN is a small stock, but at the same time Google has
a higher book-to-market ratio than LindedIN. According to the size effect, Google
should have lower return than LinkedIN because its size is bigger; but according to
the value effect, Google should have higher return than LinkedIN because its book to
market ratio is higher. Is the above statement correct? Why?
Selected
Answer:
Incorrect. Size and value effects is a portfolio-based strategy not a individual
stock-based strategy. The effects mainly hold at the portfolio level where
individual stock noises are diversified away.
Answers:
Incorrect. Size and value effects is a portfolio-based strategy not a individual
stock-based strategy. The effects mainly hold at the portfolio level where
individual stock noises are diversified away.
Correct. So size and value effects may not work well for individual stocks
that have conflicting signals based on size and book-to-market ratios.

Question 8
10 out of 10 points
Read Chapter 11.4 and then answer the following question: Do size and value effects
mean that any small stock tends to outperform large stock and that any value stock
tends to outperform growth stock?
Selected Answer:
A.
No
Answers:
A.
No
B.
Yes

Question 9
10 out of 10 points
What are the products below that makes the most sense for real believers of
market efficiency to offer to their clients? Suppose everyone lives in a Fama-French
three-factor model world?
Selected Answer:
F.
Any random portfolio of stocks
Answers:
A.
Only risk-free assets
B.
Only small stock portfolio
C.
Only large stock portfolio
D.
Only large or growth portfolios
E.
Only S&P 500
F.
Any random portfolio of stocks
G.
Only small or value portfolios

Question 10
50 out of 50 points
What are the rational and irrational reasons you think that may lead to high returns in
small and value stocks?

Selected
Answer:
I think that the irrational reasons are that small stocks are generally less tracked
by analysts, leaving them undiscovered. This also makes investing in them a
riskier, but also the reward of ending a hidden jewel can be great. Moreover,
small cap stocks cannot be bought and sold o immediately. A prompt exit might
not be feasible. But when you let a small cap stock grow and blossom, which
takes time, it will yield high returns.
On the other side, the rational reasons could be that the economic policies of
some countries are more focused on providing incentives and support to small
companies. Furthermore, sometimes, high value stocks underperform due to less
demand and high prices. Lastly, value stocks generally have more upside
potential compared to growth stocks. This is because growth stocks tend to
already possess high valuations with positive expectations. Thus, it is difficult for
growth stocks to grow compared to their undervalued counterpart.
Correct
Answer:
[None]
Question 11
10 out of 10 points
Which of the following outcome(s) are most likely to be inconsistent with the
efficient market hypothesis in a Fama-French three-factor world?
Selected
Answer:
All stocks have the same return on average.
Answers:
Even though DFA recently offered small and value portfolios, which
focus on earning the high returns in small and value stocks, investors
do not feel such stock portfolios offer more attractive investment
opportunities in terms of risk-return tradeoff than other stock
portfolios.
All stocks have the same return on average.
Small and value stocks on average have higher returns than large and
growth stocks, respectively.
Higher market beta stocks have higher returns.

Question 12
10 out of 10 points
What are the three pillars of DFA's business strategy?
Selected Answer:
D.
Academic research, market efficiency, skillful traders
Answers:
A.
Skillful traders
B.
Academic research, market
efficiency
C.
Market efficiency
D.
Academic research, market efficiency, skillful traders

Question 1
10 out of 10 points
Calculate holding period return and expected return
You put up $50 at the beginning of the year for an investment. The value of the
investment grows 4% and you earn a dividend of $3.50. Your HPR was ____.
Selected Answer:
B.
11%
Answers:
A.
4%
B.
11%
C.
3.5%
D.
7%

Question 2
10 out of 10 points
Variance and volatility of a portfolio
You put half of your money in a stock portfolio that has an expected return of 14%
and a standard deviation of 24%. You put the rest of your money in a risky bond
portfolio that has an expected return of 6% and a standard deviation of 12%. The
stock and bond portfolios have a correlation of .55. The standard deviation of the
resulting portfolio will be ________________.
Selected Answer:
D.
more than 12% but less than 18%
Answers:
A.
equal to 18%
B.
equal to 12%
C.
more than 18% but less than 24%
D.
more than 12% but less than 18%
Response
Feedback:

σ2p = .02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12).55 =
.02592; σ = 16.1%
Question 3
10 out of 10 points
Understanding risk premium
The market risk premium is defined as __________.
Selected
Answer:
D.
the difference between the expected return on an index
fund and the return on Treasury bills
Answers:
A.
the difference between the return on a small-firm mutual fund and the
return on the Standard & Poor's 500 Index
B.
the difference between the return on the risky asset with the lowest
returns and the return on Treasury bills
C.
the difference between the return on the highest-yielding asset and the
return on the lowest-yielding asset
D.
the difference between the expected return on an index
fund and the return on Treasury bills

Question 4
10 out of 10 points
Expected return and volatility of a portfolio
An investor invests 70% of her wealth in a risky asset with an expected rate of return
of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her
portfolio's expected rate of return and standard deviation are __________ and
__________ respectively
Selected Answer:
A.
12%; 15.7%
Answers:
A.
12%; 15.7%
B.
10%; 35%
C.
12%; 22.4%
D.
10%; 6.7%
Response Feedback: E(r) = .7(.15) + .3(.05) = .12

Question 5
10 out of 10 points
Risk that can be eliminated through diversification is called ______ risk.
Selected Answer:
C.
all of these options
Answers:
A.
firm-specific
B.
diversifiable
C.
all of these options
D.
unique

Question 6
10 out of 10 points
On a standard expected return versus standard deviation graph, investors
will prefer portfolios that lie to the _____________ of the current
investment opportunity set.
Selected Answer:
B.
left and above
Answers:
A.
right and above
B.
left and above
C.
left and below
D.
right and below

Question 7
10 out of 10 points
Beta is a measure of security responsiveness to _________.
Selected Answer:
B.
market risk
Answers:
A.
diversifiable risk
B.
market risk
C.
firm-specific risk
D.
unique risk

Question 8
10 out of 10 points
Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning
a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this
investment?
Selected Answer:
D.
9.2%
Answers:
A.
12.8%
B.
8.9%
C.
11%
D.
9.2%
Response Feedback: (.2)(30%) + (.5)(10%) + (.3)(-6%) = 9.2%

Question 9
10 out of 10 points
Which of the following provides the best example of a systematic-risk
event?
Selected
Answer:
A.
The Federal Reserve increases interest rates 50 basis points.
Answers:
A.
The Federal Reserve increases interest rates 50 basis points.
B.
A strike by union workers hurts a firm's quarterly earnings.
C.
Mad Cow disease in Montana hurts local ranchers and buyers of beef.
D.
A senior executive at a firm embezzles $10 million and escapes to
South America.

Question 10
10 out of 10 points
You have the following rates of return for a risky portfolio for several recent years:
If you invested $1,000 at the beginning of 2008, your investment at the end of 2011
would be worth ___________.
Selected Answer:
A.
$1,785.56
Answers:
A.
$1,785.56
B.
$1,247.87
C.
$1,645.53
D.
$2,176.60
Response Feedback: $1,000(1.3523)(1.1867)(1 + -.0987)(1.2345) = $1,785.56

Question 11
10 out of 10 points
Calculate standard deviation
Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of
earning a 10% rate of return, and a 10% chance of losing 3%. What is the standard
deviation of this investment?
Selected Answer:
A.
5.14%
Answers:
A.
5.14%
B.
7.59%
C.
8.43%
D.
9.29%

Question 12
10 out of 10 points
Suppose that a stock portfolio and a bond portfolio have a zero correlation.
This means that ______.
Selected
Answer:
D.
the returns on the stock and bond portfolios tend to vary independently
of each other
Answers:
A.
the covariance of the stock and bond portfolios will be positive
B.
the returns on the stock and bond portfolios tend to move together
C.
the returns on the stock and bond portfolios tend to move inversely
D.
the returns on the stock and bond portfolios tend to vary independently
of each other

Question 13
10 out of 10 points
One method of forecasting the risk premium is to use the _______.
Selected Answer:
D.
average historical excess returns for the asset under consideration
Answers:
A.
variations in the risk-free rate over time
B.
average abnormal return on the index portfolio
C.
coefficient of variation of analysts' earnings forecasts
D.
average historical excess returns for the asset under consideration

Question 14
10 out of 10 points
CAPM and mean variance frontier
Diversification is most effective when security returns are _________.
Selected Answer:
D.
negatively correlated
Answers:
A.
positively correlated
B.
uncorrelated
C.
high
D.
negatively correlated

Question 1
10 out of 10 points
Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock
A are ______ sensitive to changes in the market than are the returns of
stock B.
Selected Answer:
B.
20% more
Answers:
A.
20% less
B.
20% more
C.
slightly less
D.
slightly more

Question 2
10 out of 10 points
The market portfolio has a beta of _________.
Selected Answer:
A.
1
Answers:
A.
1
B.
0
C.
.5
D.
-1

Question 3
10 out of 10 points
According to capital asset pricing theory, the key determinant of portfolio
returns is _________.
Selected Answer:
C.
the systematic risk of the portfolio
Answers:
A.
the firm-specific risk of the portfolio
B.
the degree of diversification
C.
the systematic risk of the portfolio
D.
economic factors

Question 4
10 out of 10 points
According to the capital asset pricing model, fairly priced securities have ______
Selected Answer:
D. zero alphas
Answers:
A. negative betas
B. positive alphas
C. positive betas
D. zero alphas

Question 5
10 out of 10 points
A stock has a book value of$100 per share but a market value of $2000. Which of the
following is likely true, if you live in the CAPM world:
I. Investors expect very high growth in the earnings of this company
II. The stock is likely to be over-valued by the market
III. The stock pays a fixed but a large amount of dividend each quarter
Selected Answer:
A. I and II only
Answers:
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III

Question 6
10 out of 10 points
Market efficiency means:
Selected Answer:
Today’s price already reflects all the available information
Answers:
Today’s price already reflects all the available information
All stocks should have the same expected returns
Risky assets’ return should be lower than riskless assets’ return
Stock market return should be equal to bond market return

Question 7
10 out of 10 points
Which of the following variables do Fama and French claim do a better job explaining
stock returns than beta?
I. Book-to-market ratio
II. Unexpected change in industrial production
III. Firm size
Selected Answer:
C. I and III only
Answers:
A. I only
B. I and II only
C. I and III only
D. I, II, and III

Question 8
What is the expected return for a portfolio with a beta of .5?
10 out of 10 points
Selected Answer:
A.
7.5%
Answers:
A.
7.5%
B.
12.5%
C.
15%
D.
5%

Question 9
10 out of 10 points
Consider the CAPM. The risk-free rate is 6%, and the expected return on
the market is 18%. What is the expected return on a stock with a beta of
1.3?
Selected Answer:
Answers:
A.
21.6%
A.
21.6%
B.
15.6%
C.
18%
D.
6%
Response Feedback: E[rs] = 6% + [18% - 6%](1.3) = 21.6%

Question 10
10 out of 10 points
According to CAPM, Investors require a risk premium as compensation for
bearing ______________.
Selected Answer:
D.
systematic risk
Answers:
A.
unsystematic risk
B.
alpha risk
C.
residual risk
D.
systematic risk

Question 11
10 out of 10 points
Beta is a measure of ______________.
Selected Answer:
C.
relative systematic risk
Answers:
A.
relative nonsystematic risk
B.
relative business risk
C.
relative systematic risk
D.
total risk

Question 12
10 out of 10 points
A stock has a beta of 1.3. The systematic risk of this stock is ____________
the stock market as a whole.
Selected Answer:
A.
higher than
Answers:
A.
higher than
B.
equal to
C.
indeterminable compared to
D.
lower than

Question 13
10 out of 10 points
If enough investors decide to purchase stocks, they are likely to drive up
stock prices, thereby causing _____________ and ___________.
Selected Answer:
A.
expected returns to fall; risk premiums to fall
Answers:
A.
expected returns to fall; risk premiums to fall
B.
expected returns to rise; risk premiums to rise
C.
expected returns to fall; risk premiums to rise
D.
expected returns to rise; risk premiums to fall