Chapter 01 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. The material wealth of a society is a function of
A. all financial assets.
B. all real assets.
C. all financial and real assets.
D. all physical assets.
2. _______ are real assets.
A. Land
B. Machines
C. Stocks and bonds
D. Knowledge
E. Land, machines, and knowledge
3. The means by which individuals hold their claims on real assets in a well-developed economy are
A. investment assets.
B. depository assets.
C. derivative assets.
D. financial assets.
E. exchange-driven assets.
4. _______ are financial assets.
A. Bonds
B. Machines
C. Stocks
D. Bonds and stocks
E. Bonds, machines, and stocks
5. _________ financial asset(s).
A. Buildings are
B. Land is a
C. Derivatives are
D. U.S. agency bonds are
E. Derivatives and U.S. agency bonds are
6. Financial assets
A. directly contribute to the country's productive capacity.
B. indirectly contribute to the country's productive capacity.
C. contribute to the country's productive capacity, both directly and indirectly.
D. do not contribute to the country's productive capacity, either directly or indirectly.
E. are of no value to anyone.
1-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7. In 2016, ____________ was the most significant real asset of U.S. households in terms of total value.
A. consumer durables
B. automobiles
C. real estate
D. mutual fund shares
E. bank loans
8. In 2016, ____________ was the least significant financial asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
9. In 2016, ____________ was the most significant financial asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
10. In 2016, ____________ was the most significant asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
11. In 2016, ____________ were the most significant liability of U.S. households in terms of total value.
A. credit cards
B. mortgages
C. bank loans
D. student loans
E. other forms of debt
12. In 2016, which of the following financial assets make up the greatest proportion of the financial assets held by U.S. households?
A. Pension reserves
B. Life insurance reserves
C. Mutual fund shares
D. Debt securities
E. Personal trusts
13. In 2016, _______ of the assets of U.S. households were financial assets as opposed to tangible assets.
A. 20.4%
B. 34.2%
C. 69.4%
D. 71.7%
E. 82.5%
1-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
14. The largest component of domestic net worth in 2016 was
A. nonresidential real estate.
B. residential real estate.
C. inventories.
D. consumer durables.
E. equipment and software.
15. The smallest component of domestic net worth in 2016 was
A. nonresidential real estate.
B. residential real estate.
C. inventories.
D. consumer durables.
E. equipment and software.
16. The domestic net worth of the U.S. in 2016 was
A. $15.411 trillion.
B. $26.431 trillion.
C. $42.669 trillion.
D. $64.747 trillion.
E. $70.983 trillion.
17. A fixed-income security pays
A. a fixed level of income for the life of the owner.
B. a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security.
C. a variable level of income for owners on a fixed income.
D. a fixed or variable income stream at the option of the owner.
18. A debt security pays
A. a fixed level of income for the life of the owner.
B. a variable level of income for owners on a fixed income.
C. a fixed or variable income stream at the option of the owner.
D. a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security.
19. Money market securities
A. are short term.
B. are highly marketable.
C. are generally very low risk.
D. are highly marketable and are generally very low risk.
E. All of the options.
20. An example of a derivative security is
A. a common share of Microsoft.
B. a call option on Intel stock.
C. a commodity futures contract.
D. a call option on Intel stock and a commodity futures contract.
E. a common share of Microsoft and a call option on Intel stock.
1-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
21. The value of a derivative security
A. depends on the value of the related security.
B. is unable to be calculated.
C. is unrelated to the value of the related security.
D. has been enhanced due to the recent misuse and negative publicity regarding these instruments.
E. is worthless today.
22. Although derivatives can be used as speculative instruments, businesses most often use them to
A. attract customers.
B. appease stockholders.
C. offset debt.
D. hedge risks.
E. enhance their balance sheets.
23. Financial assets permit all of the following except
A. consumption timing.
B. allocation of risk.
C. separation of ownership and control.
D. elimination of risk.
24. The ____________ refers to the potential conflict between management and shareholders.
A. agency problem
B. diversification problem
C. liquidity problem
D. solvency problem
E. regulatory problem
25. A disadvantage of using stock options to compensate managers is that
A. it encourages managers to undertake projects that will increase stock price.
B. it encourages managers to engage in empire building.
C. it can create an incentive for managers to manipulate information to prop up a stock price temporarily, giving them a chance to cash
out before the price returns to a level reflective of the firm's true prospects.
D. All of the above.
26. Which of the following are mechanisms that have evolved to mitigate potential agency problems?
I) Using the firm's stock options for compensation
II) Hiring bickering family members as corporate spies
III) Boards of directors forcing out underperforming management
IV) Security analysts monitoring the firm closely
V) Takeover threats
A. II and V
B. I, III, and IV
C. I, III, IV, and V
D. III, IV, and V
E. I, III, and V
1-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
27. Corporate shareholders are best protected from incompetent management decisions by
A. the ability to engage in proxy fights.
B. management's control of pecuniary rewards.
C. the ability to call shareholder meetings.
D. the threat of takeover by other firms.
E. one-share/one-vote election rules.
28. Theoretically, takeovers should result in
A. improved management.
B. increased stock price.
C. increased benefits to existing management of the taken-over firm.
D. improved management and increased stock price.
E. All of the options.
29. During the period between 2000 and 2002, a large number of scandals were uncovered. Most of these scandals were related to
I) manipulation of financial data to misrepresent the actual condition of the firm.
II) misleading and overly optimistic research reports produced by analysts.
III) allocating IPOs to executives as a quid pro quo for personal favors.
IV) greenmail.
A. II, III, and IV
B. I, II, and IV
C. II and IV
D. I, III, and IV
E. I, II, and III
30. The Sarbanes-Oxley Act
A. requires corporations to have more independent directors.
B. requires the firm's CFO to personally vouch for the firm's accounting statements.
C. prohibits auditing firms from providing other services to clients.
D. requires corporations to have more independent directors and requires the firm's CFO to personally vouch for the firm's accounting
statements.
E. All of the above.
31. Asset allocation refers to
A. choosing which securities to hold based on their valuation.
B. investing only in "safe" securities.
C. the allocation of assets into broad asset classes.
D. bottom-up analysis.
32. Security selection refers to
A. choosing which securities to hold based on their valuation.
B. investing only in "safe" securities.
C. the allocation of assets into broad asset classes.
D. top-down analysis.
1-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
33. Which of the following portfolio construction methods starts with security analysis?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
34. Which of the following portfolio construction methods starts with asset allocation?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
35. _______ are examples of financial intermediaries.
A. Commercial banks
B. Insurance companies
C. Investment companies
D. Credit unions
E. All of the options
36. Financial intermediaries exist because small investors cannot efficiently
A. diversify their portfolios.
B. assess credit risk of borrowers.
C. advertise for needed investments.
D. diversify their portfolios and assess credit risk of borrowers.
E. All of the options.
37. ________ specialize in helping companies raise capital by selling securities.
A. Commercial bankers
B. Investment bankers
C. Investment issuers
D. Credit raters
38. Commercial banks differ from other businesses in that both their assets and their liabilities are mostly
A. illiquid.
B. financial.
C. real.
D. owned by the government.
E. regulated.
39. In 2016, ____________ was(were) the most significant financial asset(s) of U.S. commercial banks in terms of total value.
A. loans and leases
B. cash
C. real estate
D. deposits
E. investment securities
1-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
40. In 2016, ____________ was(were) the most significant liability(ies) of U.S. commercial banks in terms of total value.
A. loans and leases
B. cash
C. real estate
D. deposits
E. investment securities
41. In 2016, ____________ was(were) the most significant real asset(s) of U.S. nonfinancial businesses in terms of total value.
A. equipment and software
B. inventory
C. real estate
D. trade credit
E. marketable securities
42. In 2016, ____________ was(were) the least significant real asset(s) of U.S. nonfinancial businesses in terms of total value.
A. equipment and software
B. inventory
C. real estate
D. trade credit
E. marketable securities
43. In 2016, ____________ was(were) the least significant liability(ies) of U.S. nonfinancial businesses in terms of total value.
A. bonds and mortgages
B. bank loans
C. inventories
D. trade debt
E. marketable securities
44. In terms of total value, the most significant liability(ies) of U.S. nonfinancial businesses in 2016 was(were)
A. bank loans.
B. bonds and mortgages.
C. trade debt.
D. other loans.
E. marketable securities.
45. In 2016, ____________ was(were) the least significant financial asset(s) of U.S. nonfinancial businesses in terms of total value.
A. cash and deposits
B. trade credit
C. trade debt
D. inventory
E. marketable securities
46. New issues of securities are sold in the ________ market(s).
A. primary
B. secondary
C. over-the-counter
D. primary and secondary
1-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
47. Investors trade previously issued securities in the ________ market(s).
A. primary
B. secondary
C. primary and secondary
D. derivatives
48. Investment bankers perform which of the following role(s)?
A. Market new stock and bond issues for firms
B. Provide advice to the firms as to market conditions, price, etc.
C. Design securities with desirable properties
D. All of the options
E. None of the options
49. Until 1999, the ________ Act(s) prohibited banks in the United States from both accepting deposits and underwriting securities.
A. Sarbanes-Oxley
B. Glass-Steagall
C. SEC
D. Sarbanes-Oxley and SEC
E. None of the options
50. The spread between the LIBOR and the Treasury-bill rate is called the
A. term spread.
B. T-bill spread.
C. LIBOR spread.
D. TED spread.
51. Mortgage-backed securities were created when ________ began buying mortgage loans from originators and bundling them into
large pools that could be traded like any other financial asset.
A. GNMA
B. FNMA
C. FHLMC
D. FNMA and FHLMC
E. GNMA and FNMA
52. The sale of a mortgage portfolio by setting up mortgage pass-through securities is an example of
A. credit enhancement.
B. credit swap.
C. unbundling.
D. derivatives.
1-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
53. Which of the following is true about mortgage-backed securities?
I) They aggregate individual home mortgages into homogeneous pools.
II) The purchaser receives monthly interest and principal payments received from payments made on the pool.
III) The banks that originated the mortgages maintain ownership of them.
IV) The banks that originated the mortgages may continue to service them.
A. II, III, and IV
B. I, II, and IV
C. II and IV
D. I, III, and IV
E. I, II, III, and IV
54. ________ were designed to concentrate the credit risk of a bundle of loans on one class of investor, leaving the other investors in
the pool relatively protected from that risk.
A. Stocks
B. Bonds
C. Derivatives
D. Collateralized debt obligations
E. All of the options
55. ________ are, in essence, an insurance contract against the default of one or more borrowers.
A. Credit default swaps
B. CMOs
C. ETFs
D. Collateralized debt obligations
E. All of the options
Chapter 01 Test Bank - Static Key
Multiple Choice Questions
1. The material wealth of a society is a function of
A. all financial assets.
B. all real assets.
C. all financial and real assets.
D. all physical assets.
The material wealth of a society is a function of all real assets.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
1-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
2. _______ are real assets.
A. Land
B. Machines
C. Stocks and bonds
D. Knowledge
E. Land, machines, and knowledge
Land, machines and knowledge are real assets; stocks and bonds are financial assets.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
3. The means by which individuals hold their claims on real assets in a well-developed economy are
A. investment assets.
B. depository assets.
C. derivative assets.
D. financial assets.
E. exchange-driven assets.
Financial assets allocate the wealth of the economy. Example: it is easier for an individual to own shares of an auto company than to
own an auto company directly.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
4. _______ are financial assets.
A. Bonds
B. Machines
C. Stocks
D. Bonds and stocks
E. Bonds, machines, and stocks
Machines are real assets; stocks and bonds are financial assets.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
5. _________ financial asset(s).
A. Buildings are
B. Land is a
C. Derivatives are
D. U.S. agency bonds are
E. Derivatives and U.S. agency bonds are
Buildings and land are real assets.
1-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
6. Financial assets
A. directly contribute to the country's productive capacity.
B. indirectly contribute to the country's productive capacity.
C. contribute to the country's productive capacity, both directly and indirectly.
D. do not contribute to the country's productive capacity, either directly or indirectly.
E. are of no value to anyone.
Financial assets indirectly contribute to the country's productive capacity because these assets permit individuals to invest in firms and
governments. This in turn allows firms and governments to increase productive capacity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Real and financial assets
7. In 2016, ____________ was the most significant real asset of U.S. households in terms of total value.
A. consumer durables
B. automobiles
C. real estate
D. mutual fund shares
E. bank loans
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
8. In 2016, ____________ was the least significant financial asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
1-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9. In 2016, ____________ was the most significant financial asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
10. In 2016, ____________ was the most significant asset of U.S. households in terms of total value.
A. real estate
B. mutual fund shares
C. debt securities
D. life insurance reserves
E. pension reserves
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
11. In 2016, ____________ were the most significant liability of U.S. households in terms of total value.
A. credit cards
B. mortgages
C. bank loans
D. student loans
E. other forms of debt
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Debt financing
12. In 2016, which of the following financial assets make up the greatest proportion of the financial assets held by U.S. households?
A. Pension reserves
B. Life insurance reserves
C. Mutual fund shares
D. Debt securities
E. Personal trusts
See Table 1.1.
1-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
13. In 2016, _______ of the assets of U.S. households were financial assets as opposed to tangible assets.
A. 20.4%
B. 34.2%
C. 69.4%
D. 71.7%
E. 82.5%
See Table 1.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
14. The largest component of domestic net worth in 2016 was
A. nonresidential real estate.
B. residential real estate.
C. inventories.
D. consumer durables.
E. equipment and software.
See Table 1.2.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
15. The smallest component of domestic net worth in 2016 was
A. nonresidential real estate.
B. residential real estate.
C. inventories.
D. consumer durables.
E. equipment and software.
See Table 1.2.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
1-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
16. The domestic net worth of the U.S. in 2016 was
A. $15.411 trillion.
B. $26.431 trillion.
C. $42.669 trillion.
D. $64.747 trillion.
E. $70.983 trillion.
See Table 1.2.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
17. A fixed-income security pays
A. a fixed level of income for the life of the owner.
B. a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security.
C. a variable level of income for owners on a fixed income.
D. a fixed or variable income stream at the option of the owner.
A fixed-income security pays a fixed stream of income or a stream of income that is determined according to a specified formula for
the life of the security.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fixed-income securities
18. A debt security pays
A. a fixed level of income for the life of the owner.
B. a variable level of income for owners on a fixed income.
C. a fixed or variable income stream at the option of the owner.
D. a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security.
A debt security pays a fixed stream of income or a stream of income that is determined according to a specified formula for the life of
the security.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fixed-income securities
19. Money market securities
A. are short term.
B. are highly marketable.
C. are generally very low risk.
D. are highly marketable and are generally very low risk.
E. All of the options.
All answers are correct.
1-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
20. An example of a derivative security is
A. a common share of Microsoft.
B. a call option on Intel stock.
C. a commodity futures contract.
D. a call option on Intel stock and a commodity futures contract.
E. a common share of Microsoft and a call option on Intel stock.
The values of a call option on Intel stock and a commodity futures contract are derived from that of an underlying asset; the value of a
common share of Microsoft is based on the value of the firm only.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Derivatives general
21. The value of a derivative security
A. depends on the value of the related security.
B. is unable to be calculated.
C. is unrelated to the value of the related security.
D. has been enhanced due to the recent misuse and negative publicity regarding these instruments.
E. is worthless today.
Of the factors cited above, only the value of the related security affects the value of the derivative and/or is a true statement.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Derivatives general
22. Although derivatives can be used as speculative instruments, businesses most often use them to
A. attract customers.
B. appease stockholders.
C. offset debt.
D. hedge risks.
E. enhance their balance sheets.
Firms may use forward contracts and futures to protect against currency fluctuations or changes in commodity prices. Interest-rate
options help companies control financing costs.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Derivatives general
1-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
23. Financial assets permit all of the following except
A. consumption timing.
B. allocation of risk.
C. separation of ownership and control.
D. elimination of risk.
Financial assets do not allow risk to be eliminated. However, they do permit allocation of risk, consumption timing, and separation of
ownership and control.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Real and financial assets
24. The ____________ refers to the potential conflict between management and shareholders.
A. agency problem
B. diversification problem
C. liquidity problem
D. solvency problem
E. regulatory problem
The agency problem describes potential conflict between management and shareholders. The other problems are those of firm
management only.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Agency problems and issues
25. A disadvantage of using stock options to compensate managers is that
A. it encourages managers to undertake projects that will increase stock price.
B. it encourages managers to engage in empire building.
C. it can create an incentive for managers to manipulate information to prop up a stock price temporarily, giving them a chance to
cash out before the price returns to a level reflective of the firm's true prospects.
D. All of the above.
Encouraging managers to undertake projects that will increase stock price is a desired characteristic. Encouraging managers to engage
in empire building is not necessarily a good or bad thing in and of itself. Creating an incentive for managers to manipulate information
to prop up a stock price temporarily creates an agency problem.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Employee stock options
1-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
26. Which of the following are mechanisms that have evolved to mitigate potential agency problems?
I) Using the firm's stock options for compensation
II) Hiring bickering family members as corporate spies
III) Boards of directors forcing out underperforming management
IV) Security analysts monitoring the firm closely
V) Takeover threats
A. II and V
B. I, III, and IV
C. I, III, IV, and V
D. III, IV, and V
E. I, III, and V
All the options except hiring bickering family members as corporate spies have been used to try to limit agency problems.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Agency problems and issues
27. Corporate shareholders are best protected from incompetent management decisions by
A. the ability to engage in proxy fights.
B. management's control of pecuniary rewards.
C. the ability to call shareholder meetings.
D. the threat of takeover by other firms.
E. one-share/one-vote election rules.
Proxy fights are expensive and seldom successful, and management may often control the board or own significant shares. It is the
threat of takeover of underperforming firms that has the strongest ability to keep management on their toes.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Agency problems and issues
28. Theoretically, takeovers should result in
A. improved management.
B. increased stock price.
C. increased benefits to existing management of the taken-over firm.
D. improved management and increased stock price.
E. All of the options.
Theoretically, when firms are taken over, better managers come in and thus increase the price of the stock; existing management often
must either leave the firm, be demoted, or suffer a loss of existing benefits.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Agency problems and issues
1-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
29. During the period between 2000 and 2002, a large number of scandals were uncovered. Most of these scandals were related to
I) manipulation of financial data to misrepresent the actual condition of the firm.
II) misleading and overly optimistic research reports produced by analysts.
III) allocating IPOs to executives as a quid pro quo for personal favors.
IV) greenmail.
A. II, III, and IV
B. I, II, and IV
C. II and IV
D. I, III, and IV
E. I, II, and III
I, II, and III are all mentioned as causes of recent scandals.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Ethics and corporate governance
30. The Sarbanes-Oxley Act
A. requires corporations to have more independent directors.
B. requires the firm's CFO to personally vouch for the firm's accounting statements.
C. prohibits auditing firms from providing other services to clients.
D. requires corporations to have more independent directors and requires the firm's CFO to personally vouch for the firm's accounting
statements.
E. All of the above.
The Sarbanes-Oxley Act does all of the above.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Financial market regulation and protections
31. Asset allocation refers to
A. choosing which securities to hold based on their valuation.
B. investing only in "safe" securities.
C. the allocation of assets into broad asset classes.
D. bottom-up analysis.
Asset allocation refers to the allocation of assets into broad asset classes.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Asset allocation and security selection
1-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
32. Security selection refers to
A. choosing which securities to hold based on their valuation.
B. investing only in "safe" securities.
C. the allocation of assets into broad asset classes.
D. top-down analysis.
Security selection refers to choosing which securities to hold based on their valuation.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Asset allocation and security selection
33. Which of the following portfolio construction methods starts with security analysis?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
Bottom-up refers to using security analysis to find securities that are attractively priced. Top-down refers to using asset allocation as a
starting point.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Portfolio construction
34. Which of the following portfolio construction methods starts with asset allocation?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
Bottom-up refers to using security analysis to find securities that are attractively priced.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Portfolio construction
35. _______ are examples of financial intermediaries.
A. Commercial banks
B. Insurance companies
C. Investment companies
D. Credit unions
E. All of the options
All are institutions that bring borrowers and lenders together.
1-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
36. Financial intermediaries exist because small investors cannot efficiently
A. diversify their portfolios.
B. assess credit risk of borrowers.
C. advertise for needed investments.
D. diversify their portfolios and assess credit risk of borrowers.
E. All of the options.
The individual investor cannot efficiently and effectively perform any of the tasks above without more time and knowledge than that
available to most individual investors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
37. ________ specialize in helping companies raise capital by selling securities.
A. Commercial bankers
B. Investment bankers
C. Investment issuers
D. Credit raters
An important role of investment banking is to act as middlemen in helping firms place new issues in the market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
38. Commercial banks differ from other businesses in that both their assets and their liabilities are mostly
A. illiquid.
B. financial.
C. real.
D. owned by the government.
E. regulated.
See Table 1.3.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
1-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
39. In 2016, ____________ was(were) the most significant financial asset(s) of U.S. commercial banks in terms of total value.
A. loans and leases
B. cash
C. real estate
D. deposits
E. investment securities
See Table 1.3.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
40. In 2016, ____________ was(were) the most significant liability(ies) of U.S. commercial banks in terms of total value.
A. loans and leases
B. cash
C. real estate
D. deposits
E. investment securities
See Table 1.3.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
41. In 2016, ____________ was(were) the most significant real asset(s) of U.S. nonfinancial businesses in terms of total value.
A. equipment and software
B. inventory
C. real estate
D. trade credit
E. marketable securities
See Table 1.4.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
42. In 2016, ____________ was(were) the least significant real asset(s) of U.S. nonfinancial businesses in terms of total value.
A. equipment and software
B. inventory
C. real estate
D. trade credit
E. marketable securities
See Table 1.4.
1-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
43. In 2016, ____________ was(were) the least significant liability(ies) of U.S. nonfinancial businesses in terms of total value.
A. bonds and mortgages
B. bank loans
C. inventories
D. trade debt
E. marketable securities
See Table 1.4.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Debt financing
44. In terms of total value, the most significant liability(ies) of U.S. nonfinancial businesses in 2016 was(were)
A. bank loans.
B. bonds and mortgages.
C. trade debt.
D. other loans.
E. marketable securities.
See Table 1.4.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Debt financing
45. In 2016, ____________ was(were) the least significant financial asset(s) of U.S. nonfinancial businesses in terms of total value.
A. cash and deposits
B. trade credit
C. trade debt
D. inventory
E. marketable securities
See Table 1.4.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Real and financial assets
1-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
46. New issues of securities are sold in the ________ market(s).
A. primary
B. secondary
C. over-the-counter
D. primary and secondary
New issues of securities are sold in the primary market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Primary and secondary markets
47. Investors trade previously issued securities in the ________ market(s).
A. primary
B. secondary
C. primary and secondary
D. derivatives
Investors trade previously issued securities in the secondary market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Primary and secondary markets
48. Investment bankers perform which of the following role(s)?
A. Market new stock and bond issues for firms
B. Provide advice to the firms as to market conditions, price, etc.
C. Design securities with desirable properties
D. All of the options
E. None of the options
Investment bankers perform all of the roles described above for their clients.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
49. Until 1999, the ________ Act(s) prohibited banks in the United States from both accepting deposits and underwriting securities.
A. Sarbanes-Oxley
B. Glass-Steagall
C. SEC
D. Sarbanes-Oxley and SEC
E. None of the options
Until 1999, the Glass-Steagall Act prohibited banks in the United States from both accepting deposits and underwriting securities.
1-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial market regulation and protections
50. The spread between the LIBOR and the Treasury-bill rate is called the
A. term spread.
B. T-bill spread.
C. LIBOR spread.
D. TED spread.
The spread between the LIBOR and the Treasury-bill rate is called the TED spread.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Interest rates
51. Mortgage-backed securities were created when ________ began buying mortgage loans from originators and bundling them into
large pools that could be traded like any other financial asset.
A. GNMA
B. FNMA
C. FHLMC
D. FNMA and FHLMC
E. GNMA and FNMA
Mortgage-backed securities were created when FNMA and FHLMC began buying mortgage loans from originators and bundling them
into large pools that could be traded like any other financial asset.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Mortgage securities and issues
52. The sale of a mortgage portfolio by setting up mortgage pass-through securities is an example of
A. credit enhancement.
B. credit swap.
C. unbundling.
D. derivatives.
The financial asset is secured by the mortgages backing the instrument.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Mortgage securities and issues
1-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
53. Which of the following is true about mortgage-backed securities?
I) They aggregate individual home mortgages into homogeneous pools.
II) The purchaser receives monthly interest and principal payments received from payments made on the pool.
III) The banks that originated the mortgages maintain ownership of them.
IV) The banks that originated the mortgages may continue to service them.
A. II, III, and IV
B. I, II, and IV
C. II and IV
D. I, III, and IV
E. I, II, III, and IV
III is not correct because the bank no longer owns the mortgage investments.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Mortgage securities and issues
54. ________ were designed to concentrate the credit risk of a bundle of loans on one class of investor, leaving the other investors in
the pool relatively protected from that risk.
A. Stocks
B. Bonds
C. Derivatives
D. Collateralized debt obligations
E. All of the options
Collateralized debt obligations were designed to concentrate the credit risk of a bundle of loans on one class of investor, leaving the
other investors in the pool relatively protected from that risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Collateralized mortgage obligations
55. ________ are, in essence, an insurance contract against the default of one or more borrowers.
A. Credit default swaps
B. CMOs
C. ETFs
D. Collateralized debt obligations
E. All of the options
Credit default swaps are in essence an insurance contract against the default of one or more borrowers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Swaps
Chapter 01 Test Bank - Static Summary
1-25
Copyright © 2017 McGraw-Hill Education. All rights reserved.Category
No reproduction or distribution without the prior#written
consent of McGraw-Hill Education.
of Questions
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Topic: Agency problems and issues
Topic: Asset allocation and security selection
Topic: Collateralized mortgage obligations
Topic: Debt financing
Topic: Derivatives - general
Topic: Employee stock options
Topic: Ethics and corporate governance
Topic: Financial intermediaries and market participants
Topic: Financial market regulation and protections
Topic: Fixed-income securities
Topic: Interest rates
Topic: Money market securities
Topic: Mortgage securities and issues
Topic: Portfolio construction
Topic: Primary and secondary markets
Topic: Real and financial assets
Topic: Swaps
55
55
43
12
40
15
4
2
1
3
3
1
1
7
2
2
1
1
3
2
2
19
1
1-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 02 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Which of the following is not a characteristic of a money market instrument?
A. Liquidity
B. Marketability
C. Long maturity
D. Liquidity premium
E. Long maturity and liquidity premium
2. The money market is a subsector of the
A. commodity market.
B. capital market.
C. derivatives market.
D. equity market.
E. None of the options are correct.
3. Treasury Inflation-Protected Securities (TIPS)
A. pay a fixed interest rate for life.
B. pay a variable interest rate that is indexed to inflation but maintain a constant principal.
C. provide a constant stream of income in real (inflation-adjusted) dollars.
D. have their principal adjusted in proportion to the Consumer Price Index.
E.provide a constant stream of income in real (inflation-adjusted) dollars and have their principal adjusted in proportion to the
Consumer Price Index.
4. Which one of the following is not a money market instrument?
A. Treasury bill
B. Negotiable certificate of deposit
C. Commercial paper
D. Treasury bond
E. Eurodollar account
5. T-bills are financial instruments initially sold by ________ to raise funds.
A. commercial banks
B. the U.S. government
C. state and local governments
D. agencies of the federal government
E. the U.S. government and agencies of the federal government
6. The bid price of a T-bill in the secondary market is
A. the price at which the dealer in T-bills is willing to sell the bill.
B. the price at which the dealer in T-bills is willing to buy the bill.
C. greater than the asked price of the T-bill.
D. the price at which the investor can buy the T-bill.
E. never quoted in the financial press.
7. The smallest component of the money market is
A. repurchase agreements.
B. small-denomination time deposits.
C. savings deposits.
D. money market mutual funds.
E. commercial paper.
2-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8. The smallest component of the fixed-income market is _______ debt.
A. Treasury
B. other asset-backed
C. corporate
D. tax-exempt
E. mortgage-backed
9. The largest component of the fixed-income market is _______ debt.
A. Treasury
B. asset-backed
C. corporate
D. tax-exempt
E. mortgage-backed
10. Which of the following is not a component of the money market?
A. Repurchase agreements
B. Eurodollars
C. Real estate investment trusts
D. Money market mutual funds
E. Commercial paper
11. Commercial paper is a short-term security issued by ________ to raise funds.
A. the Federal Reserve Bank
B. commercial banks
C. large, well-known companies
D. the New York Stock Exchange
E. state and local governments
12. Which one of the following terms best describes Eurodollars?
A. Dollar-denominated deposits only in European banks.
B. Dollar-denominated deposits at branches of foreign banks in the U.S.
C. Dollar-denominated deposits at foreign banks and branches of American banks outside the U.S.
D. Dollar-denominated deposits at American banks in the U.S.
E. Dollars that have been exchanged for European currency.
13. Deposits of commercial banks at the Federal Reserve Bank are called
A. bankers'acceptances.
B. repurchase agreements.
C. time deposits.
D. federal funds.
E. reserve requirements.
14. The interest rate charged by banks with excess reserves at a Federal Reserve Bank to banks needing overnight loans to meet
reserve requirements is called the
A. prime rate.
B. discount rate.
C. federal funds rate.
D. call money rate.
E. money market rate.
15. Which of the following statement(s) is (are) true regarding municipal bonds?
I) A municipal bond is a debt obligation issued by state or local governments.
II) A municipal bond is a debt obligation issued by the federal government.
III) The interest income from a municipal bond is exempt from federal income taxation.
IV) The interest income from a municipal bond is exempt from state and local taxation in the issuing state.
2-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. I and II only
B. I and III only
C. I, II, and III only
D. I, III, and IV only
E. I and IV only
16. Which of the following statements is true regarding a corporate bond?
A. A corporate callable bond gives the holder the right to exchange it for a specified number of the company's common shares.
B. A corporate debenture is a secured bond.
C. A corporate indenture is a secured bond.
D.A corporate convertible bond gives the holder the right to exchange the bond for a specified number of the company's common
shares.
E. Holders of corporate bonds have voting rights in the company.
17. In the event of the firm's bankruptcy,
A. the most shareholders can lose is their original investment in the firm's stock.
B. common shareholders are the first in line to receive their claims on the firm's assets.
C. bondholders have claim to what is left from the liquidation of the firm's assets after paying the shareholders.
D. the claims of preferred shareholders are honored before those of the common shareholders.
E the most shareholders can lose is their original investment in the firm's stock and the claims of preferred . shareholders are
honored before those of the common shareholders.
18. Which of the following is true regarding a firm's securities?
A. Common dividends are paid before preferred dividends.
B. Preferred stockholders have voting rights.
C. Preferred dividends are usually cumulative.
D. Preferred dividends are contractual obligations.
E. Common dividends can usually be paid if preferred dividends have been skipped.
19. Which of the following is true of the Dow Jones Industrial Average?
A. It is a value-weighted average of 30 large industrial stocks.
B. It is a price-weighted average of 30 large industrial stocks.
C. The divisor must be adjusted for stock splits.
D. It is a value-weighted average of 30 large industrial stocks, and the divisor must be adjusted for stock splits.
E. It is a price-weighted average of 30 large industrial stocks, and the divisor must be adjusted for stock splits.
20. Which of the following indices is(are) market-value weighted?
I) The New York Stock Exchange Composite Index
II) The Standard and Poor's 500 Stock Index
III) The Dow Jones Industrial Average
A. I only
B. I and II only
C. I and III only
D. I, II, and III
E. II and III only
21. The Dow Jones Industrial Average (DJIA) is computed by
A. adding the prices of 30 large "blue-chip" stocks and dividing by 30.
B. calculating the total market value of the 30 firms in the index and dividing by 30.
C. adding the prices of the 30 stocks in the index and dividing by a divisor.
D. adding the prices of the 500 stocks in the index and dividing by a divisor.
E. adding the prices of the 30 stocks in the index and dividing by the value of these stocks as of some base date period.
22. Consider the following three stocks:
2-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The price-weighted index constructed with the three stocks is
A. 30.
B. 40.
C. 50.
D. 60.
E. 70.
23. Consider the following three stocks:
The value-weighted index constructed with the three stocks using a divisor of 100 is
A. 1.2.
B. 1200.
C. 490.
D. 4900.
E. 49.
24. Consider the following three stocks:
Assume at these prices that the value-weighted index constructed with the three stocks is 490. What would the index be if stock B is
split 2 for 1 and stock C 4 for 1?
A. 265
B. 430
C. 355
D. 490
E. 1000
25. The price quotations of Treasury bonds in the Wall Street Journal show an ask price of 104.25 and a bid price of 104.125. As a
buyer of the bond, what is the dollar price you expect to pay?
A. $1,048.00
B. $1,042.50
C. $1,044.00
D. $1,041.25
E. $1,040.40
26. The price quotations of Treasury bonds in the Wall Street Journal show an ask price of 104.25 and a bid price of 104.125. As a
seller of the bond, what is the dollar price you expect to receive?
A. $1,048.00
B. $1,042.50
2-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. $1,041.25
D. $1,041.75
E. $1,040.40
27. An investor purchases one municipal and one corporate bond that pay rates of return of 8% and 10%, respectively. If the
investor is in the 20% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be
________ and ______, respectively.
A. 8%; 10%
B. 8%; 8%
C. 6.4%; 8%
D. 6.4%; 10%
E. 10%; 10%
28. An investor purchases one municipal and one corporate bond that pay rates of return of 7.5% and 10.3%, respectively. If the
investor is in the 25% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be
________ and ______, respectively.
A. 7.5%; 10.3%
B. 7.5%; 7.73%
C. 5.63%; 7.73%
D. 5.63%; 10.3%
E. 10%; 10%
29. If a Treasury note has a bid price of $975, the quoted bid price in the Wall Street Journal would be
A. 97:50.
B. 97:16.
C. 97:80.
D. 94:24.
E. 97:75.
30. If a Treasury note has a bid price of $995, the quoted bid price in the Wall Street Journal would be
A. 99:50.
B. 99:16.
C. 99:80.
D. 99:24.
E. 99:32.
31. In calculating the Standard and Poor's stock price indices, the adjustment for stock split occurs
A. by adjusting the divisor.
B. automatically.
C. by adjusting the numerator.
D. quarterly on the last trading day of each quarter.
32. Which of the following statements regarding the Dow Jones Industrial Average (DJIA) is false?
A. The DJIA is not very representative of the market as a whole.
B. The DJIA consists of 30 blue chip stocks.
C. The DJIA is affected equally by changes in low- and high-priced stocks.
D. The DJIA divisor needs to be adjusted for stock splits.
E. The value of the DJIA is much higher than individual stock prices.
33. The index that includes the largest number of actively-traded stocks is
A. the NASDAQ Composite Index.
B. the NYSE Composite Index.
C. the Wilshire 5000 Index.
D. the Value Line Composite Index.
E. the Russell Index.
2-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
34. A 5.5%, 20-year municipal bond is currently priced to yield 7.2%. For a taxpayer in the 33% marginal tax bracket, this bond
would offer an equivalent taxable yield of
A. 8.20%.
B. 10.75%.
C. 11.40%.
D. 4.82%.
35. If the market prices of each of the 30 stocks in the Dow Jones Industrial Average (DJIA) all change by the same percentage
amount during a given day, which stock will have the greatest impact on the DJIA?
A. The stock trading at the highest dollar price per share
B. The stock having the greatest amount of debt in its capital structure
C. The stock having the greatest amount of equity in its capital structure
D. The stock having the lowest volatility
36. The stocks on the Dow Jones Industrial Average
A. have remained unchanged since the creation of the index.
B. include most of the stocks traded on the NYSE.
C. are changed occasionally as circumstances dictate.
D. consist of stocks on which the investor cannot lose money.
E. include most of the stocks traded on the NYSE and are changed occasionally as circumstances dictate.
37. Federally-sponsored agency debt
A. is legally insured by the U.S. Treasury.
B. would probably be backed by the U.S. Treasury in the event of a near-default.
C. has a small positive yield spread relative to U.S. Treasuries.
D.would probably be backed by the U.S. Treasury in the event of a near-default and has a small positive yield spread relative to U.S.
Treasuries.
E. is legally insured by the U.S. Treasury and has a small positive yield spread relative to U.S. Treasuries.
38. Brokers'calls
A. are funds used by individuals who wish to buy stocks on margin.
B. are funds borrowed by the broker from the bank, with the agreement to repay the bank immediately if requested to do so.
C. carry a rate that is usually about one percentage point lower than the rate on U.S. T-bills.
D. are funds used by individuals who wish to buy stocks on margin and are funds borrowed by the broker from the bank, with the
agreement to repay the bank immediately if requested to do so.
E are funds used by individuals who wish to buy stocks on margin and carry a rate that is usually about one percentage point lower
than the rate on U.S. T-bills.
39. A form of short-term borrowing by dealers in government securities is (are)
A. reserve requirements.
B. repurchase agreements.
C. bankers'acceptances.
D. commercial paper.
E. brokers'calls.
40. Which of the following securities is a money market instrument?
A. Treasury note
B. Treasury bond
C. Municipal bond
D. Commercial paper
E. Mortgage security
41. The yield to maturity reported in the financial pages for Treasury securities
A. is calculated by compounding the semiannual yield.
B. is calculated by doubling the semiannual yield.
C. is also called the bond equivalent yield.
D. is calculated as the yield-to-call for premium bonds.
E. is calculated by doubling the semiannual yield and is also called the bond equivalent yield.
2-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
42. Which of the following is not a mortgage-related government or government-sponsored agency?
A. The Federal Home Loan Bank
B. The Federal National Mortgage Association
C. The U.S. Treasury
D. Freddie Mac
E. Ginnie Mae
43. In order for you to be indifferent between the after-tax returns on a corporate bond paying 8.5% and a tax-exempt municipal
bond paying 6.12%, what would your tax bracket need to be?
A. 33%
B. 72%
C. 15%
D. 28%
E. Cannot be determined from the information given.
44. What does the term negotiable mean, with regard to negotiable certificates of deposit?
A. The CD can be sold to another investor if the owner needs to cash it in before its maturity date.
B. The rate of interest on the CD is subject to negotiation.
C. The CD is automatically reinvested at its maturity date.
D. The CD has staggered maturity dates built in.
E. The interest rate paid on the CD will vary with a designated market rate.
45. Freddie Mac and Ginnie Mae were organized to provide
A. a primary market for mortgage transactions.
B. liquidity for the mortgage market.
C. a primary market for farm loan transactions.
D. liquidity for the farm loan market.
E. a source of funds for government agencies.
46. The type of municipal bond that is used to finance commercial enterprises, such as the construction of a new building for a
corporation, is called
A. a corporate courtesy bond.
B. a revenue bond.
C. a general-obligation bond.
D. a tax-anticipation note.
E. an industrial-development bond.
47. Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and a municipal bond with a 5.93% beforetax yield. At what marginal tax rate would the investor be indifferent between investing in the corporate and investing in the muni?
A. 15.4%
B. 23.7%
C. 39.5%
D. 17.3%
E. 12.4%
48. Which of the following are characteristics of preferred stock?
I) It pays its holder a fixed amount of income each year at the discretion of its managers.
II) It gives its holder voting power in the firm.
III) Its dividends are usually cumulative.
IV) Failure to pay dividends may result in bankruptcy proceedings.
A. I, III, and IV
B. I, II, and III
C. I and III
D. I, II, and IV
E. I, II, III, and IV
49. Bond market indexes can be difficult to construct because
2-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. they cannot be based on firms'market values.
B. bonds tend to trade infrequently, making price information difficult to obtain.
C. there are so many different kinds of bonds.
D. prices cannot be obtained for companies that operate in emerging markets.
E. corporations are not required to disclose the details of their bond issues.
50. With regard to a futures contract, the long position is held by
A. the trader who bought the contract at the largest discount.
B. the trader who has to travel the farthest distance to deliver the commodity.
C. the trader who plans to hold the contract open for the lengthiest time period.
D. the trader who commits to purchasing the commodity on the delivery date.
E. the trader who commits to delivering the commodity on the delivery date.
51. In order for you to be indifferent between the after-tax returns on a corporate bond paying 9% and a tax-exempt municipal bond
paying 7%, what would your tax bracket need to be?
A. 17.6%
B. 27%
C. 22.2%
D. 19.8%
E. Cannot be determined from the information given.
52. In order for you to be indifferent between the after-tax returns on a corporate bond paying 7% and a tax-exempt municipal bond
paying 5.5%, what would your tax bracket need to be?
A. 22.6%
B. 21.4%
C. 26.2%
D. 19.8%
E. Cannot be determined from the information given.
53. An investor purchases one municipal and one corporate bond that pay rates of return of 6% and 8%, respectively. If the investor
is in the 25% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be ________ and
______, respectively.
A. 6%; 8%
B. 4.5%; 6%
C. 4.5%; 8%
D. 6%; 6%
54. An investor purchases one municipal and one corporate bond that pay rates of return of 7.2% and 9.1%, respectively. If the
investor is in the 15% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be
________ and ______, respectively.
A. 7.2%; 9.1%
B. 7.2%; 7.735%
C. 6.12%; 7.735%
D. 8.471%; 9.1%
55. For a taxpayer in the 25% marginal tax bracket, a 20-year municipal bond currently yielding 5.5% would offer an equivalent
taxable yield of
A. 7.33%.
B. 10.75%.
C. 5.5%.
D. 4.125%.
56. For a taxpayer in the 15% marginal tax bracket, a 15-year municipal bond currently yielding 6.2% would offer an equivalent
taxable yield of
A. 6.2%.
B. 5.27%.
C. 8.32%.
D. 7.29%.
2-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
57. With regard to a futures contract, the short position is held by
A. the trader who bought the contract at the largest discount.
B. the trader who has to travel the farthest distance to deliver the commodity.
C. the trader who plans to hold the contract open for the lengthiest time period.
D. the trader who commits to purchasing the commodity on the delivery date.
E. the trader who commits to delivering the commodity on the delivery date.
58. A call option allows the buyer to
A. sell the underlying asset at the exercise price on or before the expiration date.
B. buy the underlying asset at the exercise price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the exercise price on or before the expiration date and sell the option in the open market prior to
expiration.
E. buy the underlying asset at the exercise price on or before the expiration date and sell the option in the open market prior to
expiration.
59. A put option allows the holder to
A. buy the underlying asset at the strike price on or before the expiration date.
B. sell the underlying asset at the strike price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the strike price on or before the expiration date and sell the option in the open market prior to
expiration.
E. buy the underlying asset at the strike price on or before the expiration date and sell the option in the open market prior to
expiration.
60. The ____ index represents the performance of the German stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
61. The ____ index represents the performance of the Japanese stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
62. The ____ index represents the performance of the U.K. stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
63. The ____ index represents the performance of the Hong Kong stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
64. The ____ index represents the performance of the Canadian stock market.
A. DAX
B. FTSE
C. TSX
D. Hang Seng
65. The ultimate stock index in the U.S. is the
2-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. Wilshire 5000.
B. DJIA.
C. S&P 500.
D. Russell 2000.
66. The ____ is an example of a U.S. index of large firms.
A. Wilshire 5000
B. DJIA
C. DAX
D. Russell 2000
E. All of the options.
67. The ____ is an example of a U.S. index of small firms.
A. S&P 500
B. DJIA
C. DAX
D. Russell 2000
E. All of the options are correct.
68. The largest component of the money market is/are
A. repurchase agreements.
B. money market mutual funds.
C. T-bills.
D. Eurodollars.
E. savings deposits.
69. Certificates of deposit are insured by the
A. SPIC.
B. CFTC.
C. Lloyds of London.
D. FDIC.
E. All of the options are correct.
70. Certificates of deposit are insured for up to ____________ in the event of bank insolvency.
A. $10,000
B. $100,000
C. $250,000
D. $500,000
71. The maximum maturity of commercial paper that can be issued without SEC registration is
A. 270 days.
B. 180 days.
C. 90 days.
D. 30 days.
72. Which of the following is used extensively in foreign trade when the creditworthiness of one trader is unknown to the trading
partner?
A. Repos
B. Bankers'acceptances
C. Eurodollars
D. Federal funds
73. A U.S. dollar-denominated bond that is sold in Singapore is a(n)
A. Eurobond.
B. Yankee bond.
C. Samurai bond.
D. Bulldog bond.
2-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
74. A municipal bond issued to finance an airport, hospital, turnpike, or port authority is typically a
A. revenue bond.
B. general-obligation bond.
C. industrial-development bond.
D. revenue bond or general-obligation bond.
75. Unsecured bonds are called
A. junk bonds.
B. debentures.
C. indentures.
D. subordinated debentures.
E. either debentures or subordinated debentures.
76. A bond that can be retired prior to maturity by the issuer is a(n) ____________ bond.
A. convertible
B. secured
C. unsecured
D. callable
E. Yankee
77. Corporations can exclude ____________% of the dividends received from preferred stock from taxes.
A. 50
B. 70
C. 20
D. 15
E. 62
78. You purchased a futures contract on corn at a futures price of 350, and at the time of expiration, the price was 352. What was
your profit or loss?
A. $2.00
B. –$2.00
C. $100
D. –$100
79. You purchased a futures contract on corn at a futures price of 331, and at the time of expiration, the price was 343. What was
your profit or loss?
A. –$12.00
B. $12.00
C. –$600
D. $600
80. You sold a futures contract on corn at a futures price of 350, and at the time of expiration, the price was 352. What was your
profit or loss?
A. $2.00
B. –$2.00
C. $100
D. –$100
81. You sold a futures contract on corn at a futures price of 331, and at the time of expiration, the price was 343. What was your
profit or loss?
A. –$12.00
B. $12.00
C. –$600
D. $600
82. You purchased a futures contract on oats at a futures price of 233.75, and at the time of expiration, the price was 261.25. What
was your profit or loss?
2-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $1375.00
B. –$1375.00
C. –$27.50
D. $27.50
83. You sold a futures contract on oats at a futures price of 233.75, and at the time of expiration, the price was 261.25. What was
your profit or loss?
A. $1375.00
B. –$1375.00
C. –$27.50
D. $27.50
Chapter 02 Test Bank - Static Key
Multiple Choice Questions
1. Which of the following is not a characteristic of a money market instrument?
A. Liquidity
B. Marketability
C. Long maturity
D. Liquidity premium
E. Long maturity and liquidity premium
Money market instruments are short-term instruments with high liquidity and marketability; they do not have long maturities nor
pay liquidity premiums.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
2. The money market is a subsector of the
A. commodity market.
B. capital market.
C. derivatives market.
D. equity market.
E. None of the options are correct.
Money market instruments are short-term instruments with high liquidity and marketability; they do not have long maturities nor
pay liquidity premiums.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
3. Treasury Inflation-Protected Securities (TIPS)
A. pay a fixed interest rate for life.
B. pay a variable interest rate that is indexed to inflation but maintain a constant principal.
C. provide a constant stream of income in real (inflation-adjusted) dollars.
D. have their principal adjusted in proportion to the Consumer Price Index.
E. provide a constant stream of income in real (inflation-adjusted) dollars and have their principal adjusted in proportion to the
Consumer Price Index.
TIPS provide a constant stream of income in real (inflation-adjusted) dollars because their principal is adjusted in proportion to the
Consumer Price Index.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
2-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
4. Which one of the following is not a money market instrument?
A. Treasury bill
B. Negotiable certificate of deposit
C. Commercial paper
D. Treasury bond
E. Eurodollar account
Money market instruments are instruments with maturities of one year or less, which applies to all of the options except Treasury
bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
5. T-bills are financial instruments initially sold by ________ to raise funds.
A. commercial banks
B. the U.S. government
C. state and local governments
D. agencies of the federal government
E. the U.S. government and agencies of the federal government
Only the U.S. government sells T-bills in the primary market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
6. The bid price of a T-bill in the secondary market is
A. the price at which the dealer in T-bills is willing to sell the bill.
B. the price at which the dealer in T-bills is willing to buy the bill.
C. greater than the asked price of the T-bill.
D. the price at which the investor can buy the T-bill.
E. never quoted in the financial press.
T-bills are sold in the secondary market via dealers; the bid price quoted in the financial press is the price at which the dealer is
willing to buy the bill.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond price and quotes
7. The smallest component of the money market is
A. repurchase agreements.
B. small-denomination time deposits.
C. savings deposits.
D. money market mutual funds.
E. commercial paper.
According to Table 2.1, commercial paper is the smallest component of the money market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
8. The smallest component of the fixed-income market is _______ debt.
2-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. Treasury
B. other asset-backed
C. corporate
D. tax-exempt
E. mortgage-backed
According to Figure 2.9, other asset-backed debt is the smallest component of the fixed-income market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond markets and trading
9. The largest component of the fixed-income market is _______ debt.
A. Treasury
B. asset-backed
C. corporate
D. tax-exempt
E. mortgage-backed
According to Figure 2.9 Treasury debt is the largest component of the fixed-income market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond markets and trading
10. Which of the following is not a component of the money market?
A. Repurchase agreements
B. Eurodollars
C. Real estate investment trusts
D. Money market mutual funds
E. Commercial paper
Real estate investment trusts are not short-term investments.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
11. Commercial paper is a short-term security issued by ________ to raise funds.
A. the Federal Reserve Bank
B. commercial banks
C. large, well-known companies
D. the New York Stock Exchange
E. state and local governments
Commercial paper is short-term unsecured financing issued directly by large, presumably safe corporations.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
12. Which one of the following terms best describes Eurodollars?
A. Dollar-denominated deposits only in European banks.
B. Dollar-denominated deposits at branches of foreign banks in the U.S.
C. Dollar-denominated deposits at foreign banks and branches of American banks outside the U.S.
D. Dollar-denominated deposits at American banks in the U.S.
E. Dollars that have been exchanged for European currency.
2-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Although originally Eurodollars were used to describe dollar-denominated deposits in European banks, today the term has been
extended to apply to any dollar-denominated deposit outside the U.S.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Money market securities
13. Deposits of commercial banks at the Federal Reserve Bank are called
A. bankers'acceptances.
B. repurchase agreements.
C. time deposits.
D. federal funds.
E. reserve requirements.
The federal funds are required for the bank to meet reserve requirements, which is a way of influencing the money supply. No
substitutes for fed funds are permitted.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
14. The interest rate charged by banks with excess reserves at a Federal Reserve Bank to banks needing overnight loans to meet
reserve requirements is called the
A. prime rate.
B. discount rate.
C. federal funds rate.
D. call money rate.
E. money market rate.
The federal funds are required for the bank to meet reserve requirements, which is a way of influencing the money supply.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Interest rates
15. Which of the following statement(s) is (are) true regarding municipal bonds?
I) A municipal bond is a debt obligation issued by state or local governments.
II) A municipal bond is a debt obligation issued by the federal government.
III) The interest income from a municipal bond is exempt from federal income taxation.
IV) The interest income from a municipal bond is exempt from state and local taxation in the issuing state.
A. I and II only
B. I and III only
C. I, II, and III only
D. I, III, and IV only
E. I and IV only
State and local governments and agencies thereof issue municipal bonds on which the interest income is free from all federal taxes
and is exempt from state and local taxation in the issuing state.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: State and local securities
16. Which of the following statements is true regarding a corporate bond?
A. A corporate callable bond gives the holder the right to exchange it for a specified number of the company's common shares.
B. A corporate debenture is a secured bond.
2-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. A corporate indenture is a secured bond.
D. A corporate convertible bond gives the holder the right to exchange the bond for a specified number of the company's common
shares.
E. Holders of corporate bonds have voting rights in the company.
"A corporate convertible bond gives the holder the right to exchange the bond for a specified number of the company's common
shares" is the only true statement; all other statements describe something other than the term specified.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Bond types and features
17. In the event of the firm's bankruptcy,
A. the most shareholders can lose is their original investment in the firm's stock.
B. common shareholders are the first in line to receive their claims on the firm's assets.
C. bondholders have claim to what is left from the liquidation of the firm's assets after paying the shareholders.
D. the claims of preferred shareholders are honored before those of the common shareholders.
E.the most shareholders can lose is their original investment in the firm's stock and the claims of preferred shareholders are honored
before those of the common shareholders.
Shareholders have limited liability and have residual claims on assets. Bondholders have a priority claim on assets, and preferred
shareholders have priority over common shareholders.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Shareholder rights and voting
18. Which of the following is true regarding a firm's securities?
A. Common dividends are paid before preferred dividends.
B. Preferred stockholders have voting rights.
C. Preferred dividends are usually cumulative.
D. Preferred dividends are contractual obligations.
E. Common dividends can usually be paid if preferred dividends have been skipped.
Preferred dividends must be paid first and any skipped preferred dividends must be paid before common dividends may be paid.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Preferred stock
19. Which of the following is true of the Dow Jones Industrial Average?
A. It is a value-weighted average of 30 large industrial stocks.
B. It is a price-weighted average of 30 large industrial stocks.
C. The divisor must be adjusted for stock splits.
D. It is a value-weighted average of 30 large industrial stocks, and the divisor must be adjusted for stock splits.
E. It is a price-weighted average of 30 large industrial stocks, and the divisor must be adjusted for stock splits. The Dow Jones
Industrial Average is a price-weighted index of 30 large industrial firms, and the divisor must be adjusted when any of the stocks on
the index split.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
20. Which of the following indices is(are) market-value weighted?
I) The New York Stock Exchange Composite Index
II) The Standard and Poor's 500 Stock Index
III) The Dow Jones Industrial Average
2-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. I only
B. I and II only
C. I and III only
D. I, II, and III
E. II and III only
The Dow Jones Industrial Average is a price-weighted index.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
21. The Dow Jones Industrial Average (DJIA) is computed by
A. adding the prices of 30 large "blue-chip" stocks and dividing by 30.
B. calculating the total market value of the 30 firms in the index and dividing by 30.
C. adding the prices of the 30 stocks in the index and dividing by a divisor.
D. adding the prices of the 500 stocks in the index and dividing by a divisor.
E. adding the prices of the 30 stocks in the index and dividing by the value of these stocks as of some base
date period.
When the DJIA became a 30-stock index, it was computed by adding the prices of 30 large "blue-chip" stocks and dividing by 30;
however, as stocks on the index have split and been replaced, the divisor has been adjusted.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
22. Consider the following three stocks:
The price-weighted index constructed with the three stocks is
A. 30.
B. 40.
C. 50.
D. 60.
E. 70.
($40 + $70 + $10)/3 = $40.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Stock market indexes and averages
23. Consider the following three stocks:
The value-weighted index constructed with the three stocks using a divisor of 100 is
A. 1.2.
2-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. 1200.
C. 490.
D. 4900.
E. 49.
The sum of the value of the three stocks divided by 100 is 490: [($40 × 200) + ($70 × 500) + ($10 × 600)]/100 = 490.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
24. Consider the following three stocks:
Assume at these prices that the value-weighted index constructed with the three stocks is 490. What would the index be if stock B is
split 2 for 1 and stock C 4 for 1?
A. 265
B. 430
C. 355
D. 490
E. 1000
Value-weighted indexes are not affected by stock splits.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
25.The price quotations of Treasury bonds in the Wall Street Journal show an ask price of 104.25 and a bid price of 104.125. As a
buyer of the bond, what is the dollar price you expect to pay?
A. $1,048.00
B. $1,042.50
C. $1,044.00
D. $1,041.25
E. $1,040.40
You pay the asking price of the dealer, 104 8/32, or 104.25% of $1,000, or $1,042.50.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond price and quotes
26. The price quotations of Treasury bonds in the Wall Street Journal show an ask price of 104.25 and a bid price of 104.125. As a
seller of the bond, what is the dollar price you expect to receive?
A. $1,048.00
B. $1,042.50
C. $1,041.25
D. $1,041.75
E. $1,040.40
You receive the bid price of the dealer, 104 4/32, or 104.125% of $1,000, or $1,041.25.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
2-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Difficulty: 2 Intermediate
Topic: Bond price and quotes
27. An investor purchases one municipal and one corporate bond that pay rates of return of 8% and 10%, respectively. If the
investor is in the 20% marginal tax bracket, his or her after-tax rates of return on the
municipal and corporate bonds would be ________ and ______, respectively.
A. 8%; 10%
B. 8%; 8%
C. 6.4%; 8%
D. 6.4%; 10%
E. 10%; 10%
r c = 0.10(1 – 0.20) = 0.08, or 8%; r m = 0.08(1 – 0) = 8%.
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
28. An investor purchases one municipal and one corporate bond that pay rates of return of 7.5% and 10.3%, respectively. If the
investor is in the 25% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be
________ and ______, respectively.
A. 7.5%; 10.3%
B. 7.5%; 7.73%
C. 5.63%; 7.73%
D. 5.63%; 10.3%
E. 10%; 10%
r c = 0.103(1 – 0.25) = 0.07725, or 7.73%; r m = 0.075(1 – 0) = 7.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
29. If a Treasury note has a bid price of $975, the quoted bid price in the Wall Street Journal would be
A. 97:50.
B. 97:16.
C. 97:80.
D. 94:24.
E. 97:75.
Treasuries are quoted as a percent of $1,000 and in 1/32s.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond price and quotes
30. If a Treasury note has a bid price of $995, the quoted bid price in the Wall Street Journal would be
A. 99:50.
B. 99:16.
C. 99:80.
D. 99:24.
E. 99:32.
Treasuries are quoted as a percent of $1,000 and in 1/32s.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
2-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Difficulty: 1 Basic
Topic: Bond price and quotes
31. In calculating the Standard and Poor's stock price indices, the adjustment for stock split occurs
A. by adjusting the divisor.
B. automatically.
C. by adjusting the numerator.
D. quarterly on the last trading day of each quarter.
The calculation of the value-weighted S&P indices includes both price and number of shares of each of the stocks in the index.
Thus, the effects of stock splits are automatically incorporated into the calculation.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
32. Which of the following statements regarding the Dow Jones Industrial Average (DJIA) is false?
A. The DJIA is not very representative of the market as a whole.
B. The DJIA consists of 30 blue chip stocks.
C. The DJIA is affected equally by changes in low- and high-priced stocks.
D. The DJIA divisor needs to be adjusted for stock splits.
E. The value of the DJIA is much higher than individual stock prices.
The high-priced stocks have much more impact on the DJIA than do the lower-priced stocks.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Stock market indexes and averages
33. The index that includes the largest number of actively-traded stocks is
A. the NASDAQ Composite Index.
B. the NYSE Composite Index.
C. the Wilshire 5000 Index.
D. the Value Line Composite Index.
E. the Russell Index.
The Wilshire 5000 is the largest readily available stock index, consisting of the stocks traded on the organized exchanges and the
OTC stocks.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
34. A 5.5%, 20-year municipal bond is currently priced to yield 7.2%. For a taxpayer in the 33% marginal tax bracket, this bond
would offer an equivalent taxable yield of
A. 8.20%.
B. 10.75%.
C. 11.40%.
D. 4.82%.
0.072 = r(1 – t); 0.072 = r(0.67); r = 0.072/0.67; r = 0.1075 = 10.75%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
35. If the market prices of each of the 30 stocks in the Dow Jones Industrial Average (DJIA) all change by the same percentage amount
during a given day, which stock will have the greatest impact on the DJIA?
2-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. The stock trading at the highest dollar price per share
B. The stock having the greatest amount of debt in its capital structure
C. The stock having the greatest amount of equity in its capital structure
D.
The stock having the lowest volatility
Higher-priced stocks affect the DJIA more than lower-priced stocks; other choices are not relevant.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
36. The stocks on the Dow Jones Industrial Average
A. have remained unchanged since the creation of the index.
B. include most of the stocks traded on the NYSE.
C. are changed occasionally as circumstances dictate.
D. consist of stocks on which the investor cannot lose money.
E. include most of the stocks traded on the NYSE and are changed occasionally as circumstances dictate. The stocks on the DJIA
are only a small sample of the entire market and have been changed occasionally since the creation of the index; one can lose money
on any stock.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
37. Federally-sponsored agency debt
A. is legally insured by the U.S. Treasury.
B. would probably be backed by the U.S. Treasury in the event of a near-default.
C. has a small positive yield spread relative to U.S. Treasuries.
D. would probably be backed by the U.S. Treasury in the event of a near-default and has a small positive yield spread relative to
U.S. Treasuries.
E. is legally insured by the U.S. Treasury and has a small positive yield spread relative to U.S. Treasuries. Federally sponsored
agencies are not government owned. These agencies'debt is not insured by the U.S. Treasury, but probably would be backed by the
Treasury in the event of an agency near-default. As a result, the issues are very safe and carry a yield only slightly higher than that
of U.S. Treasuries.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
38. Brokers'calls
A. are funds used by individuals who wish to buy stocks on margin.
B. are funds borrowed by the broker from the bank, with the agreement to repay the bank immediately if requested to do so.
C. carry a rate that is usually about one percentage point lower than the rate on U.S. T-bills.
D are funds used by individuals who wish to buy stocks on margin and are funds borrowed by the broker from . the bank, with the
agreement to repay the bank immediately if requested to do so.
E. are funds used by individuals who wish to buy stocks on margin and carry a rate that is usually about one percentage point lower
than the rate on U.S. T-bills.
Brokers'calls are funds borrowed from banks by brokers and loaned to investors in margin accounts.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Margin
2-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
39. A form of short-term borrowing by dealers in government securities is (are)
A. reserve requirements.
B. repurchase agreements.
C. bankers'acceptances.
D. commercial paper.
E. brokers'calls.
Repurchase agreements are a form of short-term borrowing, where a dealer sells government securities to an investor with an
agreement to buy back those same securities at a slightly higher price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
40. Which of the following securities is a money market instrument?
A. Treasury note
B. Treasury bond
C. Municipal bond
D. Commercial paper
E. Mortgage security
Only commercial paper is a money market security. The others are capital market instruments.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
41. The yield to maturity reported in the financial pages for Treasury securities
A. is calculated by compounding the semiannual yield.
B. is calculated by doubling the semiannual yield.
C. is also called the bond equivalent yield.
D. is calculated as the yield-to-call for premium bonds.
E. is calculated by doubling the semiannual yield and is also called the bond equivalent yield.
The yield to maturity shown in the financial pages is an APR calculated by doubling the semiannual yield.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond yields and returns
42. Which of the following is not a mortgage-related government or government-sponsored agency?
A. The Federal Home Loan Bank
B. The Federal National Mortgage Association
C. The U.S. Treasury
D. Freddie Mac
E. Ginnie Mae
Only the U.S. Treasury issues securities that are not mortgage-backed.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Mortgage markets and regulations
2-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
43. In order for you to be indifferent between the after-tax returns on a corporate bond paying 8.5% and a tax-exempt municipal
bond paying 6.12%, what would your tax bracket need to be?
A. 33%
B. 72%
C. 15%
D. 28%
E. Cannot be determined from the information given.
0.0612 = 0.085(1 – t); (1 – t) = 0.72; t = 0.28.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 2 Intermediate
Topic: Bond yields and returns
44. What does the term negotiable mean, with regard to negotiable certificates of deposit?
A. The CD can be sold to another investor if the owner needs to cash it in before its maturity date.
B. The rate of interest on the CD is subject to negotiation.
C. The CD is automatically reinvested at its maturity date.
D. The CD has staggered maturity dates built in.
E. The interest rate paid on the CD will vary with a designated market rate.
Negotiable means that it can be sold or traded to another investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
45. Freddie Mac and Ginnie Mae were organized to provide
A. a primary market for mortgage transactions.
B. liquidity for the mortgage market.
C. a primary market for farm loan transactions.
D. liquidity for the farm loan market.
E. a source of funds for government agencies. Liquidity for the mortgage market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Mortgage markets and regulations
46. The type of municipal bond that is used to finance commercial enterprises, such as the construction of a new building for a
corporation, is called
A. a corporate courtesy bond.
B. a revenue bond.
C. a general-obligation bond.
D. a tax-anticipation note.
E. an industrial-development bond.
Industrial development bonds allow private enterprises to raise capital at lower rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: State and local securities
47. Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and a municipal bond with a 5.93% beforetax yield. At what marginal tax rate would the investor be indifferent between investing in the corporate and investing in the muni?
A. 15.4%
2-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. 23.7%
C. 39.5%
D. 17.3%
E. 12.4%
t m = 1 – (5.93%/7.17%) = 17.29%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
48. Which of the following are characteristics of preferred stock?
I) It pays its holder a fixed amount of income each year at the discretion of its managers.
II) It gives its holder voting power in the firm.
III) Its dividends are usually cumulative.
IV) Failure to pay dividends may result in bankruptcy proceedings.
A. I, III, and IV
B. I, II, and III
C. I and III
D. I, II, and IV
E. I, II, III, and IV Only I and III are true.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Preferred stock
49. Bond market indexes can be difficult to construct because
A. they cannot be based on firms'market values.
B. bonds tend to trade infrequently, making price information difficult to obtain.
C. there are so many different kinds of bonds.
D. prices cannot be obtained for companies that operate in emerging markets.
E. corporations are not required to disclose the details of their bond issues. Bond trading is often "thin," making prices stale (or not
current).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond market indexes and indicators
50. With regard to a futures contract, the long position is held by
A. the trader who bought the contract at the largest discount.
B. the trader who has to travel the farthest distance to deliver the commodity.
C. the trader who plans to hold the contract open for the lengthiest time period.
D. the trader who commits to purchasing the commodity on the delivery date.
E. the trader who commits to delivering the commodity on the delivery date.
The trader agreeing to buy the underlying asset is said to be long the contract, whereas the trader agreeing to deliver the underlying
asset is said to be short the contract.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Futures contracts
51. In order for you to be indifferent between the after-tax returns on a corporate bond paying 9% and a tax-exempt municipal bond
paying 7%, what would your tax bracket need to be?
2-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. 17.6%
B. 27%
C. 22.2%
D. 19.8%
E. Cannot be determined from the information given.
0.07 = 0.09(1 – t); (1 – t) = 0.777; t = 0.222.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
52. In order for you to be indifferent between the after-tax returns on a corporate bond paying 7% and a tax-exempt municipal bond
paying 5.5%, what would your tax bracket need to be?
A. 22.6%
B. 21.4%
C. 26.2%
D. 19.8%
E. Cannot be determined from the information given.
0.055 = 0.07(1 – t); (1 – t) = 0.786; t = 0.214.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Stock market indexes and averages
53. An investor purchases one municipal and one corporate bond that pay rates of return of 6% and 8%, respectively. If the investor
is in the 25% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be ________ and
______, respectively.
A. 6%; 8%
B. 4.5%; 6%
C. 4.5%; 8%
D. 6%; 6%
r c = 0.08(1 – 0.25) = 0.06, or 6%; r m = 0.06(1 – 0) = 6%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
54. An investor purchases one municipal and one corporate bond that pay rates of return of 7.2% and 9.1%, respectively. If the
investor is in the 15% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be
________ and ______, respectively.
A. 7.2%; 9.1%
B. 7.2%; 7.735%
C. 6.12%; 7.735%
D. 8.471%; 9.1%
r c = 0.091(1 – 0.15) = 0.07735, or 7.735%; r m = 0.072(1 0) = 7.2%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
2-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
55. For a taxpayer in the 25% marginal tax bracket, a 20-year municipal bond currently yielding 5.5% would offer an equivalent
taxable yield of
A. 7.33%.
B. 10.75%.
C. 5.5%.
D. 4.125%.
0.055 = r(1 – t); r = 0.055/0.75; r = 0.0733.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
56. For a taxpayer in the 15% marginal tax bracket, a 15-year municipal bond currently yielding 6.2% would offer an equivalent
taxable yield of
A. 6.2%.
B. 5.27%.
C. 8.32%.
D. 7.29%.
0.062 = r(1 – t); r = 0.062/(0.85); r = 0.0729 = 7.29%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
57. With regard to a futures contract, the short position is held by
A. the trader who bought the contract at the largest discount.
B. the trader who has to travel the farthest distance to deliver the commodity.
C. the trader who plans to hold the contract open for the lengthiest time period.
D. the trader who commits to purchasing the commodity on the delivery date.
E. the trader who commits to delivering the commodity on the delivery date.
The trader agreeing to buy the underlying asset is said to be long the contract, whereas the trader agreeing to deliver the underlying
asset is said to be short the contract.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Bond yields and returns
58. A call option allows the buyer to
A. sell the underlying asset at the exercise price on or before the expiration date.
B. buy the underlying asset at the exercise price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the exercise price on or before the expiration date and sell the option in the open market prior to
expiration.
E. buy the underlying asset at the exercise price on or before the expiration date and sell the option in the open market prior to
expiration.
A call option may be exercised (allowing the holder to buy the underlying asset) on or before expiration.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond yields and returns
59. A put option allows the holder to
2-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. buy the underlying asset at the strike price on or before the expiration date.
B. sell the underlying asset at the strike price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the strike price on or before the expiration date and sell the option in the open market prior to
expiration.
E. buy the underlying asset at the strike price on or before the expiration date and sell the option in the open market prior to
expiration.
A put option allows the buyer to sell the underlying asset at the strike price on or before the expiration date.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Futures contracts
60. The ____ index represents the performance of the German stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and
TSX (Canada).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Options
61. The ____ index represents the performance of the Japanese stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and
TSX (Canada).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Options
62. The ____ index represents the performance of the U.K. stock market.
A. DAX
B. FTSE
C. Nikkei
D. Hang Seng
Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and
TSX (Canada).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
63. The ____ index represents the performance of the Hong Kong stock market.
A. DAX
2-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. FTSE
C. Nikkei
D. Hang Seng
Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and
TSX (Canada).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
64. The ____ index represents the performance of the Canadian stock market.
A. DAX
B. FTSE
C. TSX
D. Hang Seng
Many major foreign stock markets exist, including the DAX (Germany), FTSE (UK), Nikkei (Japan), Hang Seng (Hong Kong), and
TSX (Canada).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
65. The ultimate stock index in the U.S. is the
A. Wilshire 5000.
B. DJIA.
C. S&P 500.
D. Russell 2000.
The Wilshire 5000 is the broadest U.S. index and contains more than 7000 stocks.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
66. The ____ is an example of a U.S. index of large firms.
A. Wilshire 5000
B. DJIA
C. DAX
D. Russell 2000
E. All of the options.
The DJIA contains 30 of some of the largest firms in the U.S.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
67. The ____ is an example of a U.S. index of small firms.
A. S&P 500
B. DJIA
C. DAX
D. Russell 2000
E. All of the options are correct.
2-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The Russell 2000 is a small firm index. The DJIA and S&P 500 are large firm U.S. indexes and the DAX is a large German firm
index.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
68. The largest component of the money market is/are
A. repurchase agreements.
B. money market mutual funds.
C. T-bills.
D. Eurodollars.
E. savings deposits.
Savings deposits are the largest component according to Table 2.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
69. Certificates of deposit are insured by the
A. SPIC.
B. CFTC.
C. Lloyds of London.
D. FDIC.
E. All of the options are correct.
The Federal Deposit Insurance Corporation (FDIC) insures saving deposits for up to $100,000.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock market indexes and averages
70. Certificates of deposit are insured for up to ____________ in the event of bank insolvency.
A. $10,000
B. $100,000
C. $250,000
D. $500,000
The Federal Deposit Insurance Corporation (FDIC) insures saving deposits for up to $100,000.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
71. The maximum maturity of commercial paper that can be issued without SEC registration is
A. 270 days.
B. 180 days.
C. 90 days.
D. 30 days.
The SEC permits issuing commercial paper for a maximum of 270 days without registration.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
2-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Topic: Financial market regulation and protections
72. Which of the following is used extensively in foreign trade when the creditworthiness of one trader is unknown to the trading
partner?
A. Repos
B. Bankers'acceptances
C. Eurodollars
D. Federal funds
A bankers'acceptance facilitates foreign trade by substituting a bank's credit for that of the trading partner.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial market regulation and protections
73. A U.S. dollar-denominated bond that is sold in Singapore is a(n)
A. Eurobond.
B. Yankee bond.
C. Samurai bond.
D. Bulldog bond.
Eurobonds are bonds denominated in a currency other than the currency of the country in which they are issued.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
74. A municipal bond issued to finance an airport, hospital, turnpike, or port authority is typically a
A. revenue bond.
B. general-obligation bond.
C. industrial-development bond.
D. revenue bond or general-obligation bond.
Revenue bonds depend on revenues from the project to pay the coupon payment and are normally issued for airports, hospitals,
turnpikes, or port authorities. General obligation bonds are backed by the taxing power of the municipality. Industrial development
bonds are used to support private enterprises.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Money market securities
75. Unsecured bonds are called
A. junk bonds.
B. debentures.
C. indentures.
D. subordinated debentures.
E. either debentures or subordinated debentures. Debentures are unsecured bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Money market securities
2-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
76. A bond that can be retired prior to maturity by the issuer is a(n) ____________ bond.
A. convertible
B. secured
C. unsecured
D. callable
E. Yankee
Only callable bonds can be retired prior to maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: State and local securities
77. Corporations can exclude ____________% of the dividends received from preferred stock from taxes.
A. 50
B. 70
C. 20
D. 15
E. 62
Corporations can exclude 70% of dividends received from preferred stock from taxes.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
78. You purchased a futures contract on corn at a futures price of 350, and at the time of expiration, the price was 352. What was
your profit or loss?
A. $2.00
B. –$2.00
C. $100
D. –$100
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your profit was (3.52 – 3.50) = $0.02 per
bushel, or $0.02 × 5,000 = $100.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond types and features
79. You purchased a futures contract on corn at a futures price of 331, and at the time of expiration, the price was 343. What was
your profit or loss?
A. –$12.00
B. $12.00
C. –$600
D. $600
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your profit was (3.43 – 3.31) = $0.12 per
bushel, or $0.12 × 5,000 = $600.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Preferred stock
80. You sold a futures contract on corn at a futures price of 350, and at the time of expiration, the price was 352. What was your
profit or loss?
2-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $2.00
B. –$2.00
C. $100
D. –$100
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your loss was ($3.50 – 3.52) = $0.02 per
bushel, or –$0.02 × 5,000 = –$100.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Futures prices and profits
81. You sold a futures contract on corn at a futures price of 331, and at the time of expiration, the price was 343. What was your
profit or loss?
A. –$12.00
B. $12.00
C. –$600
D. $600
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your profit was (3.31 – 3.43) = –$0.12 per
bushel, or –$0.12 × 5,000 = $600.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Futures prices and profits
82. You purchased a futures contract on oats at a futures price of 233.75, and at the time of expiration, the price was 261.25. What
was your profit or loss?
A. $1375.00
B. –$1375.00
C. –$27.50
D. $27.50
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your profit was (2.6125 – 2.3375) = $0.275 per
bushel, or $0.275 × 5,000 = $1,375.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Futures prices and profits
83. You sold a futures contract on oats at a futures price of 233.75, and at the time of expiration, the price was 261.25. What was
your profit or loss?
A. $1375.00
B. –$1375.00
C. –$27.50
D. $27.50
There are 5,000 bushels per contract and prices are quoted in cents per bushel. Thus, your loss was ($2.3375 – $2.6125) = –$0.275
per bushel, or – $0.275 × 5,000 = –$1,375.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Futures prices and profits
2-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 02 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Analyze
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Topic: Bond market indexes and indicators
Topic: Bond markets and trading
Topic: Bond price and quotes
Topic: Bond types and features
Topic: Bond yields and returns
Topic: Financial market regulation and protections
Topic: Futures contracts
Topic: Futures prices and profits
Topic: Interest rates
Topic: Margin
Topic: Money market securities
Topic: Mortgage markets and regulations
Topic: Options
Topic: Preferred stock
Topic: Shareholder rights and voting
Topic: State and local securities
Topic: Stock market indexes and averages
Topic: U.S. Treasury and agency securities
21
63
83
1
23
46
13
61
22
1
2
5
3
12
2
2
4
1
1
15
2
2
3
1
3
21
3
2-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 03 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. The trading of stock that was previously issued takes place
A. in the secondary market.
B. in the primary market.
C. usually with the assistance of an investment banker.
D. in the secondary and primary markets.
2. A purchase of a new issue of stock takes place
A. in the secondary market.
B. in the primary market.
C. usually with the assistance of an investment banker.
D. in the secondary and primary markets.
E. in the primary market and usually with the assistance of an investment banker.
3. Firms raise capital by issuing stock
A. in the secondary market.
B. in the primary market.
C. to unwary investors.
D. only on days when the market is up.
4. Which of the following statements regarding the specialist are true?
A. Specialists maintain a book listing outstanding, unexecuted limit orders.
B. Specialists earn income from commissions and spreads in stock prices.
C. Specialists stand ready to trade at quoted bid and ask prices.
D. Specialists cannot trade in their own accounts.
E. Specialists maintain a book listing outstanding, unexecuted limit orders, earn income from commissions and spreads in stock prices,
and stand ready to trade at quoted bid and ask prices.
5. Investment bankers
A. act as intermediaries between issuers of stocks and investors.
B. act as advisors to companies in helping them analyze their financial needs and find buyers for newly-issued securities.
C. accept deposits from savers and lend them out to companies.
D. act as intermediaries between issuers of stocks and investors and act as advisors to companies in helping them analyze their
financial needs and find buyers for newly-issued securities.
6. In a "firm commitment," the investment banker
A. buys the stock from the company and resells the issue to the public.
B. agrees to help the firm sell the stock at a favorable price.
C. finds the best marketing arrangement for the investment-banking firm.
D. agrees to help the firm sell the stock at a favorable price and finds the best marketing arrangement for the investment-banking firm.
3-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
7. The secondary market consists of
A. transactions on the AMEX.
B. transactions in the OTC market.
C. transactions through the investment banker.
D. transactions on the AMEX and in the OTC market.
E. transactions on the AMEX, through the investment banker, and in the OTC market.
8. Initial margin requirements are determined by
A. the Securities and Exchange Commission.
B. the Federal Reserve System.
C. the New York Stock Exchange.
D. the Federal Reserve System and the New York Stock Exchange.
9. You purchased JNJ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a
A. stop-buy order.
B. limit-buy order.
C. market order.
D. limit-sell order.
E. None of these options are correct.
10. You sold JCP stock short at $80 per share. Your losses could be minimized by placing a
A. limit-sell order.
B. limit-buy order.
C. stop-buy order.
D. day-order.
E. None of the options are correct.
11. Which one of the following statements regarding orders is false?
A. A market order is simply an order to buy or sell a stock immediately at the prevailing market price.
B. A limit-sell order is where investors specify prices at which they are willing to sell a security.
C. If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and when the share price falls below
$45.
D. A market order is an order to buy or sell a stock on a specific exchange (market).
12. Restrictions on trading involving insider information apply to the following, except
A. corporate officers.
B. corporate directors.
C. major stockholders.
D. All of the individuals.
E. None of the options.
13. The cost of buying and selling a stock consists of
A. broker's commissions.
B. dealer's bid-asked spread.
C. a price concession an investor may be forced to make.
D. broker's commissions and dealer's bid-asked spread.
E. broker's commissions, dealer's bid-asked spread, and a price concession an investor may be forced to make.
3-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. Assume you purchased 200 shares of GE common stock on margin at $70 per share from your broker. If the initial margin is 55%,
how much did you borrow from the broker?
A. $6,000
B. $4,000
C. $7,700
D. $7,000
E. $6,300
15. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was
A. $4,800.
B. $12,000.
C. $5,600.
D. $7,200.
16. You purchased 100 shares of IBM common stock on margin at $70 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $21
B. $50
C. $49
D. $80
17. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin.
A. 0.33
B. 0.55
C. 0.43
D. 0.23
E. 0.25
18. You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin.
A. 25.00%
B. –33.33%
C. 44.31%
D. –41.67%
E. –54.22%
19. Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return
if you repurchase the stock at $40 per share? The stock paid no dividends during the period, and you did not remove any money from
the account before making the offsetting transaction.
A. 20.03%
B. 25.67%
C. 22.22%
D. 77.46%
3-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
20. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a
margin call if the maintenance margin is 35%?
A. $51.00
B. $65.19
C. $35.22
D. $40.36
21. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would be the maintenance
margin if a margin call is made at a stock price of $60?
A. 40%
B. 33%
C. 35%
D. 25%
22. Specialists on stock exchanges perform which of the following functions?
A. Act as dealers in their own accounts
B. Analyze the securities in which they specialize
C. Provide liquidity to the market
D. Act as dealers in their own accounts and analyze the securities in which they specialize
E. Act as dealers in their own accounts and provide liquidity to the market
23. Shares for short transactions
A. are usually borrowed from other brokers.
B. are typically shares held by the short seller's broker in street name.
C. are borrowed from commercial banks.
D. are typically shares held by the short seller's broker in street name and are borrowed from commercial banks.
24. Which of the following orders is most useful to short sellers who want to limit their potential losses?
A. Limit order
B. Discretionary order
C. Limit-loss order
D. Stop-buy order
25. Which of the following orders instructs the broker to buy at the current market price?
A. Limit order
B. Discretionary order
C. Limit-loss order
D. Stop-buy order
E. Market order
26. Which of the following orders instructs the broker to buy at or below a specified price?
A. Limit-loss order
B. Discretionary order
C. Limit-buy order
D. Stop-buy order
E. Market order
3-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
27. Which of the following orders instructs the broker to sell at or below a specified price?
A. Limit-sell order
B. Stop-loss
C. Limit-buy order
D. Stop-buy order
E. Market order
28. Which of the following orders instructs the broker to sell at or above a specified price?
A. Limit-buy order
B. Discretionary order
C. Limit-sell order
D. Stop-buy order
E. Market order
29. Which of the following orders instructs the broker to buy at or above a specified price?
A. Limit-buy order
B. Discretionary order
C. Limit-sell order
D. Stop-buy order
E. Market order
30. Shelf registration
A. is a way of placing issues in the primary market.
B. allows firms to register securities for sale over a two-year period.
C. increases transaction costs to the issuing firm.
D. is a way of placing issues in the primary market and allows firms to register securities for sale over a two-year period.
E. is a way of placing issues in the primary market and increases transaction costs to the issuing firm.
31. Block transactions are transactions for more than _______ shares, and they account for about _____ percent of all trading on the
NYSE.
A. 1,000; 5
B. 500; 10
C. 100,000; 50
D. 10,000; 30
E. 5,000; 23
32. A program trade is
A. a trade of 10,000 (or more) shares of a stock.
B. a trade of many shares of one stock for one other stock.
C. a trade of analytic programs between financial analysts.
D. a coordinated purchase or sale of an entire portfolio of stocks.
E. not feasible with current technology but is expected to be popular in the near future.
33. When stocks are held in street name,
A. the investor receives a stock certificate with the owner's street address.
B. the investor receives a stock certificate without the owner's street address.
C. the investor does not receive a stock certificate.
D. the broker holds the stock in the brokerage firm's name on behalf of the client.
E. the investor does not receive a stock certificate, and the broker holds the stock in the brokerage firm's name on behalf of the client.
3-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
34. NASDAQ subscriber levels
A. permit those with the highest level, 3, to "make a market" in the security.
B. permit those with a level 2 subscription to receive all bid and ask quotes but not to enter their own quotes.
C. permit level 1 subscribers to receive general information about prices.
D. include all OTC stocks.
E. permit those with the highest level, 3, to "make a market" in the security; permit those with a level 2 subscription to receive all bid
and ask quotes but not to enter their own quotes; and permit level 1 subscribers to receive general information about prices.
35. You want to buy 100 shares of Hotstock Inc. at the best possible price as quickly as possible. You would most likely place a
A. stop-loss order.
B. stop-buy order.
C. market order.
D. limit-sell order.
E. limit-buy order.
36. You want to purchase XON stock at $60 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $3,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
37. A sale by IBM of new stock to the public would be a(n)
A. short sale.
B. seasoned equity offering.
C. private placement.
D. secondary-market transaction.
E. initial public offering.
38. The finalized registration statement for new securities approved by the SEC is called
A. a red herring.
B. the preliminary statement.
C. the prospectus.
D. a best-efforts agreement.
E. a firm commitment.
39. One outcome from the SEC investigation of the "Flash Crash of 2010" was
A. a prohibition of short selling.
B. higher margin requirements.
C. approval of new circuit breakers.
D. establishment of electronic communications networks (ECNs).
E. passage of the Sarbanes-Oxley Act.
40. All of the following are considered new trading strategies, except
A. high frequency trading.
B. algorithmic trading.
C. dark pools.
D. short selling.
3-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
41. You sell short 100 shares of Loser Co. at a market price of $45 per share. Your maximum possible loss is
A. $4,500.
B. unlimited.
C. zero.
D. $9,000.
E. Cannot be determined from the information given.
42. You buy 300 shares of Qualitycorp for $30 per share and deposit initial margin of 50%. The next day, Qualitycorp's price drops to
$25 per share. What is your actual margin?
A. 50%
B. 40%
C. 33%
D. 60%
E. 25%
43. When a firm markets new securities, a preliminary registration statement must be filed with
A. the exchange on which the security will be listed.
B. the Securities and Exchange Commission.
C. the Federal Reserve.
D. all other companies in the same line of business.
E. the Federal Deposit Insurance Corporation.
44. In a typical underwriting arrangement, the investment-banking firm I) sells shares to the public via an underwriting syndicate.
II) purchases the securities from the issuing company.
III) assumes the full risk that the shares may not be sold at the offering price.
IV) agrees to help the firm sell the issue to the public but does not actually purchase the securities.
A. I, II, and III
B. I, III, and IV
C. I and IV
D. II and III
E. I and II
45. Which of the following is true regarding private placements of primary security offerings?
A. Extensive and costly registration statements are required by the SEC.
B. For very large issues, they are better suited than public offerings.
C. They trade in secondary markets.
D. The shares are sold directly to a small group of institutional or wealthy investors.
E. They have greater liquidity than public offerings.
46. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. Your initial investment was
A. $4,800.
B. $12,000.
C. $2,250.
D. $7,200.
3-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
47. You sold short 150 shares of common stock at $27 per share. The initial margin is 45%. Your initial investment was
A. $4,800.60.
B. $12,000.25.
C. $2,250.75.
D. $1,822.50.
48. You purchased 100 shares of XON common stock on margin at $60 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $42.86
B. $50.75
C. $49.67
D. $80.34
49. You purchased 1000 shares of CSCO common stock on margin at $19 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $12.86
B. $15.75
C. $19.67
D. $13.57
50. You purchased 100 shares of common stock on margin at $40 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $25? Ignore interest on margin.
A. 0.33
B. 0.55
C. 0.20
D. 0.23
E. 0.25
51. You purchased 1,000 shares of common stock on margin at $30 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $24? Ignore interest on margin.
A. 0.33
B. 0.375
C. 0.20
D. 0.23
E. 0.25
52. You purchased 100 shares of common stock on margin for $50 per share. The initial margin is 50%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $56 per share? Ignore interest on margin.
A. 28%
B. 33%
C. 14%
D. 42%
E. 24%
3-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
53. You purchased 100 shares of common stock on margin for $35 per share. The initial margin is 50%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $42 per share? Ignore interest on margin.
A. 28%
B. 33%
C. 14%
D. 40%
E. 24%
54. Assume you sell short 1,000 shares of common stock at $35 per share, with initial margin at 50%. What would be your rate of
return if you repurchase the stock at $25 per share? The stock paid no dividends during the period, and you did not remove any money
from the account before making the offsetting transaction.
A. 20.47%
B. 25.63%
C. 57.14%
D. 77.23%
55. Assume you sell short 100 shares of common stock at $30 per share, with initial margin at 50%. What would be your rate of return
if you repurchase the stock at $35 per share? The stock paid no dividends during the period, and you did not remove any money from
the account before making the offsetting transaction.
A. –33.33%
B. –25.63%
C. –57.14%
D. –77.23%
56. You want to purchase GM stock at $40 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $4,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
57. You want to purchase IBM stock at $80 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $2,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
58. Assume you sold short 100 shares of common stock at $40 per share. The initial margin is 50%. What would be the maintenance
margin if a margin call is made at a stock price of $50?
A. 40%
B. 20%
C. 35%
D. 25%
3-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
59. Assume you sold short 100 shares of common stock at $70 per share. The initial margin is 50%. What would be the maintenance
margin if a margin call is made at a stock price of $85?
A. 40.5%
B. 20.5%
C. 35.5%
D. 23.5%
60. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. At what stock price would you receive a
margin call if the maintenance margin is 35%?
A. $50
B. $65
C. $35
D. $40
61. You sold short 100 shares of common stock at $75 per share. The initial margin is 50%. At what stock price would you receive a
margin call if the maintenance margin is 30%?
A. $90.23
B. $88.52
C. $86.54
D. $87.12
62. The preliminary prospectus is referred to as a(n)
A. red herring.
B. indenture.
C. greenmail.
D. tombstone.
E. headstone.
63. The securities act of 1933 I) requires full disclosure of relevant information relating to the issue of new securities.
II) requires registration of new securities.
III) requires issuance of a prospectus detailing financial prospects of the firm.
IV) established the SEC.
V) requires periodic disclosure of relevant financial information.
VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers.
A. I, II, and III
B. I, II, III, IV, V, and VI
C. I, II, and V
D. I, II, and IV
E. IV only
64. The Securities Act of 1934 I) requires full disclosure of relevant information relating to the issue of new securities.
II) requires registration of new securities.
III) requires issuance of a prospectus detailing financial prospects of the firm.
IV) established the SEC.
V) requires periodic disclosure of relevant financial information.
VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers.
A. I, II, and III
B. I, II, III, IV, V, and VI
C. I, II, and V
D. I, II, and IV
E. IV, V, and VI
3-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
65. Which of the following is not required under the CFA Institute Standards of Professional Conduct?
A. Knowledge of all applicable laws, rules, and regulations
B. Disclosure of all personal investments, whether or not they may conflict with a client's investments
C. Disclosure of all conflicts to clients and prospects
D. Reasonable inquiry into a client's financial situation
E. All of the options are required under the CFA Institute standards.
66. According to the CFA Institute Standards of Professional Conduct, CFA Institute members have responsibilities to all of the
following, except
A. the government.
B. the profession.
C. the public.
D. the employer.
E. clients and prospective clients.
3-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 03 Test Bank - Static Key
Multiple Choice Questions
1. The trading of stock that was previously issued takes place
A. in the secondary market.
B. in the primary market.
C. usually with the assistance of an investment banker.
D. in the secondary and primary markets.
Secondary market transactions consist of trades between investors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Primary and secondary markets
2. A purchase of a new issue of stock takes place
A. in the secondary market.
B. in the primary market.
C. usually with the assistance of an investment banker.
D. in the secondary and primary markets.
E. in the primary market and usually with the assistance of an investment banker.
Funds from the sale of new issues flow to the issuing corporation, making this a primary market transaction. Investment bankers
usually assist by pricing the issue and finding buyers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Primary and secondary markets
3. Firms raise capital by issuing stock
A. in the secondary market.
B. in the primary market.
C. to unwary investors.
D. only on days when the market is up.
Funds from the sale of new issues flow to the issuing corporation, making this a primary market transaction.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Primary and secondary markets
3-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
4. Which of the following statements regarding the specialist are true?
A. Specialists maintain a book listing outstanding, unexecuted limit orders.
B. Specialists earn income from commissions and spreads in stock prices.
C. Specialists stand ready to trade at quoted bid and ask prices.
D. Specialists cannot trade in their own accounts.
E. Specialists maintain a book listing outstanding, unexecuted limit orders, earn income from commissions and spreads in stock
prices, and stand ready to trade at quoted bid and ask prices.
The specialists' functions are all of the items listed. In addition, specialists trade in their own accounts.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock exchanges and markets
5. Investment bankers
A. act as intermediaries between issuers of stocks and investors.
B. act as advisors to companies in helping them analyze their financial needs and find buyers for newly-issued securities.
C. accept deposits from savers and lend them out to companies.
D. act as intermediaries between issuers of stocks and investors and act as advisors to companies in helping them analyze their
financial needs and find buyers for newly-issued securities.
The role of the investment banker is to assist the firm in issuing new securities, both in advisory and marketing capacities. The
investment banker does not have a role comparable to a commercial bank, as indicated in accept deposits from savers and lend them
out to companies.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Basics of issuing securities
6. In a "firm commitment," the investment banker
A. buys the stock from the company and resells the issue to the public.
B. agrees to help the firm sell the stock at a favorable price.
C. finds the best marketing arrangement for the investment-banking firm.
D. agrees to help the firm sell the stock at a favorable price and finds the best marketing arrangement for the investment-banking firm.
In a "firm commitment," the investment banker buys the stock from the company and resells the issue to the public.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Public offerings
3-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
7. The secondary market consists of
A. transactions on the AMEX.
B. transactions in the OTC market.
C. transactions through the investment banker.
D. transactions on the AMEX and in the OTC market.
E. transactions on the AMEX, through the investment banker, and in the OTC market.
The secondary market consists of transactions on the organized exchanges and in the OTC market. The investment banker is involved
in the placement of new issues in the primary market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Primary and secondary markets
8. Initial margin requirements are determined by
A. the Securities and Exchange Commission.
B. the Federal Reserve System.
C. the New York Stock Exchange.
D. the Federal Reserve System and the New York Stock Exchange.
The Board of Governors of the Federal Reserve System determines initial margin requirements.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Financial market regulation and protections
9. You purchased JNJ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a
A. stop-buy order.
B. limit-buy order.
C. market order.
D. limit-sell order.
E. None of these options are correct.
With a limit-sell order, your stock will be sold only at a specified price, or better. Thus, such an order would protect your gains. None
of the other orders are applicable to this situation.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
10. You sold JCP stock short at $80 per share. Your losses could be minimized by placing a
A. limit-sell order.
B. limit-buy order.
C. stop-buy order.
D. day-order.
E. None of the options are correct.
With a stop-buy order, the stock would be purchased if the price increased to a specified level, thus limiting your loss.
3-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
11. Which one of the following statements regarding orders is false?
A. A market order is simply an order to buy or sell a stock immediately at the prevailing market price.
B. A limit-sell order is where investors specify prices at which they are willing to sell a security.
C. If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and when the share price falls below
$45.
D. A market order is an order to buy or sell a stock on a specific exchange (market).
All of the order descriptions above are correct except a market order is an order to buy or sell a stock on a specific exchange (market).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
12. Restrictions on trading involving insider information apply to the following, except
A. corporate officers.
B. corporate directors.
C. major stockholders.
D. All of the individuals.
E. None of the options.
Corporate officers, corporate directors, and major stockholders are corporate insiders and are subject to restrictions on trading on
inside information. Further, the Supreme Court held that traders may not trade on nonpublic information even if they are not insiders.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Financial market regulation and protections
13. The cost of buying and selling a stock consists of
A. broker's commissions.
B. dealer's bid-asked spread.
C. a price concession an investor may be forced to make.
D. broker's commissions and dealer's bid-asked spread.
E. broker's commissions, dealer's bid-asked spread, and a price concession an investor may be forced to make.
All of the options are possible costs of buying and selling a stock.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
3-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. Assume you purchased 200 shares of GE common stock on margin at $70 per share from your broker. If the initial margin is 55%,
how much did you borrow from the broker?
A. $6,000
B. $4,000
C. $7,700
D. $7,000
E. $6,300
200 shares × $70/share × (1 – 0.55) = $14,000 × (0.45) = $6,300.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Margin
15. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was
A. $4,800.
B. $12,000.
C. $5,600.
D. $7,200.
200 shares × $60/share × 0.60 = $12,000 × 0.60 = $7,200.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
16. You purchased 100 shares of IBM common stock on margin at $70 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $21
B. $50
C. $49
D. $80
100 shares × $70 × 0.5 = $7,000 × 0.5 = $3,500 (loan amount); 0.30 = (100P $3,500)/100P; 30 – P = 100P – $3,500; –70P = –$3,500;
P = $50.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
3-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
17. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin.
A. 0.33
B. 0.55
C. 0.43
D. 0.23
E. 0.25
100 shares × $45/share × 0.5 = $4,500 × 0.5 = $2,250 (loan amount); X = [100($30) – $2,250]/100($30); X = 0.25.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
18. You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin.
A. 25.00%
B. –33.33%
C. 44.31%
D. –41.67%
E. –54.22%
300($60)(0.60) = $10,800 investment; 300($60) = $18,000 × (0.40) = $7,200 loan; proceeds after selling stock and repaying loan:
$13,500 – $7,200 = $6,300; Return = ($6,300 – $10,800)/$10,800 = –41.67%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
19. Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return
if you repurchase the stock at $40 per share? The stock paid no dividends during the period, and you did not remove any money from
the account before making the offsetting transaction.
A. 20.03%
B. 25.67%
C. 22.22%
D. 77.46%
Profit on stock = ($45 – $40) × 100 = $500, $500/$2,250 (initial investment) = 22.22%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Short sales
3-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
20. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a
margin call if the maintenance margin is 35%?
A. $51.00
B. $65.19
C. $35.22
D. $40.36
Equity = 300($55) × 1.6 = $26,400; 0.35 = ($26,400 – 300P)/300P; 105P = $26,400 300P; 405P = $26,400; P = $65.18.
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Short sales
21. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would be the maintenance
margin if a margin call is made at a stock price of $60?
A. 40%
B. 33%
C. 35%
D. 25%
$5,000 × 1.6 = $8,000; [$8,000 – 100($60)]/100($60) = 33%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Short sales
22. Specialists on stock exchanges perform which of the following functions?
A. Act as dealers in their own accounts
B. Analyze the securities in which they specialize
C. Provide liquidity to the market
D. Act as dealers in their own accounts and analyze the securities in which they specialize
E. Act as dealers in their own accounts and provide liquidity to the market
Specialists are both brokers and dealers and provide liquidity to the market; they are not analysts.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock exchanges and markets
23. Shares for short transactions
A. are usually borrowed from other brokers.
B. are typically shares held by the short seller's broker in street name.
C. are borrowed from commercial banks.
D. are typically shares held by the short seller's broker in street name and are borrowed from commercial banks.
Typically, the only source of shares for short transactions is the short seller's broker in street name; often these are margined shares.
3-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
24. Which of the following orders is most useful to short sellers who want to limit their potential losses?
A. Limit order
B. Discretionary order
C. Limit-loss order
D. Stop-buy order
By issuing a stop-buy order, the short seller can limit potential losses by assuring that the stock will be purchased (and the short
position closed) if the price increases to a certain level.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
25. Which of the following orders instructs the broker to buy at the current market price?
A. Limit order
B. Discretionary order
C. Limit-loss order
D. Stop-buy order
E. Market order
Market orders are to be executed immediately at the best prevailing price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
26. Which of the following orders instructs the broker to buy at or below a specified price?
A. Limit-loss order
B. Discretionary order
C. Limit-buy order
D. Stop-buy order
E. Market order
Limit-buy orders are to be executed if the market price decreases to the specified limit price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
3-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
27. Which of the following orders instructs the broker to sell at or below a specified price?
A. Limit-sell order
B. Stop-loss
C. Limit-buy order
D. Stop-buy order
E. Market order
Stop-loss orders are to be executed if the market price decreases to the specified limit price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
28. Which of the following orders instructs the broker to sell at or above a specified price?
A. Limit-buy order
B. Discretionary order
C. Limit-sell order
D. Stop-buy order
E. Market order
Limit-sell orders are to be executed if the market price increases to the specified limit price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
29. Which of the following orders instructs the broker to buy at or above a specified price?
A. Limit-buy order
B. Discretionary order
C. Limit-sell order
D. Stop-buy order
E. Market order
Stop-buy orders are to be executed if the market price increases to the specified limit price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
30. Shelf registration
A. is a way of placing issues in the primary market.
B. allows firms to register securities for sale over a two-year period.
C. increases transaction costs to the issuing firm.
D. is a way of placing issues in the primary market and allows firms to register securities for sale over a two-year period.
E. is a way of placing issues in the primary market and increases transaction costs to the issuing firm.
Shelf registration lowers transactions costs to the firm as the firm may register issues for a longer period than in the past and thus
requires the services of the investment banker less frequently.
3-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
31. Block transactions are transactions for more than _______ shares, and they account for about _____ percent of all trading on the
NYSE.
A. 1,000; 5
B. 500; 10
C. 100,000; 50
D. 10,000; 30
E. 5,000; 23
Block transactions are defined as trades of 10,000 or more shares.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
32. A program trade is
A. a trade of 10,000 (or more) shares of a stock.
B. a trade of many shares of one stock for one other stock.
C. a trade of analytic programs between financial analysts.
D. a coordinated purchase or sale of an entire portfolio of stocks.
E. not feasible with current technology but is expected to be popular in the near future.
Program trading is a coordinated purchase or sale of an entire portfolio of stocks.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
33. When stocks are held in street name,
A. the investor receives a stock certificate with the owner's street address.
B. the investor receives a stock certificate without the owner's street address.
C. the investor does not receive a stock certificate.
D. the broker holds the stock in the brokerage firm's name on behalf of the client.
E. the investor does not receive a stock certificate, and the broker holds the stock in the brokerage firm's name on behalf of the client.
When stocks are held in street name, the investor does not receive a stock certificate; the broker holds the stock in the brokerage firm's
name on behalf of the client. This arrangement speeds transfer of securities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Account registration and types
3-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
34. NASDAQ subscriber levels
A. permit those with the highest level, 3, to "make a market" in the security.
B. permit those with a level 2 subscription to receive all bid and ask quotes but not to enter their own quotes.
C. permit level 1 subscribers to receive general information about prices.
D. include all OTC stocks.
E. permit those with the highest level, 3, to "make a market" in the security; permit those with a level 2 subscription to receive all bid
and ask quotes but not to enter their own quotes; and permit level 1 subscribers to receive general information about prices.
NASDAQ links dealers in a loosely organized network with different levels of access to meet different needs.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock exchanges and markets
35. You want to buy 100 shares of Hotstock Inc. at the best possible price as quickly as possible. You would most likely place a
A. stop-loss order.
B. stop-buy order.
C. market order.
D. limit-sell order.
E. limit-buy order.
A market order is for immediate execution at the best possible price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Stock trading and strategies
36. You want to purchase XON stock at $60 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $3,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
0.5 = [(Q × $60) – $3,000]/(Q × $60); $30Q = $60Q – $3,000; $30Q = $3,000; Q = 100.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Margin
3-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
37. A sale by IBM of new stock to the public would be a(n)
A. short sale.
B. seasoned equity offering.
C. private placement.
D. secondary-market transaction.
E. initial public offering.
When a firm whose stock already trades in the secondary market issues new shares to the public, this is referred to as a seasoned
equity offering.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
38. The finalized registration statement for new securities approved by the SEC is called
A. a red herring.
B. the preliminary statement.
C. the prospectus.
D. a best-efforts agreement.
E. a firm commitment.
The prospectus is the finalized registration statement approved by the SEC.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
39. One outcome from the SEC investigation of the "Flash Crash of 2010" was
A. a prohibition of short selling.
B. higher margin requirements.
C. approval of new circuit breakers.
D. establishment of electronic communications networks (ECNs).
E. passage of the Sarbanes-Oxley Act.
See "The Flash Crash of 2010."
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Financial market regulation and protections
40. All of the following are considered new trading strategies, except
A. high frequency trading.
B. algorithmic trading.
C. dark pools.
D. short selling.
See Section 3-5, New Trading Strategies; short selling has been in use for over 100 years in the U.S.
3-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Stock trading and strategies
41. You sell short 100 shares of Loser Co. at a market price of $45 per share. Your maximum possible loss is
A. $4,500.
B. unlimited.
C. zero.
D. $9,000.
E. Cannot be determined from the information given.
A short seller loses money when the stock price rises. Since there is no upper limit on the stock price, the maximum theoretical loss is
unlimited.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
42. You buy 300 shares of Qualitycorp for $30 per share and deposit initial margin of 50%. The next day, Qualitycorp's price drops to
$25 per share. What is your actual margin?
A. 50%
B. 40%
C. 33%
D. 60%
E. 25%
AM = [300 ($25) – 0.5(300) ($30)]/[300 ($25)] = 0.40.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Margin
43. When a firm markets new securities, a preliminary registration statement must be filed with
A. the exchange on which the security will be listed.
B. the Securities and Exchange Commission.
C. the Federal Reserve.
D. all other companies in the same line of business.
E. the Federal Deposit Insurance Corporation.
The SEC requires the registration statement and must approve it before the issue can take place.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Margin
3-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
44. In a typical underwriting arrangement, the investment-banking firm I) sells shares to the public via an underwriting syndicate.
II) purchases the securities from the issuing company.
III) assumes the full risk that the shares may not be sold at the offering price.
IV) agrees to help the firm sell the issue to the public but does not actually purchase the securities.
A. I, II, and III
B. I, III, and IV
C. I and IV
D. II and III
E. I and II
A typical underwriting arrangement is made on a firm commitment basis.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Public offerings
45. Which of the following is true regarding private placements of primary security offerings?
A. Extensive and costly registration statements are required by the SEC.
B. For very large issues, they are better suited than public offerings.
C. They trade in secondary markets.
D. The shares are sold directly to a small group of institutional or wealthy investors.
E. They have greater liquidity than public offerings.
Firms can save on registration costs, but the result is that the securities cannot trade in the secondary markets and therefore are less
liquid. Public offerings are better suited for very large issues.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Private equity
46. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. Your initial investment was
A. $4,800.
B. $12,000.
C. $2,250.
D. $7,200.
100 shares × $45/share × 0.50 = $4,500 × 0.50 = $2,250.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
47. You sold short 150 shares of common stock at $27 per share. The initial margin is 45%. Your initial investment was
A. $4,800.60.
B. $12,000.25.
C. $2,250.75.
D. $1,822.50.
150 shares × $27/share × 0.45 = $4,050 × 0.45 = $1,822.50.
3-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
48. You purchased 100 shares of XON common stock on margin at $60 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $42.86
B. $50.75
C. $49.67
D. $80.34
100 shares × $60 × 0.5 = $6,000 × 0.5 = $3,000 (loan amount); 0.30 = (100P $3,000)/100P; 30 – P = 100P – $3,000; –70P = –$3,000;
P = $42.86.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
49. You purchased 1000 shares of CSCO common stock on margin at $19 per share. Assume the initial margin is 50%, and the
maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore
interest on margin.
A. $12.86
B. $15.75
C. $19.67
D. $13.57
1,000 shares × $19 × 0.5 = $19,000 × 0.5 = $9,500 (loan amount); 0.30 = (1,000P – $9,500)/1,000P; 300P = 1,000P – $9,500; –700P
= –$9,500; P = $13.57.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
50. You purchased 100 shares of common stock on margin at $40 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $25? Ignore interest on margin.
A. 0.33
B. 0.55
C. 0.20
D. 0.23
E. 0.25
100 shares × $40/share × 0.5 = $4,000 × 0.5 = $2,000 (loan amount); X = [100($25) – $2,000]/100($25); X = 0.20.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
3-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
51. You purchased 1,000 shares of common stock on margin at $30 per share. Assume the initial margin is 50%, and the stock pays no
dividend. What would the maintenance margin be if a margin call is made at a stock price of $24? Ignore interest on margin.
A. 0.33
B. 0.375
C. 0.20
D. 0.23
E. 0.25
1,000 shares × $30/share × 0.5 = $30,000 × 0.5 = $15,000 (loan amount); X = [1,000($24) – $15,000]/1,000($24); X = 0.375.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
52. You purchased 100 shares of common stock on margin for $50 per share. The initial margin is 50%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $56 per share? Ignore interest on margin.
A. 28%
B. 33%
C. 14%
D. 42%
E. 24%
100($50)(0.50) = $2,500 investment; gain on stock sale = (56 – 50)(100) = $600; Return = ($600/$2,500) = 24%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
53. You purchased 100 shares of common stock on margin for $35 per share. The initial margin is 50%, and the stock pays no
dividend. What would your rate of return be if you sell the stock at $42 per share? Ignore interest on margin.
A. 28%
B. 33%
C. 14%
D. 40%
E. 24%
100($35)(0.50) = $1,750 investment; gain on stock sale = (42 – 35)(100) = $700; Return = ($700/$1,750) = 40%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
3-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
54. Assume you sell short 1,000 shares of common stock at $35 per share, with initial margin at 50%. What would be your rate of
return if you repurchase the stock at $25 per share? The stock paid no dividends during the period, and you did not remove any money
from the account before making the offsetting transaction.
A. 20.47%
B. 25.63%
C. 57.14%
D. 77.23%
Profit on stock = ($35 – $25)(1,000) = $10,000; initial investment = ($35)(1,000)(0.5) = $17,500; return = $10,000/$17,500 = 57.14%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
55. Assume you sell short 100 shares of common stock at $30 per share, with initial margin at 50%. What would be your rate of return
if you repurchase the stock at $35 per share? The stock paid no dividends during the period, and you did not remove any money from
the account before making the offsetting transaction.
A. –33.33%
B. –25.63%
C. –57.14%
D. –77.23%
Profit on stock = ($30 – $35)(100) = –500; initial investment = ($30)(100)(0.5) = $1,500; return = $500/$1,500 = –33.33%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Short sales
56. You want to purchase GM stock at $40 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $4,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
You can buy ($4,000/$40) = 100 shares outright and you can borrow $4,000 to buy another 100 shares.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Margin
3-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
57. You want to purchase IBM stock at $80 from your broker using as little of your own money as possible. If initial margin is 50%
and you have $2,000 to invest, how many shares can you buy?
A. 100 shares
B. 200 shares
C. 50 shares
D. 500 shares
E. 25 shares
You can buy ($2,000/$80) = 25 shares outright and you can borrow $2,000 to buy another 25 shares.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Margin
58. Assume you sold short 100 shares of common stock at $40 per share. The initial margin is 50%. What would be the maintenance
margin if a margin call is made at a stock price of $50?
A. 40%
B. 20%
C. 35%
D. 25%
$4,000 × 1.5 = $6,000; [$6,000 – 100($50)]/100($50) = 20%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
59. Assume you sold short 100 shares of common stock at $70 per share. The initial margin is 50%. What would be the maintenance
margin if a margin call is made at a stock price of $85?
A. 40.5%
B. 20.5%
C. 35.5%
D. 23.5%
$7,000 × 1.5 = $10,500; [$10,500 – 100($85)]/100($85) = 23.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
60. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. At what stock price would you receive a
margin call if the maintenance margin is 35%?
A. $50
B. $65
C. $35
D. $40
Equity = 100($45) × 1.5 = $6,750; 0.35 = ($6,750 – 100P)/100P; 35P = $6,750 – 100P; 135P = $6,750; P = $50.00
3-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Margin
61. You sold short 100 shares of common stock at $75 per share. The initial margin is 50%. At what stock price would you receive a
margin call if the maintenance margin is 30%?
A. $90.23
B. $88.52
C. $86.54
D. $87.12
Equity = 100($75) × 1.5 = $11,250; 0.30 = ($11,250 – 100P)/100P; 30P = $11,250 – 100P; 130P = $11,250; P = $86.54.
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Margin
62. The preliminary prospectus is referred to as a(n)
A. red herring.
B. indenture.
C. greenmail.
D. tombstone.
E. headstone.
The preliminary prospectus is referred to as a red herring.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
63. The securities act of 1933 I) requires full disclosure of relevant information relating to the issue of new securities.
II) requires registration of new securities.
III) requires issuance of a prospectus detailing financial prospects of the firm.
IV) established the SEC.
V) requires periodic disclosure of relevant financial information.
VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers.
A. I, II, and III
B. I, II, III, IV, V, and VI
C. I, II, and V
D. I, II, and IV
E. IV only
The Securities Act of 1933 requires full disclosure of relevant information relating to the issue of new securities, requires registration
of new securities, and requires issuance of a prospectus detailing financial prospects of the firm.
3-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Basics of issuing securities
Topic: Financial market regulation and protections
64. The Securities Act of 1934 I) requires full disclosure of relevant information relating to the issue of new securities.
II) requires registration of new securities.
III) requires issuance of a prospectus detailing financial prospects of the firm.
IV) established the SEC.
V) requires periodic disclosure of relevant financial information.
VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers.
A. I, II, and III
B. I, II, III, IV, V, and VI
C. I, II, and V
D. I, II, and IV
E. IV, V, and VI
The Securities Act of 1934 established the SEC, requires periodic disclosure of relevant financial information, and empowers SEC to
regulate exchanges, OTC trading, brokers, and dealers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial market regulation and protections
65. Which of the following is not required under the CFA Institute Standards of Professional Conduct?
A. Knowledge of all applicable laws, rules, and regulations
B. Disclosure of all personal investments, whether or not they may conflict with a client's investments
C. Disclosure of all conflicts to clients and prospects
D. Reasonable inquiry into a client's financial situation
E. All of the options are required under the CFA Institute standards.
See "Excerpts from CFA Institute Standards of Professional Conduct." Personal investments need not be disclosed unless they are in
potential or actual conflict.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Professional standards, practices, and conduct
66. According to the CFA Institute Standards of Professional Conduct, CFA Institute members have responsibilities to all of the
following, except
A. the government.
B. the profession.
C. the public.
D. the employer.
E. clients and prospective clients.
See "Excerpts from CFA Institute Standards of Professional Conduct."
3-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Professional standards, practices, and conduct
3-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 03 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Difficulty: 3 Challenge
Topic: Account registration and types
Topic: Basics of issuing securities
Topic: Financial market regulation and protections
Topic: Margin
Topic: Primary and secondary markets
Topic: Private equity
Topic: Professional standards, practices, and conduct
Topic: Public offerings
Topic: Short sales
Topic: Stock exchanges and markets
Topic: Stock trading and strategies
# of Questions
16
52
66
15
12
39
13
37
16
1
7
5
19
4
1
2
2
10
3
13
3-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 04 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Which one of the following statements regarding open-end mutual funds is false?
A. The funds redeem shares at net asset value.
B. The funds offer investors professional management.
C. The funds offer investors a guaranteed rate of return.
D. The funds redeem shares at net asset value and offer investors professional management.
2. Which one of the following statements regarding closed-end mutual funds is false?
A. The funds always trade at a discount from NAV.
B. The funds redeem shares at their net asset value.
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 are correct.
3. Which of the following functions do investment companies perform for their investors?
A. Record keeping and administration
B. Diversification and divisibility
C. Professional management
D. Lower transaction costs
E. All of the options.
4. 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?
A. $18.11
B. $18.81
C. $69.96
D. $7.00
E. $181.07
5. Growth Fund had year-end assets of $862,000,000 and liabilities of $12,000,000. There were 32,675,254 shares in the fund at year
end. What was Growth Fund's net asset value?
A. $28.17
B. $25.24
C. $19.62
D. $26.01
E. $21.56
6. Diversified Portfolios had year-end assets of $279,000,000 and liabilities of $43,000,000. If Diversified's NAV was $42.13, how
many shares must have been held in the fund?
A. 43,000,000
B. 6,488,372
C. 5,601,709
D. 1,182,203
4-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
7. Pinnacle Fund had year-end assets of $825,000,000 and liabilities of $25,000,000. If Pinnacle's NAV was $32.18, how many shares
must have been held in the fund?
A. 21,619,346.92
B. 22,930,546.28
C. 24,860,161.59
D. 25,693,645.25
8. Most actively-managed mutual funds, when compared to a market index such as the Wilshire 5000,
A. beat the market return in all years.
B. beat the market return in most years.
C. exceed the return on index funds.
D. do not outperform the market.
9. Pools of money invested in a portfolio that is fixed for the life of the fund are called
A. closed-end funds.
B. open-end funds.
C. unit investment trusts.
D. REITS.
E. redeemable trust certificates.
10. Investors in closed-end funds who wish to liquidate their positions must
A. sell their shares through a broker.
B. sell their shares to the issuer at a discount to net asset value.
C. sell their shares to the issuer at a premium to net asset value.
D. sell their shares to the issuer for net asset value.
E. hold their shares to maturity.
11. Closed-end funds are frequently issued at a ______ to NAV and subsequently trade at a __________ to NAV.
A. discount; discount
B. discount; premium
C. premium; premium
D. premium; discount
E. No consistent relationship has been observed.
12. At issue, offering prices of open-end funds will often be
A. less than NAV due to loads.
B. greater than NAV due to loads.
C. less than NAV due to limited demand.
D. greater than NAV due to excess demand.
E. less than or greater than NAV with no apparent pattern.
13. Which of the following statements about real estate investment trusts is true?
A. REITs invest in real estate or loans secured by real estate.
B. REITs raise capital by borrowing from banks and issuing mortgages.
C. REITs are similar to open-end funds, with shares redeemable at NAV.
D. REITs invest in real estate or loans secured by real estate and raise capital by borrowing from banks and issuing mortgages.
E. All of the options are true.
4-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. Which of the following statements about real estate investment trusts is true?
A. REITs may be equity trusts or mortgage trusts.
B. REITs are usually highly leveraged.
C. REITs are similar to closed-end funds.
D. REITs may be equity trusts or mortgage trusts and are usually highly leveraged.
E. All of the options are true.
15. Which of the following statements about money market mutual funds is true?
A. They invest in commercial paper, CDs, and repurchase agreements.
B. They usually offer check-writing privileges.
C. They are highly leveraged and risky.
D. They invest in commercial paper, CDs, and repurchase agreements, and they usually offer check-writing privileges.
E. All of the options are true.
16. In 2016, the proportion of mutual funds (based on total assets) specializing in common stocks was
A. 21.7%.
B. 28.0%.
C. 52.1%.
D. 73.4%.
E. 63.5%.
17. In 2016, the proportion of mutual funds (based on total assets) specializing in bonds was
A. 21.8%.
B. 28.0%.
C. 54.1%.
D. 73.4%.
E. 63.5%.
18. In 2016, the proportion of mutual funds (based on total assets) specializing in money market securities was
A. 21.7%.
B. 28.0%.
C. 54.1%.
D. 73.4%.
E. 17.6%.
19. In 2016, the proportion of hybrid (bond and stock) mutual funds (based on total assets) was
A. 21.7%.
B. 28.0%.
C. 54.1%.
D. 8.5%.
E. 22.6%.
20. Management fees and other expenses of mutual funds may include
A. front-end loads.
B. back-end loads.
C. 12b-1 charges.
D. front-end and back-end loads.
E. front-end loads, back-end loads, and 12b-1 charges.
4-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
21. The Profitability Fund had NAV per share of $17.50 on January 1, 2016. On December 31 of the same year, the fund's NAV was
$19.47. Income distributions were $0.75, and the fund had capital gain distributions of $1.00. Without considering taxes and
transactions costs, what rate of return did an investor receive on the Profitability Fund last year?
A. 11.26%
B. 15.54%
C. 16.97%
D. 21.26%
E. 9.83%
22. The Yachtsman Fund had NAV per share of $36.12 on January 1, 2016. On December 31 of the same year, the fund's NAV was
$39.71. Income distributions were $0.64, and the fund had capital gain distributions of $1.13. Without considering taxes and
transactions costs, what rate of return did an investor receive on the Yachtsman Fund last year?
A. 22.92%
B. 17.68%
C. 14.39%
D. 18.52%
E. 14.84%
23. Investors' Choice Fund had NAV per share of $37.25 on January 1, 2016. On December 31 of the same year, the fund s rate of
return for the year was 17.3%. Income distributions were $1.14, and the fund had capital gain distributions of $1.35. Without
considering taxes and transactions costs, what ending NAV would you calculate for Investors' Choice?
A. $41.20
B. $33.88
C. $43.69
D. $42.03
E. $46.62
24. Which of the following is not an advantage of owning mutual funds?
A. They offer a variety of investment styles.
B. They offer small investors the benefits of diversification.
C. They treat income as "passed through" to the investor for tax purposes.
D. All of the options are advantages of mutual funds.
E. None of the options are an advantage of mutual funds.
25. Which of the following would increase the net asset value of a mutual fund share, assuming all other things remain unchanged?
A. An increase in the number of fund shares outstanding
B. An increase in the fund's accounts payable
C. A change in the fund's management
D. An increase in the value of one of the fund's stocks
26. Which of the following characteristics apply to unit investment trusts? I) Most are invested in fixed-income portfolios.
II) They are actively-managed portfolios.
III) The sponsor pools securities, then sells public shares in the trust.
IV) The portfolio is fixed for the life of the fund.
A. I and IV
B. I and II
C. I, III, and IV
D. I, II, and III
E. I, II, III, and IV
4-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
27. As of 2016, which class of mutual funds had the largest amount of assets invested?
A. Equity funds
B. Bond funds
C. Mixed asset classes, such as asset allocation funds
D. Money market funds
E. Global funds
28. Commingled funds are
A. amounts invested in equity and fixed-income mutual funds.
B. funds that may be purchased at intervals of 3, 6, or 12 months at the discretion of management.
C. amounts invested in domestic and global equities.
D. closed-end funds that may be repurchased only once every two years at the discretion of mutual fund management.
E. partnerships of investors that pool their funds, which are then managed for a fee.
29. Which of the following is true regarding equity mutual funds?
I) They invest primarily in stock.
II) They may hold fixed-income securities, as well as stock.
III) Most hold money market securities, as well as stock.
IV) Two types of equity funds are income funds and growth funds.
A. I and IV
B. I, III, and IV
C. I, II, and IV
D. I, II, and III
E. I, II, III, and IV
30. The fee that mutual funds use to help pay for advertising and promotional literature is called a
A. front-end load fee.
B. back-end load fee.
C. operating expense fee.
D. 12b-1 fee.
E. structured fee.
31. Patty O Furniture purchased 100 shares of Green Isle mutual fund at a net asset value of $42 per share. During the year, Patty
received dividend income distributions of $2.00 per share and capital gains distributions of $4.30 per share. At the end of the year, the
shares had a net asset value of $40 per share. What was Patty's rate of return on this investment?
A. 5.43%
B. 10.24%
C. 7.19%
D. 12.44%
E. 9.18%
32. Assume that you purchased 200 shares of Super Performing mutual fund at a net asset value of $21 per share. During the year, you
received dividend income distributions of $1.50 per share and capital gains distributions of $2.85 per share. At the end of the year, the
shares had a net asset value of $23 per share. What was your rate of return on this investment?
A. 30.24%
B. 25.37%
C. 27.19%
D. 22.44%
E. 29.18%
4-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
33. Assume that you purchased shares of High Flying mutual fund at a net asset value of $12.50 per share. During the year, you
received dividend income distributions of $0.78 per share and capital gains distributions of $1.67 per share. At the end of the year, the
shares had a net asset value of $13.87 per share. What was your rate of return on this investment?
A. 29.43%
B. 30.56%
C. 31.19%
D. 32.44%
E. 29.18%
34. Assume that you purchased shares of a mutual fund at a net asset value of $14.50 per share. During the year, you received
dividend income distributions of $0.27 per share and capital gains distributions of $0.65 per share. At the end of the year, the shares
had a net asset value of $13.74 per share. What was your rate of return on this investment?
A. 2.91%
B. 3.07%
C. 1.10%
D. 1.78%
E. –1.18%
35. Assume that you purchased shares of a mutual fund at a net asset value of $10.00 per share. During the year, you received
dividend income distributions of $0.05 per share and capital gains distributions of $0.06 per share. At the end of the year, the shares
had a net asset value of $8.16 per share. What was your rate of return on this investment?
A. –18.24%
B. –16.1%
C. 16.10%
D. –17.3%
E. 17.3%
36. A mutual fund had year-end assets of $560,000,000 and liabilities of $26,000,000. There were 23,850,000 shares in the fund at
year end. What was the mutual fund's net asset value?
A. $22.87
B. $22.39
C. $22.24
D. $17.61
E. $19.25
37. A mutual fund had year-end assets of $250,000,000 and liabilities of $4,000,000. There were 3,750,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $92.53
B. $67.39
C. $63.24
D. $65.60
E. $17.46
38. A mutual fund had year-end assets of $700,000,000 and liabilities of $7,000,000. There were 40,150,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $9.63
B. $57.71
C. $16.42
D. $17.87
E. $17.26
4-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
39. A mutual fund had year-end assets of $750,000,000 and liabilities of $7,500,000. There were 40,000,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $9.63
B. $18.56
C. $16.42
D. $17.87
E. $17.26
40. A mutual fund had year-end assets of $465,000,000 and liabilities of $37,000,000. If the fund NAV was $56.12, how many shares
must have been held in the fund?
A. 4,300,000
B. 6,488,372
C. 8,601,709
D. 7,626,515
E. None of these options are correct.
41. A mutual fund had year-end assets of $521,000,000 and liabilities of $63,000,000. If the fund NAV was $26.12, how many shares
must have been held in the fund?
A. 17,534,456
B. 16,488,372
C. 18,601,742
D. 17,542,515
42. A mutual fund had year-end assets of $327,000,000 and liabilities of $46,000,000. If the fund NAV was $30.48, how many shares
must have been held in the fund?
A. 11,354,751
B. 8,412,642
C. 10,165,476
D. 9,165,414
E. 9,219,160
43. A mutual fund had year-end assets of $437,000,000 and liabilities of $37,000,000. If the fund NAV was $60.12, how many shares
must have been held in the fund?
A. 6,653,360
B. 8,412,642
C. 10,165,476
D. 9,165,414
E. 9,219,160
44. A mutual fund had NAV per share of $19.00 on January 1, 2016. On December 31 of the same year, the fund's NAV was $19.14.
Income distributions were $0.57, and the fund had capital gain distributions of $1.12. Without considering taxes and transactions
costs, what rate of return did an investor receive on the fund last year?
A. 11.26%
B. 10.54%
C. 7.97%
D. 8.26%
E. 9.63%
4-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
45. A mutual fund had NAV per share of $23.00 on January 1, 2016. On December 31 of the same year, the fund's NAV was $23.15.
Income distributions were $0.63, and the fund had capital gain distributions of $1.26. Without considering taxes and transactions
costs, what rate of return did an investor receive on the fund last year?
A. 11.26%
B. 10.54%
C. 8.87%
D. 8.26%
E. 9.63%
46. A mutual fund had NAV per share of $26.25 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 16.4%. Income distributions were $1.27, and the fund had capital gain distributions of $1.85. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $27.44
B. $33.88
C. $24.69
D. $42.03
E. $16.62
47. A mutual fund had NAV per share of $16.75 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 26.6%. Income distributions were $1.79, and the fund had capital gain distributions of $2.80. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $17.44
B. $13.28
C. $14.96
D. $17.25
E. $16.62
48. A mutual fund had NAV per share of $36.15 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 14.0%. Income distributions were $1.16, and the fund had capital gain distributions of $2.12. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $37.93
B. $34.52
C. $44.69
D. $47.25
E. $36.28
49. A mutual fund had NAV per share of $37.12 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 11.0%. Income distributions were $2.26, and the fund had capital gain distributions of $1.64. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $37.93
B. $34.52
C. $37.30
D. $47.25
E. $36.28
4-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
50. Differences between hedge funds and mutual funds are that
A. hedge funds are only subject to minimal SEC regulation.
B. hedge funds are typically open only to wealthy or institutional investors.
C. hedge fund managers can pursue strategies not available to mutual funds, such as short selling, heavy use of derivatives, and
leverage.
D. hedge funds are commonly structured as private partnerships.
E. All of the options.
51. Of the following types of mutual funds, an investor who wishes to invest in a diversified portfolio of stocks worldwide (including
the U.S.) should choose
A. international funds.
B. global funds.
C. regional funds.
D. emerging-market funds.
52. Of the following types of mutual funds, an investor who wishes to invest in a diversified portfolio of foreign stocks (excluding the
U.S.) should choose
A. international funds.
B. global funds.
C. regional funds.
D. emerging-market funds.
53. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the S&P 500 should choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
54. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Dow Jones Industrials
should choose
A. SPY.
B. DIA.
C. QQQQ.
D. IWM.
E. VTI.
55. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Nasdaq 100 should
choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
4-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
56. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Russell 2000 should
choose
A. SPY.
B. DIA.
C. QQQQ.
D. IWM.
E. VTI.
57. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Wilshire 5000 should
choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
58. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the MSCI Japan Index
should choose
A. SPY.
B. EWJ.
C. QQQQ.
D. IWM.
E. VTI.
59. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the MSCI France Index
should choose
A. SPY.
B. EWJ.
C. EWQ.
D. IWM.
E. VTI.
60. A mutual fund had average daily assets of $3.0 billion in 2016. The fund sold $600 million worth of stock and purchased $700
million worth of stock during the year. The fund's turnover ratio is
A. 27.5%.
B. 12%.
C. 15%.
D. 25%.
E. 20%.
61. A mutual fund had average daily assets of $2.0 billion in 2016. The fund sold $500 million worth of stock and purchased $600
million worth of stock during the year. The fund's turnover ratio is
A. 27.5%.
B. 12%.
C. 15%.
D. 25%.
E. 20%.
4-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
62. A mutual fund had average daily assets of $4.0 billion in 2016. The fund sold $1.5 billion worth of stock and purchased $1.6
billion worth of stock during the year. The fund's turnover ratio is
A. 37.5%.
B. 22%.
C. 15%.
D. 45%.
E. 20%.
63. A mutual fund had average daily assets of $4.7 billion in 2016. The fund sold $2.2 billion worth of stock and purchased $3.6
billion worth of stock during the year. The fund's turnover ratio is
A. 37.5%.
B. 22.6%.
C. 15.3%.
D. 46.8%.
E. 20.7%.
64. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 5.75%.
If the securities in which the fund invested increased in value by 11% during the year, and the fund's expense ratio was 1.25%, your
return if you sold the fund at the end of the year would be
A. 4.33%.
B. 3.44%.
C. 2.45%.
D. 6.87%.
65. You purchased shares of a mutual fund at a price of $12 per share at the beginning of the year and paid a front-end load of 4.75%.
If the securities in which the fund invested increased in value by 9% during the year, and the fund's expense ratio was 1.5%, your
return if you sold the fund at the end of the year would be
A. 4.75%.
B. 3.54%.
C. 2.65%.
D. 2.39%.
66. You purchased shares of a mutual fund at a price of $17 per share at the beginning of the year and paid a front-end load of 5.0%. If
the securities in which the fund invested increased in value by 12% during the year, and the fund's expense ratio was 1.0%, your return
if you sold the fund at the end of the year would be
A. 4.75%.
B. 5.45%.
C. 5.65%.
D. 4.39%.
67. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 6.0%. If
the securities in which the fund invested increased in value by 10% during the year, and the fund's expense ratio was 1.5%, your return
if you sold the fund at the end of the year would be
A. 1.99%.
B. 2.32%.
C. 1.65%.
D. 2.06%.
E. None of the options are correct.
4-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 04 Test Bank - Static Key
Multiple Choice Questions
1. Which one of the following statements regarding open-end mutual funds is false?
A. The funds redeem shares at net asset value.
B. The funds offer investors professional management.
C. The funds offer investors a guaranteed rate of return.
D. The funds redeem shares at net asset value and offer investors professional management.
Mutual funds do not offer a guaranteed rate of return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Open-end funds
2. Which one of the following statements regarding closed-end mutual funds is false?
A. The funds always trade at a discount from NAV.
B. The funds redeem shares at their net asset value.
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 are correct.
Closed-end funds are sold at the prevailing market price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Closed-end funds
3. Which of the following functions do investment companies perform for their investors?
A. Record keeping and administration
B. Diversification and divisibility
C. Professional management
D. Lower transaction costs
E. All of the options.
Investment companies are attractive to investors because they offer all of the listed services.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Closed-end funds
4-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
4. 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?
A. $18.11
B. $18.81
C. $69.96
D. $7.00
E. $181.07
($457,000,000 – 17,000,000)/24,300,000 = $18.11.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
5. Growth Fund had year-end assets of $862,000,000 and liabilities of $12,000,000. There were 32,675,254 shares in the fund at year
end. What was Growth Fund's net asset value?
A. $28.17
B. $25.24
C. $19.62
D. $26.01
E. $21.56
($862,000,000 – 12,000,000)/32,675,254 = $26.01.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
6. Diversified Portfolios had year-end assets of $279,000,000 and liabilities of $43,000,000. If Diversified's NAV was $42.13, how
many shares must have been held in the fund?
A. 43,000,000
B. 6,488,372
C. 5,601,709
D. 1,182,203
($279,000,000 – 43,000,000)/$42.13 = 5,601,708.996.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
4-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
7. Pinnacle Fund had year-end assets of $825,000,000 and liabilities of $25,000,000. If Pinnacle's NAV was $32.18, how many shares
must have been held in the fund?
A. 21,619,346.92
B. 22,930,546.28
C. 24,860,161.59
D. 25,693,645.25
($825,000,000 – 25,000,000)/$32.18 = 24,860,161.59.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
8. Most actively-managed mutual funds, when compared to a market index such as the Wilshire 5000,
A. beat the market return in all years.
B. beat the market return in most years.
C. exceed the return on index funds.
D. do not outperform the market.
Most actively managed mutual funds fail to equal the return earned by index funds, possibly due to higher transactions costs.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund evaluation and performance
9. Pools of money invested in a portfolio that is fixed for the life of the fund are called
A. closed-end funds.
B. open-end funds.
C. unit investment trusts.
D. REITS.
E. redeemable trust certificates.
Unit investment trusts are funds that invest in a portfolio, often fixed-income securities, and hold it to maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund classifications
10. Investors in closed-end funds who wish to liquidate their positions must
A. sell their shares through a broker.
B. sell their shares to the issuer at a discount to net asset value.
C. sell their shares to the issuer at a premium to net asset value.
D. sell their shares to the issuer for net asset value.
E. hold their shares to maturity.
Closed-end fund shares are sold on organized exchanges through a broker.
4-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Closed-end funds
11. Closed-end funds are frequently issued at a ______ to NAV and subsequently trade at a __________ to NAV.
A. discount; discount
B. discount; premium
C. premium; premium
D. premium; discount
E. No consistent relationship has been observed.
Closed-end funds are typically issued at a premium to net asset value and subsequently trade at a discount.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund pricing
12. At issue, offering prices of open-end funds will often be
A. less than NAV due to loads.
B. greater than NAV due to loads.
C. less than NAV due to limited demand.
D. greater than NAV due to excess demand.
E. less than or greater than NAV with no apparent pattern.
Open-end funds are redeemable on demand at NAV so they should never sell for less than NAV. However, loads can increase the
price above NAV.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Fund pricing
13. Which of the following statements about real estate investment trusts is true?
A. REITs invest in real estate or loans secured by real estate.
B. REITs raise capital by borrowing from banks and issuing mortgages.
C. REITs are similar to open-end funds, with shares redeemable at NAV.
D. REITs invest in real estate or loans secured by real estate and raise capital by borrowing from banks and issuing mortgages.
E. All of the options are true.
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.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Real estate investment trusts
4-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. Which of the following statements about real estate investment trusts is true?
A. REITs may be equity trusts or mortgage trusts.
B. REITs are usually highly leveraged.
C. REITs are similar to closed-end funds.
D. REITs may be equity trusts or mortgage trusts and are usually highly leveraged.
E. All of the options are true.
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.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Real estate investment trusts
15. Which of the following statements about money market mutual funds is true?
A. They invest in commercial paper, CDs, and repurchase agreements.
B. They usually offer check-writing privileges.
C. They are highly leveraged and risky.
D. They invest in commercial paper, CDs, and repurchase agreements, and they usually offer check-writing privileges.
E. All of the options are true.
Money market mutual funds invest in commercial paper, CDs, repurchase agreements, and other money market securities. They
usually offer check-writing privileges. Their NAV is fixed at $1 per share.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund classifications
16. In 2016, the proportion of mutual funds (based on total assets) specializing in common stocks was
A. 21.7%.
B. 28.0%.
C. 52.1%.
D. 73.4%.
E. 63.5%.
See Table 4.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fund classifications
4-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
17. In 2016, the proportion of mutual funds (based on total assets) specializing in bonds was
A. 21.8%.
B. 28.0%.
C. 54.1%.
D. 73.4%.
E. 63.5%.
See Table 4.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fund classifications
18. In 2016, the proportion of mutual funds (based on total assets) specializing in money market securities was
A. 21.7%.
B. 28.0%.
C. 54.1%.
D. 73.4%.
E. 17.6%.
See Table 4.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fund classifications
19. In 2016, the proportion of hybrid (bond and stock) mutual funds (based on total assets) was
A. 21.7%.
B. 28.0%.
C. 54.1%.
D. 8.5%.
E. 22.6%.
See Table 4.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fund classifications
20. Management fees and other expenses of mutual funds may include
A. front-end loads.
B. back-end loads.
C. 12b-1 charges.
D. front-end and back-end loads.
E. front-end loads, back-end loads, and 12b-1 charges.
All of the listed expenses may be included in the cost of owning a mutual fund.
4-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund management fees, loads, and other charges
21. The Profitability Fund had NAV per share of $17.50 on January 1, 2016. On December 31 of the same year, the fund's NAV was
$19.47. Income distributions were $0.75, and the fund had capital gain distributions of $1.00. Without considering taxes and
transactions costs, what rate of return did an investor receive on the Profitability Fund last year?
A. 11.26%
B. 15.54%
C. 16.97%
D. 21.26%
E. 9.83%
R = ($19.47 – 17.50 + 0.75 + 1.00)/$17.50 = 21.26%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
22. The Yachtsman Fund had NAV per share of $36.12 on January 1, 2016. On December 31 of the same year, the fund's NAV was
$39.71. Income distributions were $0.64, and the fund had capital gain distributions of $1.13. Without considering taxes and
transactions costs, what rate of return did an investor receive on the Yachtsman Fund last year?
A. 22.92%
B. 17.68%
C. 14.39%
D. 18.52%
E. 14.84%
R = ($39.71 – 36.12 + 0.64 + 1.13)/$36.12 = 14.84%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
23. Investors' Choice Fund had NAV per share of $37.25 on January 1, 2016. On December 31 of the same year, the fund s rate of
return for the year was 17.3%. Income distributions were $1.14, and the fund had capital gain distributions of $1.35. Without
considering taxes and transactions costs, what ending NAV would you calculate for Investors' Choice?
A. $41.20
B. $33.88
C. $43.69
D. $42.03
E. $46.62
0.173 = (P – $37.25 + 1.14 + 1.35)/$37.25; P = $41.20.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
4-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
24. Which of the following is not an advantage of owning mutual funds?
A. They offer a variety of investment styles.
B. They offer small investors the benefits of diversification.
C. They treat income as "passed through" to the investor for tax purposes.
D. All of the options are advantages of mutual funds.
E. None of the options are an advantage of mutual funds.
A disadvantage of mutual funds is that investment income is passed through for tax purposes and investors may therefore lose the
ability to engage in tax management.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Open-end funds
25. Which of the following would increase the net asset value of a mutual fund share, assuming all other things remain unchanged?
A. An increase in the number of fund shares outstanding
B. An increase in the fund's accounts payable
C. A change in the fund's management
D. An increase in the value of one of the fund's stocks
An increase in the number of fund shares outstanding and an increase in the fund's accounts payable would decrease NAV, and a
change in the fund's management would have an uncertain effect (and then only in the future). However, an increase in the value of
one of the fund's stocks would increase NAV.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Fund pricing
26. Which of the following characteristics apply to unit investment trusts? I) Most are invested in fixed-income portfolios.
II) They are actively-managed portfolios.
III) The sponsor pools securities, then sells public shares in the trust.
IV) The portfolio is fixed for the life of the fund.
A. I and IV
B. I and II
C. I, III, and IV
D. I, II, and III
E. I, II, III, and IV
Three chief characteristics of UITs are that (1) the sponsor pools securities, and then sells public shares in the trust, (2) the portfolio is
fixed for the life of the fund, and (3) most are invested in fixed-income portfolios.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund classifications
4-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
27. As of 2016, which class of mutual funds had the largest amount of assets invested?
A. Equity funds
B. Bond funds
C. Mixed asset classes, such as asset allocation funds
D. Money market funds
E. Global funds
See Table 4.1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund classifications
28. Commingled funds are
A. amounts invested in equity and fixed-income mutual funds.
B. funds that may be purchased at intervals of 3, 6, or 12 months at the discretion of management.
C. amounts invested in domestic and global equities.
D. closed-end funds that may be repurchased only once every two years at the discretion of mutual fund management.
E. partnerships of investors that pool their funds, which are then managed for a fee.
Commingled funds are partnerships of investors that pool their funds, which are then managed for a fee.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund classifications
29. Which of the following is true regarding equity mutual funds?
I) They invest primarily in stock.
II) They may hold fixed-income securities, as well as stock.
III) Most hold money market securities, as well as stock.
IV) Two types of equity funds are income funds and growth funds.
A. I and IV
B. I, III, and IV
C. I, II, and IV
D. I, II, and III
E. I, II, III, and IV
Equity mutual funds can be classified as income funds or growth funds. Equity mutual funds invest primarily in stock, but may hold
fixed-income securities as well. Most hold money market securities to reduce the need to redeem securities to meet uncertain
redemptions on a daily basis.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund characteristics and considerations
4-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
30. The fee that mutual funds use to help pay for advertising and promotional literature is called a
A. front-end load fee.
B. back-end load fee.
C. operating expense fee.
D. 12b-1 fee.
E. structured fee.
A front-end load fee and back-end load fee are used to compensate the sales force, and an operating expense fee is used to cover
operating expenses. Rule 12b-1 allows a small fee to cover advertising and promotion.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Fund management fees, loads, and other charges
31. Patty O Furniture purchased 100 shares of Green Isle mutual fund at a net asset value of $42 per share. During the year, Patty
received dividend income distributions of $2.00 per share and capital gains distributions of $4.30 per share. At the end of the year, the
shares had a net asset value of $40 per share. What was Patty's rate of return on this investment?
A. 5.43%
B. 10.24%
C. 7.19%
D. 12.44%
E. 9.18%
R = ($40 – 42 + 2 + 4.3)/$42 = 10.238%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
32. Assume that you purchased 200 shares of Super Performing mutual fund at a net asset value of $21 per share. During the year, you
received dividend income distributions of $1.50 per share and capital gains distributions of $2.85 per share. At the end of the year, the
shares had a net asset value of $23 per share. What was your rate of return on this investment?
A. 30.24%
B. 25.37%
C. 27.19%
D. 22.44%
E. 29.18%
R = ($23 – 21 + 1.5 + 2.85)/$21 = 30.238%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
4-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
33. Assume that you purchased shares of High Flying mutual fund at a net asset value of $12.50 per share. During the year, you
received dividend income distributions of $0.78 per share and capital gains distributions of $1.67 per share. At the end of the year, the
shares had a net asset value of $13.87 per share. What was your rate of return on this investment?
A. 29.43%
B. 30.56%
C. 31.19%
D. 32.44%
E. 29.18%
R = ($13.87 – 12.50 + 0.78 + 1.67)/$12.50 = 30.56%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
34. Assume that you purchased shares of a mutual fund at a net asset value of $14.50 per share. During the year, you received
dividend income distributions of $0.27 per share and capital gains distributions of $0.65 per share. At the end of the year, the shares
had a net asset value of $13.74 per share. What was your rate of return on this investment?
A. 2.91%
B. 3.07%
C. 1.10%
D. 1.78%
E. –1.18%
R = ($13.74 – 14.50 + 0.27 + 0.65)/$14.50 = 1.103%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
35. Assume that you purchased shares of a mutual fund at a net asset value of $10.00 per share. During the year, you received
dividend income distributions of $0.05 per share and capital gains distributions of $0.06 per share. At the end of the year, the shares
had a net asset value of $8.16 per share. What was your rate of return on this investment?
A. –18.24%
B. –16.1%
C. 16.10%
D. –17.3%
E. 17.3%
R = ($8.16 – 10.00 + 0.05 + 0.06)/$10.00 = 17.3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
4-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
36. A mutual fund had year-end assets of $560,000,000 and liabilities of $26,000,000. There were 23,850,000 shares in the fund at
year end. What was the mutual fund's net asset value?
A. $22.87
B. $22.39
C. $22.24
D. $17.61
E. $19.25
($560,000,000 – 26,000,000)/23,850,000 = $22.389.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
37. A mutual fund had year-end assets of $250,000,000 and liabilities of $4,000,000. There were 3,750,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $92.53
B. $67.39
C. $63.24
D. $65.60
E. $17.46
($250,000,000 – 4,000,000)/3,750,000 = $65.60.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
38. A mutual fund had year-end assets of $700,000,000 and liabilities of $7,000,000. There were 40,150,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $9.63
B. $57.71
C. $16.42
D. $17.87
E. $17.26
($700,000,000 – 7,000,000)/40,150,000 = $17.26.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
4-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
39. A mutual fund had year-end assets of $750,000,000 and liabilities of $7,500,000. There were 40,000,000 shares in the fund at year
end. What was the mutual fund's net asset value?
A. $9.63
B. $18.56
C. $16.42
D. $17.87
E. $17.26
($750,000,000 7,500,000)/40,000,000 = $18.5625.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
40. A mutual fund had year-end assets of $465,000,000 and liabilities of $37,000,000. If the fund NAV was $56.12, how many shares
must have been held in the fund?
A. 4,300,000
B. 6,488,372
C. 8,601,709
D. 7,626,515
E. None of these options are correct.
($465,000,000 – 37,000,000)/$56.12 = 7,626,515.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
41. A mutual fund had year-end assets of $521,000,000 and liabilities of $63,000,000. If the fund NAV was $26.12, how many shares
must have been held in the fund?
A. 17,534,456
B. 16,488,372
C. 18,601,742
D. 17,542,515
($521,000,000 – 63,000,000)/$26.12 = 17,534,456.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
4-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
42. A mutual fund had year-end assets of $327,000,000 and liabilities of $46,000,000. If the fund NAV was $30.48, how many shares
must have been held in the fund?
A. 11,354,751
B. 8,412,642
C. 10,165,476
D. 9,165,414
E. 9,219,160
($327,000,000 – 46,000,000)/$30.48 = 9,219,160.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
43. A mutual fund had year-end assets of $437,000,000 and liabilities of $37,000,000. If the fund NAV was $60.12, how many shares
must have been held in the fund?
A. 6,653,360
B. 8,412,642
C. 10,165,476
D. 9,165,414
E. 9,219,160
($437,000,000 – 37,000,000)/$60.12 = 6,653,359.947.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund pricing
44. A mutual fund had NAV per share of $19.00 on January 1, 2016. On December 31 of the same year, the fund's NAV was $19.14.
Income distributions were $0.57, and the fund had capital gain distributions of $1.12. Without considering taxes and transactions
costs, what rate of return did an investor receive on the fund last year?
A. 11.26%
B. 10.54%
C. 7.97%
D. 8.26%
E. 9.63%
R = ($19.14 – 19.00 + 0.57 + 1.12)/$19.00 = 9.63%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
4-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
45. A mutual fund had NAV per share of $23.00 on January 1, 2016. On December 31 of the same year, the fund's NAV was $23.15.
Income distributions were $0.63, and the fund had capital gain distributions of $1.26. Without considering taxes and transactions
costs, what rate of return did an investor receive on the fund last year?
A. 11.26%
B. 10.54%
C. 8.87%
D. 8.26%
E. 9.63%
R = ($23.15 – 23.00 + 0.63 + 1.26)/$23.00 = 8.869%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
46. A mutual fund had NAV per share of $26.25 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 16.4%. Income distributions were $1.27, and the fund had capital gain distributions of $1.85. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $27.44
B. $33.88
C. $24.69
D. $42.03
E. $16.62
0.164 = (P – $26.25 + 1.27 + 1.85)/$26.25; P = $27.435.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
47. A mutual fund had NAV per share of $16.75 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 26.6%. Income distributions were $1.79, and the fund had capital gain distributions of $2.80. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $17.44
B. $13.28
C. $14.96
D. $17.25
E. $16.62
.266 = (P – $16.75 + 1.79 + 2.80)/$16.75; P = $16.615.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
4-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
48. A mutual fund had NAV per share of $36.15 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 14.0%. Income distributions were $1.16, and the fund had capital gain distributions of $2.12. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $37.93
B. $34.52
C. $44.69
D. $47.25
E. $36.28
0.14 = (P – $36.15 + 1.16 + 2.12)/$36.15; P = $37.931.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
49. A mutual fund had NAV per share of $37.12 on January 1, 2016. On December 31 of the same year, the fund's rate of return for
the year was 11.0%. Income distributions were $2.26, and the fund had capital gain distributions of $1.64. Without considering taxes
and transactions costs, what ending NAV would you calculate?
A. $37.93
B. $34.52
C. $37.30
D. $47.25
E. $36.28
0.11 = (P – $37.12 + 2.26 + 1.64)/$37.12; P = $37.303.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund returns, yields, and taxation
50. Differences between hedge funds and mutual funds are that
A. hedge funds are only subject to minimal SEC regulation.
B. hedge funds are typically open only to wealthy or institutional investors.
C. hedge fund managers can pursue strategies not available to mutual funds, such as short selling, heavy use of derivatives, and
leverage.
D. hedge funds are commonly structured as private partnerships.
E. All of the options.
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.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Hedge funds versus mutual funds
4-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
51. Of the following types of mutual funds, an investor who wishes to invest in a diversified portfolio of stocks worldwide (including
the U.S.) should choose
A. international funds.
B. global funds.
C. regional funds.
D. emerging-market funds.
International funds exclude the U.S. but global funds include the U.S.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund classifications
52. Of the following types of mutual funds, an investor who wishes to invest in a diversified portfolio of foreign stocks (excluding the
U.S.) should choose
A. international funds.
B. global funds.
C. regional funds.
D. emerging-market funds.
International funds exclude the U.S. but global funds include the U.S.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fund classifications
53. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the S&P 500 should choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
SPY tracks the S&P 500.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
54. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Dow Jones Industrials
should choose
A. SPY.
B. DIA.
C. QQQQ.
D. IWM.
E. VTI.
DIA tracks the DJIA.
4-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
55. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Nasdaq 100 should
choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
QQQ tracks the Nasdaq 100.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
56. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Russell 2000 should
choose
A. SPY.
B. DIA.
C. QQQQ.
D. IWM.
E. VTI.
IWM tracks the Russell 2000.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
57. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the Wilshire 5000 should
choose
A. SPY.
B. DIA.
C. QQQ.
D. IWM.
E. VTI.
VTI tracks the Wilshire 5000.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
4-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
58. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the MSCI Japan Index
should choose
A. SPY.
B. EWJ.
C. QQQQ.
D. IWM.
E. VTI.
EWJ tracks the MSCI Japan Index.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
59. Of the following types of ETFs, an investor who wishes to invest in a diversified portfolio that tracks the MSCI France Index
should choose
A. SPY.
B. EWJ.
C. EWQ.
D. IWM.
E. VTI.
EWQ tracks the MSCI France Index.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Exchange traded funds
60. A mutual fund had average daily assets of $3.0 billion in 2016. The fund sold $600 million worth of stock and purchased $700
million worth of stock during the year. The fund's turnover ratio is
A. 27.5%.
B. 12%.
C. 15%.
D. 25%.
E. 20%.
600,000,000/3,000,000,000 = 20%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund evaluation and performance
4-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
61. A mutual fund had average daily assets of $2.0 billion in 2016. The fund sold $500 million worth of stock and purchased $600
million worth of stock during the year. The fund's turnover ratio is
A. 27.5%.
B. 12%.
C. 15%.
D. 25%.
E. 20%.
500,000,000/2,000,000,000 = 25%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund evaluation and performance
62. A mutual fund had average daily assets of $4.0 billion in 2016. The fund sold $1.5 billion worth of stock and purchased $1.6
billion worth of stock during the year. The fund's turnover ratio is
A. 37.5%.
B. 22%.
C. 15%.
D. 45%.
E. 20%.
1,500,000,000/4,000,000,000 = 37.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund evaluation and performance
63. A mutual fund had average daily assets of $4.7 billion in 2016. The fund sold $2.2 billion worth of stock and purchased $3.6
billion worth of stock during the year. The fund's turnover ratio is
A. 37.5%.
B. 22.6%.
C. 15.3%.
D. 46.8%.
E. 20.7%.
2,200,000,000/4,700,000,000 = 46.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Fund evaluation and performance
4-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
64. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 5.75%.
If the securities in which the fund invested increased in value by 11% during the year, and the fund's expense ratio was 1.25%, your
return if you sold the fund at the end of the year would be
A. 4.33%.
B. 3.44%.
C. 2.45%.
D. 6.87%.
{[$20 × 0.9425 × (1.11 – 0.0125)] –$20}/$20 = 3.44%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Fund management fees, loads, and other charges
65. You purchased shares of a mutual fund at a price of $12 per share at the beginning of the year and paid a front-end load of 4.75%.
If the securities in which the fund invested increased in value by 9% during the year, and the fund's expense ratio was 1.5%, your
return if you sold the fund at the end of the year would be
A. 4.75%.
B. 3.54%.
C. 2.65%.
D. 2.39%.
{[$12 × 0.9525 × (1.09 – 0.015)] –$12}/$12 = 2.39%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Fund management fees, loads, and other charges
66. You purchased shares of a mutual fund at a price of $17 per share at the beginning of the year and paid a front-end load of 5.0%. If
the securities in which the fund invested increased in value by 12% during the year, and the fund's expense ratio was 1.0%, your return
if you sold the fund at the end of the year would be
A. 4.75%.
B. 5.45%.
C. 5.65%.
D. 4.39%.
{[$17 × 0.95 × (1.12 – 0.01)] $17}/$17 = 5.45%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Fund management fees, loads, and other charges
4-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
67. You purchased shares of a mutual fund at a price of $20 per share at the beginning of the year and paid a front-end load of 6.0%. If
the securities in which the fund invested increased in value by 10% during the year, and the fund's expense ratio was 1.5%, your return
if you sold the fund at the end of the year would be
A. 1.99%.
B. 2.32%.
C. 1.65%.
D. 2.06%.
E. None of the options are correct.
{[$20 × 0.94 × (1.10 – 0.015)] –$20}/$20 = 1.99%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Fund management fees, loads, and other charges
4-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 04 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Difficulty: 3 Challenge
Topic: Closed-end funds
Topic: Exchange traded funds
Topic: Fund characteristics and considerations
Topic: Fund classifications
Topic: Fund evaluation and performance
Topic: Fund management fees, loads, and other charges
Topic: Fund pricing
Topic: Fund returns, yields, and taxation
Topic: Hedge funds versus mutual funds
Topic: Open-end funds
Topic: Real estate investment trusts
# of Questions
34
33
67
34
13
20
8
54
5
3
7
1
11
5
6
15
14
1
2
2
4-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 05 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Over the past year, you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over
the same period. The exact actual growth rate of your purchasing power was
A. 15.5%.
B. 10.0%.
C. 5.0%.
D. 4.8%.
E. 15.0%.
2. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over the
same period. The exact actual growth rate of your purchasing power was
A. 15.5%.
B. 10.0%.
C. 3.8%.
D. 4.8%.
E. 15.0%.
3. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your
approximate annual real rate of return if the rate of inflation was 4% over the year?
A. 5%
B. 10%
C. 7%
D. 3%
4. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your
approximate annual real rate of return if the rate of inflation was 3.5% over the year?
A. 1.5%
B. 10%
C. 7%
D. 3%
E. None of the options are correct.
5. If the annual real rate of interest is 5%, and the expected inflation rate is 4%, the nominal rate of interest would be
Approximately
A. 1%.
B. 9%.
C. 20%.
D. 15%.
6. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.7%, the nominal rate of interest
would be approximately
A. 3.7%.
B. 6.2%.
C. 2.5%.
D. –1.2%.
5-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
7. You purchased a share of stock for $20. One year later, you received $1 as a dividend and sold the share for $29.
What was your holding-period return?
A. 45%
B. 50%
C. 5%
D. 40%
E. None of the options are correct.
8. You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share for
$74.50. What was your holding-period return?
A. 12.5%
B. 14.0%
C. 13.6%
D. 11.8%
9. Which of the following determine(s) the level of real interest rates?
I) The supply of savings by households and business firms
II) The demand for investment funds
III) The government's net supply and/or demand for funds
A. I only
B. II only
C. I and II only
D. I, II, and III
10. Which of the following statement(s) is(are) true?
I) The real rate of interest is determined by the supply and demand for funds.
II) The real rate of interest is determined by the expected rate of inflation.
III) The real rate of interest can be affected by actions of the Fed.
IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation.
A. I and II only
B. I and III only
C. III and IV only
D. II and III only
E. I, II, III, and IV only
11. Which of the following statement(s) is(are) true?
A. Inflation has no effect on the nominal rate of interest.
B. The realized nominal rate of interest is always greater than the real rate of interest.
C. Certificates of deposit offer a guaranteed real rate of interest.
D. None of the options are true.
12. Other things equal, an increase in the government budget deficit
A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. increases business prospects.
5-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
13. Ceteris paribus, a decrease in the demand for loans
A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. results from an increase in business prospects and a decrease in the level of savings.
14. The holding-period return (HPR) on a share of stock is equal to
A. the capital gain yield during the period plus the inflation rate.
B. the capital gain yield during the period plus the dividend yield.
C. the current yield plus the dividend yield.
D. the dividend yield plus the risk premium.
E. the change in stock price.
15. Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2015 show
That
A. stocks offered investors greater rates of return than bonds and bills.
B. stock returns were less volatile than those of bonds and bills.
C. bonds offered investors greater rates of return than stocks and bills.
D. bills outperformed stocks and bonds.
E. Treasury bills always offered a rate of return greater than inflation.
16. If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of
inflation,
A. borrowers gain and savers lose.
B. savers gain and borrowers lose.
C. both borrowers and savers lose.
D. neither borrowers nor savers gain nor lose.
E. both borrowers and savers gain.
17. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected holding-period return for KMP stock?
A. 10.40%
B. 9.32%
C. 11.63%
D. 11.54%
E. 10.88%
5-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
18. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected standard deviation for KMP stock?
A. 6.91%
B. 8.13%
C. 7.79%
D. 7.25%
E. 8.85%
19. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected variance for KMP stock?
A. 66.04%
B. 69.96%
C. 77.04%
D. 63.72%
E. 78.45%
20. If the nominal return is constant, the after-tax real rate of return
A. declines as the inflation rate increases.
B. increases as the inflation rate increases.
C. declines as the inflation rate declines.
D. increases as the inflation rate decreases.
E. declines as the inflation rate increases and increases as the inflation rate decreases.
21. The risk premium for common stocks
A. cannot be zero, for investors would be unwilling to invest in common stocks.
B. must always be positive, in theory.
C. is negative, as common stocks are risky.
D. cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in
theory.
E. cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks
are risky.
22. If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio's
excess returns was 34%, the risk premium would be
A. 13%.
B. 18%.
C. 49%.
5-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. 12%.
E. 29%.
23. You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the stock
for $92. What was your holding-period return?
A. 4.44%
B. 2.22%
C. 3.33%
D. 5.56%
E. None of the options are correct.
24. Toyota stock has the following probability distribution of expected prices one year from now:
If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected
holding-period return on Toyota?
A. 17.72%
B. 18.89%
C. 17.91%
D. 18.18%
25. Which of the following factors would not be expected to affect the nominal interest rate?
A. The supply of loans
B. The demand for loans
C. The coupon rate on previously issued government bonds
D. The expected rate of inflation
E. Government spending and borrowing
26. If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio's
excess returns was 25%, the risk premium would be
A. 14%.
B. 6%.
C. 35%.
D. 21%.
E. 5%.
27. In words, the real rate of interest is approximately equal to
A. the nominal rate minus the inflation rate.
B. the inflation rate minus the nominal rate.
C. the nominal rate times the inflation rate.
D. the inflation rate divided by the nominal rate.
E. the nominal rate plus the inflation rate.
5-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
28. If the Federal Reserve lowers the Fed Funds rate, ceteris paribus, the equilibrium levels of funds lent will
__________, and the equilibrium level of real interest rates will ___________.
A. increase; increase
B. increase; decrease
C. decrease; increase
D. decrease; decrease
E. reverse direction from their previous trends; reverse direction from their previous trends
29. "Bracket Creep" happens when
A. tax liabilities are based on real income and there is a negative inflation rate.
B. tax liabilities are based on real income and there is a positive inflation rate.
C. tax liabilities are based on nominal income and there is a negative inflation rate.
D. tax liabilities are based on nominal income and there is a positive inflation rate.
E. too many peculiar people make their way into the highest tax bracket.
30. The holding-period return (HPR) for a stock is equal to
A. the real yield minus the inflation rate.
B. the nominal yield minus the real yield.
C. the capital gains yield minus the tax rate.
D. the capital gains yield minus the dividend yield.
E. the dividend yield plus the capital gains yield.
31. You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:
Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these returns?
A. 4.72%
B. 6.30%
C. 4.38%
D. 5.74%
E. None of the options are correct.
32. An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980.
What is the holding-period return on his investment?
A. 1.02%
B. 0.50%
C. 1.92%
D. 0.01%
5-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
33. An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987.
What is the holding-period return on his investment?
A. 1.52%
B. 2.45%
C. 1.92%
D. 2.68%
34. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5% over
the same period. The exact actual growth rate of your purchasing power was
A. 15.55%.
B. 4.35%.
C. 5.02%.
D. 4.81%.
E. 15.04%.
35. Over the past year, you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over
the same period. The exact actual growth rate of your purchasing power was
A. 11.76%.
B. 16.00%.
C. 15.02%.
D. 14.32%.
36. Over the past year, you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6%
over the same period. The exact actual growth rate of your purchasing power was
A. 9.15%.
B. 9.90%.
C. 9.65%.
D. 10.52%.
37. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your
approximate annual real rate of return if the rate of inflation was 2% over the year?
A. 4%
B. 2%
C. 6%
D. 3%
38. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your
approximate annual real rate of return if the rate of inflation was 4% over the year?
A. 1%
B. –1%
C. 7%
D. 3%
39. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your
approximate annual real rate of return if the rate of inflation was 1.6% over the year?
A. 4.1%
B. 2.5%
C. 2.9%
D. 1.6%
5-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
40. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your
approximate annual real rate of return if the rate of inflation was 3.4% over the year?
A. 0.9%
B. 0.9%
C. 5.9%
D. 3.4%
41. A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate
annual real rate of return if the rate of inflation was 2% over the year?
A. 18%
B. 2%
C. 16%
D. 15%
42. If the annual real rate of interest is 3.5%, and the expected inflation rate is 2.5%, the nominal rate of interest
would be approximately
A. 3.5%.
B. 2.5%.
C. 1%.
D. 6.8%.
E. None of the options are correct.
43. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.4%, the nominal rate of interest
would be approximately
A. 4.9%.
B. 0.9%.
C. –0.9%.
D. 7%.
E. None of the options are correct.
44. If the annual real rate of interest is 4%, and the expected inflation rate is 3%, the nominal rate of interest would
be approximately
A. 4%.
B. 3%.
C. 1%.
D. 5%.
E. None of the options are correct.
45. You purchased a share of stock for $12. One year later, you received $0.25 as a dividend and sold the share for
$12.92. What was your holding-period return?
A. 9.75%
B. 10.65%
C. 11.75%
D. 11.25%
E. None of the options are correct.
5-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
46. You purchased a share of stock for $120. One year later, you received $1.82 as a dividend and sold the share for
$136. What was your holding-period return?
A. 15.67%
B. 22.12%
C. 18.85%
D. 13.24%
E. None of the options are correct.
47. You purchased a share of stock for $65. One year later, you received $2.37 as a dividend and sold the share for
$63. What was your holding-period return?
A. 0.57%
B. –0.2550%
C. –0.89%
D. 1.63%
E. None of the options are correct.
48. You have been given this probability distribution for the holding-period return for a stock:
What is the expected holding-period return for the stock?
A. 11.67%
B. 8.33%
C. 9.56%
D. 12.4%
E. None of the options are correct.
49. You have been given this probability distribution for the holding-period return for a stock:
What is the expected standard deviation for the stock?
A. 2.07%
B. 9.96%
C. 7.04%
D. 1.44%
E. None of the options are correct.
5-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
50. You have been given this probability distribution for the holding-period return for a stock:
What is the expected variance for the stock?
A. 142.07%
B. 189.96%
C. 177.04%
D. 128.17%
E. None of the options are correct.
51. Which of the following measures of risk best highlights the potential loss from extreme negative returns?
A. Standard deviation
B. Variance
C. Upper partial standard deviation
D. Value at risk (VaR)
E. None of the options are correct.
52. Over the past year, you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1%
over the same period. The exact actual growth rate of your purchasing power was
A. 3.6%.
B. 3.1%.
C. 0.48%.
D. 6.7%.
53. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4.3%. What is your
approximate annual real rate of return if the rate of inflation was 3% over the year?
A. 4.3%
B. –1.3%
C. 7.3%
D. 3%
E. None of the options.
54. If the annual real rate of interest is 3.5%, and the expected inflation rate is 3.5%, the nominal rate of interest
would be approximately
A. 0%.
B. 3.5%.
C. 12.25%.
D. 7%.
5-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
55. You purchased a share of CSCO stock for $20. One year later, you received $2 as a dividend and sold the share
for $31. What was your holding-period return?
A. 45%
B. 50%
C. 60%
D. 40%
E. None of the options are correct.
56. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected holding-period return for GM stock?
A. 10.4%
B. 11.4%
C. 12.4%
D. 13.4%
E. 14.4%
57. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected standard deviation for GM stock?
A. 16.91%
B. 16.13%
C. 13.79%
D. 15.25%
E. 14.87%
58. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected variance for GM stock?\
A. 200.00%
B. 221.04%
C. 246.37%
5-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. 14.87%
E. 16.13%
59. You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock
for $97. What was your holding-period return?
A. 14.44%
B. 12.22%
C. 13.33%
D. 5.56%
60. When comparing investments with different horizons, the ____________ provides the more accurate
comparison.
A. arithmetic average
B. effective annual rate
C. average annual return
D. historical annual average
61. Annual percentage rates (APRs) are computed using
A. simple interest.
B. compound interest.
C. either simple interest or compound interest.
D. best estimates of expected real costs.
E. None of the options are correct.
62. If an investment provides a 2% return semi-annually, its effective annual rate is
A. 2%.
B. 4%.
C. 4.02%.
D. 4.04%.
E. None of the options are correct.
63. If an investment provides a 1.25% return quarterly, its effective annual rate is
A. 5.23%.
B. 5.09%.
C. 4.02%.
D. 4.04%.
64. If an investment provides a 0.78% return monthly, its effective annual rate is
A. 9.36%.
B. 9.63%.
C. 10.02%.
D. 9.77%.
65. If an investment provides a 3% return semi-annually, its effective annual rate is
A. 3%.
B. 6%.
C. 6.06%.
D. 6.09%.
5-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
66. If an investment provides a 2.1% return quarterly, its effective annual rate is
A. 2.1%.
B. 8.4%.
C. 8.56%.
D. 8.67%.
67. Skewness is a measure of
A. how fat the tails of a distribution are.
B. the downside risk of a distribution.
C. the symmetry of a distribution.
D. the dividend yield of the distribution.
E. None of the options are correct.
68. Kurtosis is a measure of
A. how fat the tails of a distribution are.
B. the downside risk of a distribution.
C. the normality of a distribution.
D. the dividend yield of the distribution.
E. how fat the tails of a distribution are.
69. When a distribution is positively skewed,
A. standard deviation overestimates risk.
B. standard deviation correctly estimates risk.
C. standard deviation underestimates risk.
D. the tails are fatter than in a normal distribution.
70. When a distribution is negatively skewed,
A. standard deviation overestimates risk.
B. standard deviation correctly estimates risk.
C. standard deviation underestimates risk.
D. the tails are fatter than in a normal distribution.
71. If a distribution has "fat tails," it exhibits
A. positive skewness.
B. negative skewness.
C. a kurtosis of zero.
D. kurtosis.
E. positive skewness and kurtosis.
72. If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's
excess returns was 20%, the Sharpe measure would be
A. 0.08.
B. 0.03.
C. 0.20.
D. 0.11.
E. 0.25.
5-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
73. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's
excess returns was 25%, the Sharpe measure would be
A. 0.12.
B. 0.04.
C. 0.32.
D. 0.16.
E. 0.25.
74. If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio's
excess returns was 30%, the Sharpe measure would be
A. 0.20.
B. 0.35.
C. 0.45.
D. 0.33.
E. 0.25.
75. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's
excess returns was 25%, the risk premium would be
A. 8%.
B. 16%.
C. 37%.
D. 21%.
E. 29%.
76. ________ is a risk measure that indicates vulnerability to extreme negative returns.
A. Value at risk
B. Lower partial standard deviation
C. Standard deviation
D. Value at risk and lower partial standard deviation
E. None of the options are correct.
77. ________ is a risk measure that indicates vulnerability to extreme negative returns.
A. Value at risk
B. Lower partial standard deviation
C. Expected shortfall
D. None of the options
E. None of the options are correct.
78. The most common measure of loss associated with extremely negative returns is
A. lower partial standard deviation.
B. value at risk.
C. expected shortfall.
D. standard deviation.
79. Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and
________% will be worse.
A. 25; 75; 25
B. 75; 25; 75
C. 1; 99; 51
5-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. 95; 5; 95
E. 80; 80; 20
80. When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the
A. most realistic, as it is the most complete measure of risk.
B. most pessimistic, as it is the most complete measure of risk.
C. most optimistic, as it is the most complete measure of risk.
D. most optimistic, as it takes the highest return (smallest loss) of all the cases.
81. When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure
would be
A. expected shortfall.
B. value at risk.
C. conditional tail expectation.
D. expected shortfall and value at risk.
E. expected shortfall and conditional tail expectation.
Chapter 05 Test Bank - Static Key
Multiple Choice Questions
1. Over the past year, you earned a nominal rate of interest of 10% on your money. The inflation rate was 5% over
the same period. The exact actual growth rate of your purchasing power was
A. 15.5%.
B. 10.0%.
C. 5.0%.
D. 4.8%.
E. 15.0%.
r = (1 + R)/(1 + I) –1; 1.10%/1.05% – 1 = 4.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
2. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 4% over
the same period. The exact actual growth rate of your purchasing power was
A. 15.5%.
B. 10.0%.
C. 3.8%.
D. 4.8%.
E. 15.0%.
r = (1 + R)/(1 + I) – 1; 1.08%/1.04% – 1 = 3.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
5-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
3. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 9%. What is your
approximate annual real rate of return if the rate of inflation was 4% over the year?
A. 5%
B. 10%
C. 7%
D. 3%
9% – 4% = 5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
4. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your
approximate annual real rate of return if the rate of inflation was 3.5% over the year?
A. 1.5%
B. 10%
C. 7%
D. 3%
E. None of the options are correct.
5% – 3.5% = 1.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
5. If the annual real rate of interest is 5%, and the expected inflation rate is 4%, the nominal rate of interest would
be approximately
A. 1%.
B. 9%.
C. 20%.
D. 15%.
5% + 4% = 9%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
6. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.7%, the nominal rate of interest
would be approximately
A. 3.7%.
B. 6.2%.
C. 2.5%.
D. –1.2%.
2.5% + 3.7% = 6.2%.
5-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
7. You purchased a share of stock for $20. One year later, you received $1 as a dividend and sold the share for
$29. What was your holding-period return?
A. 45%
B. 50%
C. 5%
D. 40%
E. None of the options are correct.
($1 + $29 – $20)/$20 = 0.5000, or 50%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
8. You purchased a share of stock for $68. One year later, you received $3.00 as a dividend and sold the share
for $74.50. What was your holding-period return?
A. 12.5%
B. 14.0%
C. 13.6%
D. 11.8%
($3.00 + $74.50 – $68.00)/$68.00 = 0.1397, or 14.0%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
9. Which of the following determine(s) the level of real interest rates?
I) The supply of savings by households and business firms
II) The demand for investment funds
III) The government's net supply and/or demand for funds
A. I only
B. II only
C. I and II only
D. I, II, and III
The value of savings by households is the major supply of funds; the demand for investment funds is a portion
of the total demand for funds; the government's position can be one of either net supplier or net demander of
funds. The above factors constitute the total supply and demand for funds, which determine real interest rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Nominal and real rates
5-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
10. Which of the following statement(s) is(are) true?
I) The real rate of interest is determined by the supply and demand for funds.
II) The real rate of interest is determined by the expected rate of inflation.
III) The real rate of interest can be affected by actions of the Fed.
IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation.
A. I and II only
B. I and III only
C. III and IV only
D. II and III only
E. I, II, III, and IV only
The expected rate of inflation is a determinant of nominal, not real, interest rates. Real rates are determined by
the supply and demand for funds, which can be affected by the Fed.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal and real rates
11. Which of the following statement(s) is(are) true?
A. Inflation has no effect on the nominal rate of interest.
B. The realized nominal rate of interest is always greater than the real rate of interest.
C. Certificates of deposit offer a guaranteed real rate of interest.
D. None of the options are true.
Expected inflation rates are a determinant of nominal interest rates. The realized nominal rate of interest
would be negative if the difference between actual and anticipated inflation rates exceeded the real rate. The
realized nominal rate of interest would be less than the real rate if the unexpected inflation were greater than
the real rate of interest. Certificates of deposit contain a real rate based on an estimate of inflation that is not
guaranteed.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal and real rates
12. Other things equal, an increase in the government budget deficit
A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. increases business prospects.
An increase in the government budget deficit, other things equal, causes the government to increase its
borrowing, which increases the demand for funds and drives interest rates up.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal interest rate factors
5-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
13. Ceteris paribus, a decrease in the demand for loans
A. drives the interest rate down.
B. drives the interest rate up.
C. might not have any effect on interest rates.
D. results from an increase in business prospects and a decrease in the level of savings.
A decrease in demand, ceteris paribus, always drives interest rates down. An increase in business prospects
would increase the demand for funds. The savings level affects the supply of, not the demand for, funds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal interest rate factors
14. The holding-period return (HPR) on a share of stock is equal to
A. the capital gain yield during the period plus the inflation rate.
B. the capital gain yield during the period plus the dividend yield.
C. the current yield plus the dividend yield.
D. the dividend yield plus the risk premium.
E. the change in stock price.
The HPR of any investment is the sum of the capital gain and the cash flow over the period, which for common
stock is B.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Rate of return
15. Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2015 show
That
A. stocks offered investors greater rates of return than bonds and bills.
B. stock returns were less volatile than those of bonds and bills.
C. bonds offered investors greater rates of return than stocks and bills.
D. bills outperformed stocks and bonds.
E. Treasury bills always offered a rate of return greater than inflation.
The historical data show that, as expected, stocks offer a greater return and greater volatility than the other
investment alternatives. Inflation sometimes exceeded the T-bill return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Historical market performance
16. If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate
of inflation,
A. borrowers gain and savers lose.
B. savers gain and borrowers lose.
C. both borrowers and savers lose.
D. neither borrowers nor savers gain nor lose.
E. both borrowers and savers gain.
5-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
If the described interest rate accurately reflects the rate of inflation, both borrowers and lenders are paying and
receiving, respectively, the real rate of interest; thus, neither group gains.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal and real rates
17. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected holding-period return for KMP stock?
A. 10.40%
B. 9.32%
C. 11.63%
D. 11.54%
E. 10.88%
HPR = 0.30 (18%) + 0.50 (12%) + 0.20 (–5%) = 10.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
18. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected standard deviation for KMP stock?
A. 6.91%
B. 8.13%
C. 7.79%
D. 7.25%
E. 8.85%
s = [0.30 (18 – 10.4)2 + 0.50 (12 – 10.4)2 + 0.20 (–5 – 10.4)2]1/2 = 8.13%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
5-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
19. You have been given this probability distribution for the holding-period return for KMP stock:
What is the expected variance for KMP stock?
A. 66.04%
B. 69.96%
C. 77.04%
D. 63.72%
E. 78.45%
Variance = [0.30 (18 – 10.4)2 + 0.50 (12 10.4)2 + 0.20 (–5 – 10.4)2] = 66.04%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
20. If the nominal return is constant, the after-tax real rate of return
A. declines as the inflation rate increases.
B. increases as the inflation rate increases.
C. declines as the inflation rate declines.
D. increases as the inflation rate decreases.
E. declines as the inflation rate increases and increases as the inflation rate decreases.
Inflation rates have an inverse effect on after-tax real rates of return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Nominal and real rates
21. The risk premium for common stocks
A. cannot be zero, for investors would be unwilling to invest in common stocks.
B. must always be positive, in theory.
C. is negative, as common stocks are risky.
D. cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in
theory.
E. cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common
stocks are risky.
If the risk premium for common stocks were zero or negative, investors would be unwilling to accept the lower
returns for the increased risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk premiums
5-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
22. If a portfolio had a return of 18%, the risk-free asset return was 5%, and the standard deviation of the portfolio's
excess returns was 34%, the risk premium would be
A. 13%.
B. 18%.
C. 49%.
D. 12%.
E. 29%.
18 – 5 = 13%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk premiums
23. You purchase a share of Boeing stock for $90. One year later, after receiving a dividend of $3, you sell the
stock for $92. What was your holding-period return?
A. 4.44%
B. 2.22%
C. 3.33%
D. 5.56%
E. None of the options are correct.
HPR = (92 – 90 + 3)/90 = 5.56%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
24. Toyota stock has the following probability distribution of expected prices one year from now:
If you buy Toyota today for $55 and it will pay a dividend during the year of $4 per share, what is your expected
holding-period return on Toyota?
A. 17.72%
B. 18.89%
C. 17.91%
D. 18.18%
E(P1) = 0.25 (54/55 – 1) + 0.40 (64/55 – 1) + 0.35 (74/55 – 1) = 18.18%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Rate of return
5-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
25. Which of the following factors would not be expected to affect the nominal interest rate?
A. The supply of loans
B. The demand for loans
C. The coupon rate on previously issued government bonds
D. The expected rate of inflation
E. Government spending and borrowing
The nominal interest rate is affected by supply, demand, government actions, and inflation. Coupon rates on
previously issued government bonds reflect historical interest rates but should not affect the current level of
interest rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Nominal interest rate factors
26. If a portfolio had a return of 11%, the risk-free asset return was 6%, and the standard deviation of the portfolio's
excess returns was 25%, the risk premium would be
A. 14%.
B. 6%.
C. 35%.
D. 21%.
E. 5%.
11 – 6 = 5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk premiums
27. In words, the real rate of interest is approximately equal to
A. the nominal rate minus the inflation rate.
B. the inflation rate minus the nominal rate.
C. the nominal rate times the inflation rate.
D. the inflation rate divided by the nominal rate.
E. the nominal rate plus the inflation rate.
The actual relationship is (1 + real rate) = (1 + nominal rate)/(1 + inflation rate). This can be approximated by
the equation: Real rate = nominal rate inflation rate.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Nominal and real rates
28. If the Federal Reserve lowers the Fed Funds rate, ceteris paribus, the equilibrium levels of funds lent will
__________, and the equilibrium level of real interest rates will ___________.
A. increase; increase
B. increase; decrease
C. decrease; increase
5-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. decrease; decrease
E. reverse direction from their previous trends; reverse direction from their previous trends
A lower Fed Funds rate would encourage banks to make more loans, which would increase the money supply.
The supply curve would shift to the right and the equilibrium level of funds would increase while the equilibrium
interest rate would fall.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal interest rate factors
29. "Bracket Creep" happens when
A. tax liabilities are based on real income and there is a negative inflation rate.
B. tax liabilities are based on real income and there is a positive inflation rate.
C. tax liabilities are based on nominal income and there is a negative inflation rate.
D. tax liabilities are based on nominal income and there is a positive inflation rate.
E. too many peculiar people make their way into the highest tax bracket.
A positive inflation rate typically leads to higher nominal income. Higher nominal income means people will
have higher tax liabilities and in some cases will put them in higher tax brackets. This can happen even when
real income has declined.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Taxes and related issues
30. The holding-period return (HPR) for a stock is equal to
A. the real yield minus the inflation rate.
B. the nominal yield minus the real yield.
C. the capital gains yield minus the tax rate.
D. the capital gains yield minus the dividend yield.
E. the dividend yield plus the capital gains yield.
HPR consists of an income component and a price change component. The income component on a stock is
the dividend yield. The price change component is the capital gains yield.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Rate of return
31. You have been given this probability distribution for the holding-period return for Cheese, Inc. stock:
Assuming that the expected return on Cheese's stock is 14.35%, what is the standard deviation of these
returns?
5-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 4.72%
B. 6.30%
C. 4.38%
D. 5.74%
E. None of the options are correct.
Variance = 0.20 × (24 – 14.35)2 + 0.45 × (15 – 14.35)2 + 0.35 × (8 – 14.35)2 = 32.9275. Standard deviation =
32.92751/2 = 5.74.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
32. An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980.
What is the holding-period return on his investment?
A. 1.02%
B. 0.50%
C. 1.92%
D. 0.01%
HPR = ($15 + 980 – 985)/$985 = 0.010152284 = approximately 1.02%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Rate of return
33. An investor purchased a bond 63 days ago for $980. He received $17 in interest and sold the bond for $987.
What is the holding-period return on his investment?
A. 1.52%
B. 2.45%
C. 1.92%
D. 2.68%
HPR = ($17 + 987 – 980)/$980 = .0244898 = approximately 2.45%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Rate of return
34. Over the past year, you earned a nominal rate of interest of 8% on your money. The inflation rate was 3.5%
over the same period. The exact actual growth rate of your purchasing power was
A. 15.55%.
B. 4.35%.
C. 5.02%.
D. 4.81%.
E. 15.04%.
r = (1 + R)/(1 + I) – 1; 1.08/1.035 – 1 = 4.35%.
5-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
35. Over the past year, you earned a nominal rate of interest of 14% on your money. The inflation rate was 2% over
the same period. The exact actual growth rate of your purchasing power was
A. 11.76%.
B. 16.00%.
C. 15.02%.
D. 14.32%.
r = (1 + R)/(1 + I) – 1; 1.14/1.02 – 1 = 11.76%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
36. Over the past year, you earned a nominal rate of interest of 12.5% on your money. The inflation rate was 2.6%
over the same period. The exact actual growth rate of your purchasing power was
A. 9.15%.
B. 9.90%.
C. 9.65%.
D. 10.52%.
r = (1 + R)/(1 + I) – 1; 1.125/1.026 – 1 = 9.65%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
37. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 6%. What is your
approximate annual real rate of return if the rate of inflation was 2% over the year?
A. 4%
B. 2%
C. 6%
D. 3%
6% – 2% = 4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
38. A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 3%. What is your
approximate annual real rate of return if the rate of inflation was 4% over the year?
A. 1%
B. –1%
C. 7%
D. 3%
5-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
3% – 4% = –1%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
39. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 5.7%. What is your
approximate annual real rate of return if the rate of inflation was 1.6% over the year?
A. 4.1%
B. 2.5%
C. 2.9%
D. 1.6%
5.7% – 1.6% = 4.1%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
40. A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your
approximate annual real rate of return if the rate of inflation was 3.4% over the year?
A. 0.9%
B. 0.9%
C. 5.9%
D. 3.4%
2.5% – 3.4% = 0.9%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
41. A year ago, you invested $12,000 in an investment that produced a return of 18%. What is your approximate
annual real rate of return if the rate of inflation was 2% over the year?
A. 18%
B. 2%
C. 16%
D. 15%
18% – 2% = 16%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
42. If the annual real rate of interest is 3.5%, and the expected inflation rate is 2.5%, the nominal rate of interest
would be approximately
A. 3.5%.
B. 2.5%.
5-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 1%.
D. 6.8%.
E. None of the options are correct.
3.5% + 2.5% = 6%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
43. If the annual real rate of interest is 2.5%, and the expected inflation rate is 3.4%, the nominal rate of interest
would be approximately
A. 4.9%.
B. 0.9%.
C. –0.9%.
D. 7%.
E. None of the options are correct.
2.5% + 3.4% = 5.9%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
44. If the annual real rate of interest is 4%, and the expected inflation rate is 3%, the nominal rate of interest would
be approximately
A. 4%.
B. 3%.
C. 1%.
D. 5%.
E. None of the options are correct.
4% + 3% = 7%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
45. You purchased a share of stock for $12. One year later, you received $0.25 as a dividend and sold the share
for $12.92. What was your holding-period return?
A. 9.75%
B. 10.65%
C. 11.75%
D. 11.25%
E. None of the options are correct.
($0.25 + $12.92 – $12)/$12 = 0.0975, or 9.75%.
5-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
46. You purchased a share of stock for $120. One year later, you received $1.82 as a dividend and sold the share
for $136. What was your holding-period return?
A. 15.67%
B. 22.12%
C. 18.85%
D. 13.24%
E. None of the options are correct.
($1.82 + $136 – $120)/$120 = 0.1485, or 14.85%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
47. You purchased a share of stock for $65. One year later, you received $2.37 as a dividend and sold the share
for $63. What was your holding-period return?
A. 0.57%
B. –0.2550%
C. –0.89%
D. 1.63%
E. None of the options are correct.
($2.37 + $63 – $65)/$65 = 0.00569, or 0.57%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
48. You have been given this probability distribution for the holding-period return for a stock:
What is the expected holding-period return for the stock?
A. 11.67%
B. 8.33%
C. 9.56%
D. 12.4%
E. None of the options are correct.
HPR = 0.40 (22%) + 0.35 (11%) + 0.25 (–9%) = 10.4%.
5-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
49. You have been given this probability distribution for the holding-period return for a stock:
What is the expected standard deviation for the stock?
A. 2.07%
B. 9.96%
C. 7.04%
D. 1.44%
E. None of the options are correct.
s = [0.40 (22 – 10.4)2 + 0.35 (11 – 10.4)2 + 0.25 (–9 – 10.4)2]1/2 = 12.167%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
50. You have been given this probability distribution for the holding-period return for a stock:
What is the expected variance for the stock?
A. 142.07%
B. 189.96%
C. 177.04%
D. 128.17%
E. None of the options are correct.
Variance = [0.40 (22 10.4)2 + 0.35 (11 10.4)2 + 0.25 (-9 10.4)2] = 148.04%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
51. Which of the following measures of risk best highlights the potential loss from extreme negative returns?
A. Standard deviation
B. Variance
5-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. Upper partial standard deviation
D. Value at risk (VaR)
E. None of the options are correct.
Only VaR measures potential loss from extreme negative returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Value-at-risk
52. Over the past year, you earned a nominal rate of interest of 3.6% on your money. The inflation rate was 3.1%
over the same period. The exact actual growth rate of your purchasing power was
A. 3.6%.
B. 3.1%.
C. 0.48%.
D. 6.7%.
r = (1 + R)/(1 + I) – 1; 1.036/1.031% – 1 = 0.484%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Nominal and real rates
53. A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4.3%. What is your
approximate annual real rate of return if the rate of inflation was 3% over the year?
A. 4.3%
B. –1.3%
C. 7.3%
D. 3%
E. None of the options.
4.3% – 3% = 1.3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
54. If the annual real rate of interest is 3.5%, and the expected inflation rate is 3.5%, the nominal rate of interest
would be approximately
A. 0%.
B. 3.5%.
C. 12.25%.
D. 7%.
3.5% + 3.5% = 7%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Nominal and real rates
5-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
55. You purchased a share of CSCO stock for $20. One year later, you received $2 as a dividend and sold the
share for $31. What was your holding-period return?
A. 45%
B. 50%
C. 60%
D. 40%
E. None of the options are correct.
($2 + $31 – $20)/$20 = 0.65, or 65%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
56. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected holding-period return for GM stock?
A. 10.4%
B. 11.4%
C. 12.4%
D. 13.4%
E. 14.4%
HPR = 0.40 (30%) + 0.40 (11%) + 0.20 (–10%) = 14.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
57. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected standard deviation for GM stock?
A. 16.91%
B. 16.13%
C. 13.79%
D. 15.25%
E. 14.87%
5-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
s = [0.40 (30 – 14.4)2 + 0.40 (11 – 14.4)2 + 0.20 (–10 – 14.4)2]1/2 = 14.87%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
58. You have been given this probability distribution for the holding-period return for GM stock:
What is the expected variance for GM stock?
A. 200.00%
B. 221.04%
C. 246.37%
D. 14.87%
E. 16.13%
Variance = [0.40 (30 – 14.4)2 + 0.40 (11 – 14.4)2 + 0.20 (–10 – 14.4)2] = 221.04%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
59. You purchase a share of CAT stock for $90. One year later, after receiving a dividend of $4, you sell the stock
for $97. What was your holding-period return?
A. 14.44%
B. 12.22%
C. 13.33%
D. 5.56%
HPR = ([97 – 90] + 4)/90 = 12.22%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Rate of return
60. When comparing investments with different horizons, the ____________ provides the more accurate
comparison.
A. arithmetic average
B. effective annual rate
C. average annual return
D. historical annual average
The effective annual rate provides the more accurate comparison of investments with different horizons
because it expresses the returns in a common period.
5-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Annual, holding period, and effective rates
61. Annual percentage rates (APRs) are computed using
A. simple interest.
B. compound interest.
C. either simple interest or compound interest.
D. best estimates of expected real costs.
E. None of the options are correct.
APRs use simple interest.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Annual, holding period, and effective rates
62. If an investment provides a 2% return semi-annually, its effective annual rate is
A. 2%.
B. 4%.
C. 4.02%.
D. 4.04%.
E. None of the options are correct.
(1.02)2 – 1 = 4.04%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Annual, holding period, and effective rates
63. If an investment provides a 1.25% return quarterly, its effective annual rate is
A. 5.23%.
B. 5.09%.
C. 4.02%.
D. 4.04%.
(1.0125)4 – 1 = 5.09%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Annual, holding period, and effective rates
64. If an investment provides a 0.78% return monthly, its effective annual rate is
A. 9.36%.
B. 9.63%.
C. 10.02%.
D. 9.77%.
(1.0078)12 – 1 = 9.77%.
5-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Annual, holding period, and effective rates
65. If an investment provides a 3% return semi-annually, its effective annual rate is
A. 3%.
B. 6%.
C. 6.06%.
D. 6.09%.
(1.03)2 – 1 = 6.09%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Annual, holding period, and effective rates
66. If an investment provides a 2.1% return quarterly, its effective annual rate is
A. 2.1%.
B. 8.4%.
C. 8.56%.
D. 8.67%.
(1.021)4 – 1 = 8.67%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Annual, holding period, and effective rates
67. Skewness is a measure of
A. how fat the tails of a distribution are.
B. the downside risk of a distribution.
C. the symmetry of a distribution.
D. the dividend yield of the distribution.
E. None of the options are correct.
Skewness is a measure of the normality of a distribution.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Deviations from normality
68. Kurtosis is a measure of
A. how fat the tails of a distribution are.
B. the downside risk of a distribution.
C. the normality of a distribution.
D. the dividend yield of the distribution.
E. how fat the tails of a distribution are.
Kurtosis is a measure of how fat the tails of a distribution are.
5-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Deviations from normality
69. When a distribution is positively skewed,
A. standard deviation overestimates risk.
B. standard deviation correctly estimates risk.
C. standard deviation underestimates risk.
D. the tails are fatter than in a normal distribution.
When a distribution is positively skewed, standard deviation overestimates risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Deviations from normality
70. When a distribution is negatively skewed,
A. standard deviation overestimates risk.
B. standard deviation correctly estimates risk.
C. standard deviation underestimates risk.
D. the tails are fatter than in a normal distribution.
When a distribution is negatively skewed, standard deviation underestimates risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Deviations from normality
71. If a distribution has "fat tails," it exhibits
A. positive skewness.
B. negative skewness.
C. a kurtosis of zero.
D. kurtosis.
E. positive skewness and kurtosis.
Kurtosis is a measure of the tails of a distribution, or "fat tails."
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Deviations from normality
72. If a portfolio had a return of 8%, the risk-free asset return was 3%, and the standard deviation of the portfolio's
excess returns was 20%, the Sharpe measure would be
A. 0.08.
B. 0.03.
C. 0.20.
D. 0.11.
E. 0.25.
5-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
(8 – 3)/20 = 0.25.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
73. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's
excess returns was 25%, the Sharpe measure would be
A. 0.12.
B. 0.04.
C. 0.32.
D. 0.16.
E. 0.25.
(12 – 4)/25 = 0.32.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
74. If a portfolio had a return of 15%, the risk-free asset return was 5%, and the standard deviation of the portfolio's
excess returns was 30%, the Sharpe measure would be
A. 0.20.
B. 0.35.
C. 0.45.
D. 0.33.
E. 0.25.
(15 – 5)/30 = 0.33.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
75. If a portfolio had a return of 12%, the risk-free asset return was 4%, and the standard deviation of the portfolio's
excess returns was 25%, the risk premium would be
A. 8%.
B. 16%.
C. 37%.
D. 21%.
E. 29%.
12 – 4 = 8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Risk premiums
5-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
76. ________ is a risk measure that indicates vulnerability to extreme negative returns.
A. Value at risk
B. Lower partial standard deviation
C. Standard deviation
D. Value at risk and lower partial standard deviation
E. None of the options are correct.
Value at risk and lower partial standard deviation are risk measures that indicate vulnerability to extreme
negative returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Value-at-risk
77. ________ is a risk measure that indicates vulnerability to extreme negative returns.
A. Value at risk
B. Lower partial standard deviation
C. Expected shortfall
D. None of the options
E. None of the options are correct.
All of the options are risk measures that indicate vulnerability to extreme negative returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Value-at-risk
78. The most common measure of loss associated with extremely negative returns is
A. lower partial standard deviation.
B. value at risk.
C. expected shortfall.
D. standard deviation.
The most common measure of loss associated with extremely negative returns is value at risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Value-at-risk
79. Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and
________% will be worse.
A. 25; 75; 25
B. 75; 25; 75
C. 1; 99; 51
D. 95; 5; 95
E. 80; 80; 20
Practitioners often use a 1% VaR, meaning that 99% of returns will exceed the VaR, and 1% will be worse.
5-38
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Value-at-risk
80. When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the
A. most realistic, as it is the most complete measure of risk.
B. most pessimistic, as it is the most complete measure of risk.
C. most optimistic, as it is the most complete measure of risk.
D. most optimistic, as it takes the highest return (smallest loss) of all the cases.
When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the most optimistic as it takes the
highest return (smallest loss) of all the cases.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Value-at-risk
81. When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside
exposure would be
A. expected shortfall.
B. value at risk.
C. conditional tail expectation.
D. expected shortfall and value at risk.
E. expected shortfall and conditional tail expectation.
When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside
exposure would be expected shortfall (or conditional tail expectation).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Normal probability distribution
5-39
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 05 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
54
AACSB: Reflective Thinking
27
Accessibility: Keyboard Navigation
81
Blooms: Apply
54
Blooms: Remember
9
Blooms: Understand
18
Difficulty: 1 Basic
22
Difficulty: 2 Intermediate
46
Difficulty: 3 Challenge
13
Topic: Annual, holding period, and effective rates
7
Topic: Deviations from normality
5
Topic: Historical market performance
1
Topic: Nominal and real rates
26
Topic: Nominal interest rate factors
4
Topic: Normal probability distribution
1
Topic: Rate of return
16
Topic: Risk premiums
4
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
3
Topic: Standard deviation and variance
7
Topic: Taxes and related issues
1
Topic: Value-at-risk
6
5-40
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 06 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Which of the following statements regarding risk-averse investors is true?
A. They only care about the rate of return.
B. They accept investments that are fair games.
C. They only accept risky investments that offer risk premiums over the risk-free rate.
D. They are willing to accept lower returns and high risk.
E. They only care about the rate of return, and they accept investments that are fair games.
2. Which of the following statements is(are) true?
I) Risk-averse investors reject investments that are fair games.
II) Risk-neutral investors judge risky investments only by the expected returns.
III) Risk-averse investors judge investments only by their riskiness.
IV) Risk-loving investors will not engage in fair games.
A. I only
B. II only
C. I and II only
D. II and III only
E. II, III, and IV only
3. Which of the following statements is(are) false?
I) Risk-averse investors reject investments that are fair games.
II) Risk-neutral investors judge risky investments only by the expected returns.
III) Risk-averse investors judge investments only by their riskiness.
IV) Risk-loving investors will not engage in fair games.
A. I only
B. II only
C. I and II only
D. II and III only
E. III and IV only
4. In the mean-standard deviation graph, an indifference curve has a ________ slope.
A. negative
B. zero
C. positive
D. vertical
E. Cannot be determined.
5. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference
curve of a risk-averse investor?
A. It is the locus of portfolios that have the same expected rates of return and different standard deviations.
B. It is the locus of portfolios that have the same standard deviations and different rates of return.
C. It is the locus of portfolios that offer the same utility according to returns and standard deviations.
D. It connects portfolios that offer increasing utilities according to returns and standard deviations.
E. None of the options are correct.
6-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
6. In a return-standard deviation space, which of the following statements is(are) true for risk-averse investors?
(The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis,
respectively.)
I) An investor's own indifference curves might intersect.
II) Indifference curves have negative slopes.
III) In a set of indifference curves, the highest offers the greatest utility.
IV) Indifference curves of two investors might intersect.
A. I and II only
B. II and III only
C. I and IV only
D. III and IV only
E. None of the options are correct.
7. Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore,
A. for the same risk, David requires a higher rate of return than Elias.
B. for the same return, Elias tolerates higher risk than David.
C. for the same risk, Elias requires a lower rate of return than David.
D. for the same return, David tolerates higher risk than Elias.
E. Cannot be determined.
8. When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least
likely to assess?
A. The investor's prior investing experience
B. The investor's degree of financial security
C. The investor's tendency to make risky or conservative choices
D. The level of return the investor prefers
E. The investor's feelings about loss
9. Assume an investor with the following utility function: U = E(r) – 3/2(s2).
To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a
standard deviation of ________, respectively.
A. 12%; 20%
B. 10%; 15%
C. 10%; 10%
D. 8%; 10%
10. To maximize her expected utility, which one of the following investment alternatives would she choose?
Assume an investor with the following utility function: U = E(r) 3/2(s2).
A. A portfolio that pays 10% with a 60% probability or 5% with 40% probability.
B. A portfolio that pays 10% with 40% probability or 5% with a 60% probability.
C. A portfolio that pays 12% with 60% probability or 5% with 40% probability.
D. A portfolio that pays 12% with 40% probability or 5% with 60% probability.
11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6%. An
investor has the following utility function: U = E(r) (A/2)s2. Which value of A makes this investor indifferent
between the risky portfolio and the risk-free asset?
6-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 5
B. 6
C. 7
D. 8
12. According to the mean-variance criterion, which one of the following investments dominates all others?
A. E(r) = 0.15; Variance = 0.20
B. E(r) = 0.10; Variance = 0.20
C. E(r) = 0.10; Variance = 0.25
D. E(r) = 0.15; Variance = 0.25
E. None of these options dominates the other alternatives.
13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation of 0.15, that lies
on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve for a
risk averse investor?
A. E(r) = 0.15; Standard deviation = 0.20
B. E(r) = 0.15; Standard deviation = 0.10
C. E(r) = 0.10; Standard deviation = 0.10
D. E(r) = 0.20; Standard deviation = 0.15
E. E(r) = 0.10; Standard deviation = 0.20
14. Use the below information to answer the following question.
U = E(r ) – (A/2)s2,where A = 4.0.
Based on the utility function above, which investment would you select?
A. 1
B. 2
C. 3
D. 4
E. Cannot be determined from the information given.
15. Use the below information to answer the following question.
6-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
U = E(r ) – (A/2)s2
Which investment would you select if you were risk neutral?
A. 1
B. 2
C. 3
D. 4
E. Cannot be determined from the information given.
16. Use the below information to answer the following question.
U = E(r ) (A/2)s2,where A = 4.0.
The variable (A) in the utility function represents the
A. investor's return requirement.
B. investor's aversion to risk.
C. certainty-equivalent rate of the portfolio.
D. minimum required utility of the portfolio.
17. The exact indifference curves of different investors
A. cannot be known with perfect certainty.
B. can be calculated precisely with the use of advanced calculus.
C. are known with perfect certainty and allow the advisor to create more suitable portfolios for the client.
D. although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client.
18. The riskiness of individual assets
A. should be considered for the asset in isolation.
B. should be considered in the context of the effect on overall portfolio volatility.
C. should be combined with the riskiness of other individual assets in the proportions these assets constitute the
entire portfolio.
D. should be considered in the context of the effect on overall portfolio volatility and should be combined with the
riskiness of other individual assets in the proportions these assets constitute the entire portfolio.
19. A fair game
A. will not be undertaken by a risk-averse investor.
B. is a risky investment with a zero risk premium.
C. is a riskless investment.
D. will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium.
E. will not be undertaken by a risk-averse investor and is a riskless investment.
20. The presence of risk means that
A. investors will lose money.
B. more than one outcome is possible.
6-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. the standard deviation of the payoff is larger than its expected value.
D. final wealth will be greater than initial wealth.
E. terminal wealth will be less than initial wealth.
21. The utility score an investor assigns to a particular portfolio, other things equal,
A. will decrease as the rate of return increases.
B. will decrease as the standard deviation decreases.
C. will decrease as the variance decreases.
D. will increase as the variance increases.
E. will increase as the rate of return increases.
22. The certainty equivalent rate of a portfolio is
A. the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the
risky portfolio.
B. the rate that the investor must earn for certain to give up the use of his money.
C. the minimum rate guaranteed by institutions such as banks.
D. the rate that equates "A" in the utility function with the average risk aversion coefficient for all risk-averse
investors.
E. represented by the scaling factor "-.005" in the utility function.
23. According to the mean-variance criterion, which of the statements below is correct?
A. Investment B dominates investment A.
B. Investment B dominates investment C.
C. Investment D dominates all of the other investments.
D. Investment D dominates only investment B.
E. Investment C dominates investment A.
24. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the
following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the
horizontal axis.
I) Steve and Edie's indifference curves might intersect.
II) Steve's indifference curves will have flatter slopes than Edie's.
III) Steve's indifference curves will have steeper slopes than Edie's.
IV) Steve and Edie's indifference curves will not intersect.
V) Steve's indifference curves will be downward sloping, and Edie's will be upward sloping.
A. I and V
B. I and III
C. III and IV
D. I and II
E. II and IV
25. The capital allocation line can be described as the
A. investment opportunity set formed with a risky asset and a risk-free asset.
6-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. investment opportunity set formed with two risky assets.
C. line on which lie all portfolios that offer the same utility to a particular investor.
D. line on which lie all portfolios with the same expected rate of return and different standard deviations.
26. Which of the following statements regarding the capital allocation line (CAL) is false?
A. The CAL shows risk-return combinations.
B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional
standard deviation.
C. The slope of the CAL is also called the reward-to-volatility ratio.
D. The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.
27. Given the capital allocation line, an investor's optimal portfolio is the portfolio that
A. maximizes her expected profit.
B. maximizes her risk.
C. minimizes both her risk and return.
D. maximizes her expected utility.
E. None of the options are correct.
28. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of
0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.114; 0.12
B. 0.087; 0.06
C. 0.295; 0.06
D. 0.087; 0.12
E. None of the options are correct.
29. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of
0.03 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.114; 0.128
B. 0.087; 0.063
C. 0.295; 0.125
D. 0.081; 0.052
30. An investor invests 40% of his wealth in a risky asset with an expected rate of return of 0.17 and a variance of
0.08 and 60% in a T-bill that pays 4.5%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.114; 0.126
B. 0.087; 0.068
C. 0.095; 0.113
D. 0.087; 0.124
E. None of the options are correct.
31. An investor invests 70% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of
0.04 and 30% in a T-bill that pays 5%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.120; 0.14
B. 0.087; 0.06
C. 0.295; 0.12
6-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. 0.087; 0.12
32. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
Tbill with a rate of return of 0.05.
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a
portfolio with an expected return of 0.09?
A. 85% and 15%
B. 75% and 25%
C. 67% and 33%
D. 57% and 43%
E. Cannot be determined.
33. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
Tbill with a rate of return of 0.05.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a
portfolio with a standard deviation of 0.06?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
34. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
Tbill with a rate of return of 0.05.
A portfolio that has an expected outcome of $115 is formed by
A. investing $100 in the risky asset.
B. investing $80 in the risky asset and $20 in the risk-free asset.
C. borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset.
D. investing $43 in the risky asset and $57 in the riskless asset.
E. Such a portfolio cannot be formed.
35. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
Tbill with a rate of return of 0.05.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.4667.
B. 0.8000.
C. 2.14.
D. 0.41667.
E. Cannot be determined.
36. Consider a T-bill with a rate of return of 5% and the following risky securities:
Security A: E(r) = 0.15; Variance = 0.04
Security B: E(r) = 0.10; Variance = 0.0225
Security C: E(r) = 0.12; Variance = 0.01
Security D: E(r) = 0.13; Variance = 0.0625
From which set of portfolios, formed with the T-bill and any one of the four risky securities, would a risk-averse
6-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
investor always choose his portfolio?
A. The set of portfolios formed with the T-bill and security A.
B. The set of portfolios formed with the T-bill and security B.
C. The set of portfolios formed with the T-bill and security C.
D. The set of portfolios formed with the T-bill and security D.
E. Cannot be determined.
37. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of
return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
If you want to form a portfolio with an expected rate of return of 0.11, what percentages of your money must you
invest in the T-bill and P, respectively?
A. 0.25; 0.75
B. 0.19; 0.81
C. 0.65; 0.35
D. 0.50; 0.50
E. Cannot be determined.
38. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of
return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
If you want to form a portfolio with an expected rate of return of 0.10, what percentages of your money must you
invest in the T-bill, X, and Y, respectively, if you keep X and Y in the same proportions to each other as in portfolio
P?
A. 0.25; 0.45; 0.30
B. 0.19; 0.49; 0.32
C. 0.32; 0.41; 0.27
D. 0.50; 0.30; 0.20
E. Cannot be determined.
39. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of
return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
What would be the dollar values of your positions in X and Y, respectively, if you decide to hold 40% of your money
in the risky portfolio and 60% in T-bills?
A. $240; $360
B. $360; $240
C. $100; $240
D. $240; $160
E. Cannot be determined.
40. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate of
return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
What would be the dollar value of your positions in X, Y, and the T-bills, respectively, if you decide to hold a
portfolio that has an expected outcome of $1,120?
A. $568; $378; $54
6-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. $568; $54; $378
C. $378; $54; $568
D. $108; $514; $378
E. Cannot be determined.
41. A reward-to-volatility ratio is useful in
A. measuring the standard deviation of returns.
B. understanding how returns increase relative to risk increases.
C. analyzing returns on variable-rate bonds.
D. assessing the effects of inflation.
E. None of the options are correct.
42. The change from a straight to a kinked capital allocation line is a result of
A. reward-to-volatility ratio increasing.
B. borrowing rate exceeding lending rate.
C. an investor's risk tolerance decreasing.
D. increase in the portfolio proportion of the risk-free asset.
43. The first major step in asset allocation is
A. assessing risk tolerance.
B. analyzing financial statements.
C. estimating security betas.
D. identifying market anomalies.
44. Based on their relative degrees of risk tolerance,
A. investors will hold varying amounts of the risky asset in their portfolios.
B. all investors will have the same portfolio asset allocations.
C. investors will hold varying amounts of the risk-free asset in their portfolios.
D. investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their
portfolios.
45. Asset allocation may involve
A. the decision as to the allocation between a risk-free asset and a risky asset.
B. the decision as to the allocation among different risky assets.
C. considerable security analysis.
D. the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the allocation
among different risky assets.
E. the decision as to the allocation between a risk-free asset and a risky asset and considerable security analysis.
46. In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P,
is called
A. the security market line.
B. the capital allocation line.
C. the indifference curve.
D. the investor's utility line.
47. Treasury bills are commonly viewed as risk-free assets because
A. their short-term nature makes their values insensitive to interest rate fluctuations.
6-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. the inflation uncertainty over their time to maturity is negligible.
C. their term to maturity is identical to most investors' desired holding periods.
D. their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty
over their time to maturity is negligible.
E. the inflation uncertainty over their time to maturity is negligible, and their term to maturity is identical to most
investors' desired holding periods.
48. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What is the expected return on Bo's complete portfolio?
A. 10.32%
B. 5.28%
C. 9.62%
D. 8.44%
E. 7.58%
49. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What is the standard deviation of Bo's complete portfolio?
6-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 7.20%
B. 5.40%
C. 6.92%
D. 4.98%
E. 5.76%
50. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What is the equation of Bo's capital allocation line?
A. E(rC) = 7.2 + 3.6 × Standard Deviation of P
B. E(rC) = 3.6 + 1.167 × Standard Deviation of P
C. E(rC) = 3.6 + 12.0 × Standard Deviation of P
D. E(rC) = 0.2 + 1.167 × Standard Deviation of P
E. E(rC) = 3.6 + 0.857 × Standard Deviation of P
51. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What are the proportions of stocks A, B, and C, respectively, in Bo's complete portfolio?
A. 40%, 25%, 35%
6-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. 8%, 5%, 7%
C. 32%, 20%, 28%
D. 16%, 10%, 14%
E. 20%, 12.5%, 17.5%
52. To build an indifference curve, we can first find the utility of a portfolio with 100% in the risk-free asset, then
A. find the utility of a portfolio with 0% in the risk-free asset.
B. change the expected return of the portfolio and equate the utility to the standard deviation.
C. find another utility level with 0% risk.
D. change the standard deviation of the portfolio and find the expected return the investor would require to maintain
the same utility level.
E. change the risk-free rate and find the utility level that results in the same standard deviation.
53. The capital market line
I) is a special case of the capital allocation line.
II) represents the opportunity set of a passive investment strategy.
III) has the one-month T-Bill rate as its intercept.
IV) uses a broad index of common stocks as its risky portfolio.
A. I, III, and IV
B. II, III, and IV
C. III and IV
D. I, II, and III
E. I, II, III, and IV
54. An investor invests 35% of his wealth in a risky asset with an expected rate of return of 0.18 and a variance of
0.10 and 65% in a T-bill that pays 4%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.089; 0.111
B. 0.087; 0.063
C. 0.096; 0.126
D. 0.087; 0.144
55. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.11 and a variance of
0.12 and 70% in a T-bill that pays 3%. His portfolio's expected return and standard deviation are __________ and
__________, respectively.
A. 0.086; 0.242
B. 0.054; 0.104
C. 0.295; 0.123
D. 0.087; 0.182
E. None of the options are correct.
56. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
Tbill with a rate of return of 0.03.
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a
portfolio with an expected return of 0.08?
6-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 85% and 15%
B. 75% and 25%
C. 62.5% and 37.5%
D. 57% and 43%
E. Cannot be determined.
57. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
Tbill with a rate of return of 0.03.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a
portfolio with a standard deviation of 0.08?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
58. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
Tbill with a rate of return of 0.03.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.47.
B. 0.80.
C. 2.14.
D. 0.40.
E. Cannot be determined.
59. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
Tbill with a rate of return of 0.04.
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a
portfolio with an expected return of 0.11?
A. 53.8% and 46.2%
B. 75% and 25%
C. 62.5% and 37.5%
D. 46.2% and 53.8%
E. Cannot be determined.
60. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
Tbill with a rate of return of 0.04.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a
portfolio with a standard deviation of 0.20?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
61. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
Tbill with a rate of return of 0.04.
6-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.325.
B. 0.675.
C. 0.912.
D. 0.407.
E. Cannot be determined.
62. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
Tbill with a rate of return of 0.045.
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a
portfolio with an expected return of 0.13?
A. 130.77% and –30.77%
B. –30.77% and 130.77%
C. 67.67% and 33.33%
D. 57.75% and 42.25%
E. Cannot be determined.
63. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
Tbill with a rate of return of 0.045.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to form a
portfolio with a standard deviation of 0.08?
A. 30.1% and 69.9%
B. 50.5% and 49.50%
C. 60.0% and 40.0%
D. 61.9% and 38.1%
E. Cannot be determined.
64. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
Tbill with a rate of return of 0.045.
A portfolio that has an expected outcome of $114 is formed by
A. investing $100 in the risky asset.
B. investing $80 in the risky asset and $20 in the risk-free asset.
C. borrowing $46 at the risk-free rate and investing the total amount ($146) in the risky asset.
D. investing $43 in the risky asset and $57 in the risk-free asset.
E. Such a portfolio cannot be formed.
65. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
Tbill with a rate of return of 0.045.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.4667.
B. 0.8000.
C. 0.3095.
D. 0.41667.
E. Cannot be determined.
6-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 06 Test Bank - Static Key
Multiple Choice Questions
1. Which of the following statements regarding risk-averse investors is true?
A. They only care about the rate of return.
B. They accept investments that are fair games.
C. They only accept risky investments that offer risk premiums over the risk-free rate.
D. They are willing to accept lower returns and high risk.
E. They only care about the rate of return, and they accept investments that are fair games.
Risk-averse investors only accept risky investments that offer risk premiums over the risk-free rate.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk aversion
2. Which of the following statements is(are) true?
I) Risk-averse investors reject investments that are fair games.
II) Risk-neutral investors judge risky investments only by the expected returns.
III) Risk-averse investors judge investments only by their riskiness.
IV) Risk-loving investors will not engage in fair games.
A. I only
B. II only
C. I and II only
D. II and III only
E. II, III, and IV only
Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral
investors look only at expected returns when making an investment decision.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk aversion
3. Which of the following statements is(are) false?
I) Risk-averse investors reject investments that are fair games.
II) Risk-neutral investors judge risky investments only by the expected returns.
III) Risk-averse investors judge investments only by their riskiness.
IV) Risk-loving investors will not engage in fair games.
6-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. I only
B. II only
C. I and II only
D. II and III only
E. III and IV only
Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral
investors look only at expected returns when making an investment decision.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk aversion
4. In the mean-standard deviation graph, an indifference curve has a ________ slope.
A. negative
B. zero
C. positive
D. vertical
E. Cannot be determined.
The risk-return trade-off is one in which greater risk is taken if greater returns can be expected, resulting in a
positive slope.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Indifference curves
5. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference
curve of a risk-averse investor?
A. It is the locus of portfolios that have the same expected rates of return and different standard deviations.
B. It is the locus of portfolios that have the same standard deviations and different rates of return.
C. It is the locus of portfolios that offer the same utility according to returns and standard deviations.
D. It connects portfolios that offer increasing utilities according to returns and standard deviations.
E. None of the options are correct.
Indifference curves plot trade-off alternatives that provide equal utility to the individual (in this case, the tradeoffs
are the risk-return characteristics of the portfolios).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Indifference curves
6. In a return-standard deviation space, which of the following statements is(are) true for risk-averse investors?
(The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis,
respectively.)
I) An investor's own indifference curves might intersect.
II) Indifference curves have negative slopes.
III) In a set of indifference curves, the highest offers the greatest utility.
IV) Indifference curves of two investors might intersect.
6-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. I and II only
B. II and III only
C. I and IV only
D. III and IV only
E. None of the options are correct.
An investor's indifference curves are parallel (thus they cannot intersect) and have positive slopes. The highest
indifference curve (the one in the most northwestern position) offers the greatest utility. Indifference curves of
investors with similar risk-return trade-offs might intersect.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Indifference curves
7. Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore,
A. for the same risk, David requires a higher rate of return than Elias.
B. for the same return, Elias tolerates higher risk than David.
C. for the same risk, Elias requires a lower rate of return than David.
D. for the same return, David tolerates higher risk than Elias.
E. Cannot be determined.
The more risk averse the investor, the less risk that is tolerated for a given rate of return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk aversion
8. When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be
least likely to assess?
A. The investor's prior investing experience
B. The investor's degree of financial security
C. The investor's tendency to make risky or conservative choices
D. The level of return the investor prefers
E. The investor's feelings about loss
Investment advisors would be least likely to assess the level of return the investor prefers. The investor's
investing experience, financial security, feelings about loss, and disposition toward risky or conservative
choices will impact risk tolerance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk aversion
9. Assume an investor with the following utility function: U = E(r) – 3/2(s2).
To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a
standard deviation of ________, respectively.
A. 12%; 20%
B. 10%; 15%
6-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 10%; 10%
D. 8%; 10%
U = 0.10 – 3/2(0.10) 2 = 8.5%; highest utility of choices.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Utility values
10. To maximize her expected utility, which one of the following investment alternatives would she choose?
Assume an investor with the following utility function: U = E(r) 3/2(s2).
A. A portfolio that pays 10% with a 60% probability or 5% with 40% probability.
B. A portfolio that pays 10% with 40% probability or 5% with a 60% probability.
C. A portfolio that pays 12% with 60% probability or 5% with 40% probability.
D. A portfolio that pays 12% with 40% probability or 5% with 60% probability.
U(c) = 9.02%; highest utility of possibilities.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Utility values
11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6%. An
investor has the following utility function: U = E(r) (A/2)s2. Which value of A makes this investor indifferent
between the risky portfolio and the risk-free asset?
A. 5
B. 6
C. 7
D. 8
0.06 = 0.15 – A/2(0.15)2; 0.06 – 0.15 = A/2(0.0225); 0.09 = –0.01125A; A = 8; U
= 0.15 8/2(0.15)2 = 6%; U(Rf ) = 6%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Utility values
12. According to the mean-variance criterion, which one of the following investments dominates all others?
A. E(r) = 0.15; Variance = 0.20
B. E(r) = 0.10; Variance = 0.20
C. E(r) = 0.10; Variance = 0.25
D. E(r) = 0.15; Variance = 0.25
E. None of these options dominates the other alternatives.
A gives the highest return with the least risk; return per unit of risk is 0.75, which dominates the reward-risk ratio
for the other choices.
AACSB: Reflective Thinking
6-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Risk and return
13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard deviation of 0.15, that lies
on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve for
a risk averse investor?
A. E(r) = 0.15; Standard deviation = 0.20
B. E(r) = 0.15; Standard deviation = 0.10
C. E(r) = 0.10; Standard deviation = 0.10
D. E(r) = 0.20; Standard deviation = 0.15
E. E(r) = 0.10; Standard deviation = 0.20
Portfolio A has a reward to risk ratio of 1.0; portfolio C is the only choice with the same risk-return trade-off.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Indifference curves
14. Use the below information to answer the following question.
U = E(r ) – (A/2)s2,where A = 4.0.
Based on the utility function above, which investment would you select?
A. 1
B. 2
C. 3
D. 4
E. Cannot be determined from the information given.
U(c) = 0.21 – 4/2(0.16)2 = 15.88 (highest utility of choices).
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Utility values
15. Use the below information to answer the following question.
6-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
U = E(r ) – (A/2)s2
Which investment would you select if you were risk neutral?
A. 1
B. 2
C. 3
D. 4
E. Cannot be determined from the information given.
If you are risk neutral, your only concern is with return, not risk.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Utility values
16. Use the below information to answer the following question.
U = E(r ) (A/2)s2,where A = 4.0.
The variable (A) in the utility function represents the
A. investor's return requirement.
B. investor's aversion to risk.
C. certainty-equivalent rate of the portfolio.
D. minimum required utility of the portfolio.
A is an arbitrary scale factor used to measure investor risk tolerance. The higher the value of A, the more risk
averse the investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Utility values
17. The exact indifference curves of different investors
A. cannot be known with perfect certainty.
6-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. can be calculated precisely with the use of advanced calculus.
C. are known with perfect certainty and allow the advisor to create more suitable portfolios for the client.
D. although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the
client.
Indifference curves cannot be calculated precisely, but the theory does allow for the creation of more suitable
portfolios for investors of differing levels of risk tolerance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Indifference curves
18. The riskiness of individual assets
A. should be considered for the asset in isolation.
B. should be considered in the context of the effect on overall portfolio volatility.
C. should be combined with the riskiness of other individual assets in the proportions these assets constitute
the entire portfolio.
D. should be considered in the context of the effect on overall portfolio volatility and should be combined with the
riskiness of other individual assets in the proportions these assets constitute the entire portfolio.
The relevant risk is portfolio risk; thus, the riskiness of an individual security should be considered in the context
of the portfolio as a whole.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
19. A fair game
A. will not be undertaken by a risk-averse investor.
B. is a risky investment with a zero risk premium.
C. is a riskless investment.
D. will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium.
E. will not be undertaken by a risk-averse investor and is a riskless investment.
A fair game is a risky investment with a payoff exactly equal to its expected value. Since it offers no risk
premium, it will not be acceptable to a risk-averse investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Risk and return
20. The presence of risk means that
A. investors will lose money.
B. more than one outcome is possible.
C. the standard deviation of the payoff is larger than its expected value.
D. final wealth will be greater than initial wealth.
E. terminal wealth will be less than initial wealth.
The presence of risk means that more than one outcome is possible.
6-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Risk and return
21. The utility score an investor assigns to a particular portfolio, other things equal,
A. will decrease as the rate of return increases.
B. will decrease as the standard deviation decreases.
C. will decrease as the variance decreases.
D. will increase as the variance increases.
E. will increase as the rate of return increases.
Utility is enhanced by higher expected returns and diminished by higher risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Utility values
22. The certainty equivalent rate of a portfolio is
A. the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as
the risky portfolio.
B. the rate that the investor must earn for certain to give up the use of his money.
C. the minimum rate guaranteed by institutions such as banks.
D. the rate that equates "A" in the utility function with the average risk aversion coefficient for all risk-averse
investors.
E. represented by the scaling factor "-.005" in the utility function.
The certainty equivalent rate of a portfolio is the rate that a risk-free investment would need to offer with
certainty to be considered equally attractive as the risky portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Risk and return
23. According to the mean-variance criterion, which of the statements below is correct?
A. Investment B dominates investment A.
B. Investment B dominates investment C.
C. Investment D dominates all of the other investments.
6-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. Investment D dominates only investment B.
E. Investment C dominates investment A.
Investment B dominates investment C because investment B has a higher return and a lower standard
deviation (risk) than investment C.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk and return
24. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the
following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on
the horizontal axis.
I) Steve and Edie's indifference curves might intersect.
II) Steve's indifference curves will have flatter slopes than Edie's.
III) Steve's indifference curves will have steeper slopes than Edie's.
IV) Steve and Edie's indifference curves will not intersect.
V) Steve's indifference curves will be downward sloping, and Edie's will be upward sloping.
A. I and V
B. I and III
C. III and IV
D. I and II
E. II and IV
This question tests whether the student understands the graphical properties of indifference curves and how
they relate to the degree of risk tolerance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Indifference curves
25. The capital allocation line can be described as the
A. investment opportunity set formed with a risky asset and a risk-free asset.
B. investment opportunity set formed with two risky assets.
C. line on which lie all portfolios that offer the same utility to a particular investor.
D. line on which lie all portfolios with the same expected rate of return and different standard deviations.
The CAL has an intercept equal to the risk-free rate. It is a straight line through the point representing the riskfree
asset and the risky portfolio, in expected-return/standard deviation space.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
26. Which of the following statements regarding the capital allocation line (CAL) is false?
A. The CAL shows risk-return combinations.
B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of
additional standard deviation.
C. The slope of the CAL is also called the reward-to-volatility ratio.
6-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.
The CAL consists of combinations of a risky asset and a risk-free asset whose slope is the reward-to-volatility
ratio; thus, all statements except D are true.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
27. Given the capital allocation line, an investor's optimal portfolio is the portfolio that
A. maximizes her expected profit.
B. maximizes her risk.
C. minimizes both her risk and return.
D. maximizes her expected utility.
E. None of the options are correct.
By maximizing expected utility, the investor is obtaining the best risk-return relationships possible and
acceptable for her.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital allocation line
28. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of
0.04 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.114; 0.12
B. 0.087; 0.06
C. 0.295; 0.06
D. 0.087; 0.12
E. None of the options are correct.
E(r P) = 0.3(15%) + 0.7(6%) = 8.7%; sP = 0.3(0.04)1/2 = 6%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
29. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.13 and a variance of
0.03 and 70% in a T-bill that pays 6%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.114; 0.128
B. 0.087; 0.063
C. 0.295; 0.125
D. 0.081; 0.052
E(r P) = 0.3(13%) + 0.7(6%) = 8.1%; sP = 0.3(0.03)1/2 = 5.19%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
6-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
30. An investor invests 40% of his wealth in a risky asset with an expected rate of return of 0.17 and a variance of
0.08 and 60% in a T-bill that pays 4.5%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.114; 0.126
B. 0.087; 0.068
C. 0.095; 0.113
D. 0.087; 0.124
E. None of the options are correct.
E(r P) = 0.4(17%) + 0.6(4.5%) = 9.5%; sP = 0.4(0.08)1/2 = 11.31%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
31. An investor invests 70% of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of
0.04 and 30% in a T-bill that pays 5%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.120; 0.14
B. 0.087; 0.06
C. 0.295; 0.12
D. 0.087; 0.12
E(r P) = 0.7(15%) + 0.3(5%) = 12.0%; sP = 0.7(0.04)1/2 = 14%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
32. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
T-bill with a rate of return of 0.05.
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to
form a portfolio with an expected return of 0.09?
A. 85% and 15%
B. 75% and 25%
C. 67% and 33%
D. 57% and 43%
E. Cannot be determined.
9% = w1(12%) + (1 – w1)(5%); 9% = 12%w1 + 5% – 5%w1; 4% = 7%w1; w1 = 0.57; 1 – w1 =
0.43; 0.57(12%) + 0.43(5%) = 8.99%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
33. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
6-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
T-bill with a rate of return of 0.05.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to
form a portfolio with a standard deviation of 0.06?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
0.06 = x(0.15); x = 40% in risky asset.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
34. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
T-bill with a rate of return of 0.05.
A portfolio that has an expected outcome of $115 is formed by
A. investing $100 in the risky asset.
B. investing $80 in the risky asset and $20 in the risk-free asset.
C. borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky asset.
D. investing $43 in the risky asset and $57 in the riskless asset.
E. Such a portfolio cannot be formed.
For $100: (115 – 100)/100 = 15%; .15 = w1(0.12) + (1 w1)(0.05); .15 = 0.12w1 + 0.05 – 0.05w1; 0.10 = 0.07w1;
w1 = 1.43($100) = $143; (1 – w1)$100 = –$43.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Portfolio weights
35. You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a
T-bill with a rate of return of 0.05.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.4667.
B. 0.8000.
C. 2.14.
D. 0.41667.
E. Cannot be determined.
(0.12 – 0.05)/0.15 = 0.4667.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
36. Consider a T-bill with a rate of return of 5% and the following risky securities:
6-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Security A: E(r) = 0.15; Variance = 0.04
Security B: E(r) = 0.10; Variance = 0.0225
Security C: E(r) = 0.12; Variance = 0.01
Security D: E(r) = 0.13; Variance = 0.0625
From which set of portfolios, formed with the T-bill and any one of the four risky securities, would a risk-averse
investor always choose his portfolio?
A. The set of portfolios formed with the T-bill and security A.
B. The set of portfolios formed with the T-bill and security B.
C. The set of portfolios formed with the T-bill and security C.
D. The set of portfolios formed with the T-bill and security D.
E. Cannot be determined.
Security C has the highest reward-to-volatility ratio.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Risk aversion
37. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate
of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
If you want to form a portfolio with an expected rate of return of 0.11, what percentages of your money must
you invest in the T-bill and P, respectively?
A. 0.25; 0.75
B. 0.19; 0.81
C. 0.65; 0.35
D. 0.50; 0.50
E. Cannot be determined.
E(r p) = 0.6(14%) + 0.4(10%) = 12.4%; 11% = 5x + 12.4(1 – x); x = 0.189 (T-bills)
(1–x) = 0.811 (risky asset).
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
38. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate
of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
If you want to form a portfolio with an expected rate of return of 0.10, what percentages of your money must
you invest in the T-bill, X, and Y, respectively, if you keep X and Y in the same proportions to each other as in
portfolio P?
A. 0.25; 0.45; 0.30
B. 0.19; 0.49; 0.32
C. 0.32; 0.41; 0.27
D. 0.50; 0.30; 0.20
E. Cannot be determined.
10 = 5w + 12.4(1 – w); w = 0.32 (weight of T-bills); as composition of X and Y are 0.6 and 0.4 of P, respectively,
6-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
then for 0.68 weight in P, the respective weights must be 0.41 and 0.27; .6(0.68) = 41%; .4(0.68) = 27%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Portfolio weights
39. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate
of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
What would be the dollar values of your positions in X and Y, respectively, if you decide to hold 40% of your
money in the risky portfolio and 60% in T-bills?
A. $240; $360
B. $360; $240
C. $100; $240
D. $240; $160
E. Cannot be determined.
$400(0.6) = $240 in X; $400(0.4) = $160 in Y.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
40. You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P, constructed with two
risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40, respectively. X has an expected rate
of return of 0.14 and variance of 0.01, and Y has an expected rate of return of 0.10 and a variance of 0.0081.
What would be the dollar value of your positions in X, Y, and the T-bills, respectively, if you decide to hold a
portfolio that has an expected outcome of $1,120?
A. $568; $378; $54
B. $568; $54; $378
C. $378; $54; $568
D. $108; $514; $378
E. Cannot be determined.
($1,120 – $1,000)/$1,000 = 12%; (0.6)14% + (0.4)10% = 12.4%; 12% = w5% + 12.4%(1 – w);w = 0.054; 1-w
= 0.946; w = 0.054($1,000) = $54 (T-bills); 1 – w = 1 – 0.054 = 0.946($1,000) = $946; $946 × 0.6 = $568 in X;
$946 × 0.4 = $378 in Y.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Portfolio weights
41. A reward-to-volatility ratio is useful in
A. measuring the standard deviation of returns.
B. understanding how returns increase relative to risk increases.
C. analyzing returns on variable-rate bonds.
D. assessing the effects of inflation.
E. None of the options are correct.
A reward-to-volatility ratio is useful in understanding how returns increase relative to risk increases.
6-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
42. The change from a straight to a kinked capital allocation line is a result of
A. reward-to-volatility ratio increasing.
B. borrowing rate exceeding lending rate.
C. an investor's risk tolerance decreasing.
D. increase in the portfolio proportion of the risk-free asset.
The linear capital allocation line assumes that the investor may borrow and lend at the same rate (the risk-free
rate), which obviously is not true. Relaxing this assumption and incorporating the higher borrowing rates into
the model results in the kinked capital allocation line.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Capital allocation line
43. The first major step in asset allocation is
A. assessing risk tolerance.
B. analyzing financial statements.
C. estimating security betas.
D. identifying market anomalies.
Assessing risk tolerance should be the first consideration in asset allocation. The other options refer to security
selection.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Risk aversion
44. Based on their relative degrees of risk tolerance,
A. investors will hold varying amounts of the risky asset in their portfolios.
B. all investors will have the same portfolio asset allocations.
C. investors will hold varying amounts of the risk-free asset in their portfolios.
D. investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their
portfolios.
By determining levels of risk tolerance, investors can select the optimum portfolio for their own needs; these
asset allocations will vary between amounts of risk-free and risky assets based on risk tolerance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Risk aversion
45. Asset allocation may involve
A. the decision as to the allocation between a risk-free asset and a risky asset.
6-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. the decision as to the allocation among different risky assets.
C. considerable security analysis.
D. the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the
allocation among different risky assets.
E. the decision as to the allocation between a risk-free asset and a risky asset and considerable security
analysis.
The decision as to the allocation between a risk-free asset and a risky asset and the decision as to the
allocation among different risky assets are possible steps in asset allocation. Considerable security analysis is
related to security selection.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Portfolio weights
46. In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P,
is called
A. the security market line.
B. the capital allocation line.
C. the indifference curve.
D. the investor's utility line.
The capital allocation line (CAL) illustrates the possible combinations of a risk-free asset and a risky asset
available to the investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital allocation line
47. Treasury bills are commonly viewed as risk-free assets because
A. their short-term nature makes their values insensitive to interest rate fluctuations.
B. the inflation uncertainty over their time to maturity is negligible.
C. their term to maturity is identical to most investors' desired holding periods.
D. their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation
uncertainty over their time to maturity is negligible.
E. the inflation uncertainty over their time to maturity is negligible, and their term to maturity is identical to most
investors' desired holding periods.
Treasury bills do not exactly match most investors' desired holding periods, but because they mature in only a
few weeks or months they are relatively free of interest rate sensitivity and inflation uncertainty.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
48. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
6-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
What is the expected return on Bo's complete portfolio?
A. 10.32%
B. 5.28%
C. 9.62%
D. 8.44%
E. 7.58%
E(r C) = 0.8 × 12.00% + 0.2 × 3.6% = 10.32%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
49. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What is the standard deviation of Bo's complete portfolio?
A. 7.20%
B. 5.40%
6-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 6.92%
D. 4.98%
E. 5.76%
Std. Dev. of C = 0.8 × 7.20% = 5.76%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Standard deviation and variance
50. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What is the equation of Bo's capital allocation line?
A. E(rC) = 7.2 + 3.6 × Standard Deviation of P
B. E(rC) = 3.6 + 1.167 × Standard Deviation of P
C. E(rC) = 3.6 + 12.0 × Standard Deviation of P
D. E(rC) = 0.2 + 1.167 × Standard Deviation of P
E. E(rC) = 3.6 + 0.857 × Standard Deviation of P
The intercept is the risk-free rate (3.60%) and the slope is (12.00% – 3.60%)/7.20% = 1.167.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
6-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
51. Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets (P) and T-Bills.
The information below refers to these assets.
What are the proportions of stocks A, B, and C, respectively, in Bo's complete portfolio?
A. 40%, 25%, 35%
B. 8%, 5%, 7%
C. 32%, 20%, 28%
D. 16%, 10%, 14%
E. 20%, 12.5%, 17.5%
Proportion in A = 0.8 × 40% = 32%; proportion in B = 0.8 × 25% = 20%; proportion in C = 0.8 × 35% = 28%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
52. To build an indifference curve, we can first find the utility of a portfolio with 100% in the risk-free asset, then
A. find the utility of a portfolio with 0% in the risk-free asset.
B. change the expected return of the portfolio and equate the utility to the standard deviation.
C. find another utility level with 0% risk.
D. change the standard deviation of the portfolio and find the expected return the investor would require to
maintain the same utility level.
E. change the risk-free rate and find the utility level that results in the same standard deviation.
This question references the procedure described in the text. The authors describe how to trace out
indifference curves using a spreadsheet.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Indifference curves
53. The capital market line
6-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
I) is a special case of the capital allocation line.
II) represents the opportunity set of a passive investment strategy.
III) has the one-month T-Bill rate as its intercept.
IV) uses a broad index of common stocks as its risky portfolio.
A. I, III, and IV
B. II, III, and IV
C. III and IV
D. I, II, and III
E. I, II, III, and IV
The capital market line is the capital allocation line based on the one-month T-Bill rate and a broad index of
common stocks. It applies to an investor pursuing a passive management strategy.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital market line
54. An investor invests 35% of his wealth in a risky asset with an expected rate of return of 0.18 and a variance of
0.10 and 65% in a T-bill that pays 4%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.089; 0.111
B. 0.087; 0.063
C. 0.096; 0.126
D. 0.087; 0.144
E(r P) = 0.35(18%) + 0.65(4%) = 8.9%; sP = 0.35(0.10)1/2 = 11.07%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
55. An investor invests 30% of his wealth in a risky asset with an expected rate of return of 0.11 and a variance of
0.12 and 70% in a T-bill that pays 3%. His portfolio's expected return and standard deviation are __________
and __________, respectively.
A. 0.086; 0.242
B. 0.054; 0.104
C. 0.295; 0.123
D. 0.087; 0.182
E. None of the options are correct.
E(r P) = 0.3(11%) + 0.7(3%) = 5.4%; sP = 0.3(0.12)1/2 = 10.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
56. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
T-bill with a rate of return of 0.03.
6-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to
form a portfolio with an expected return of 0.08?
A. 85% and 15%
B. 75% and 25%
C. 62.5% and 37.5%
D. 57% and 43%
E. Cannot be determined.
8% = w1(11%) + (1 w1)(3%); 8% = 11%w1 + 3% 3%w1; 5% = 8%w1; w1 = 0.625; 1 w1
= 0.375; 0.625(11%) + 0.375(3%) = 8.0%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
57. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
T-bill with a rate of return of 0.03.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to
form a portfolio with a standard deviation of 0.08?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
0.08 = x(0.20); x = 40% in risky asset.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
58. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.20 and a
T-bill with a rate of return of 0.03.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.47.
B. 0.80.
C. 2.14.
D. 0.40.
E. Cannot be determined.
(0.11 – 0.03)/0.20 = 0.40.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
59. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
T-bill with a rate of return of 0.04.
6-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to
form a portfolio with an expected return of 0.11?
A. 53.8% and 46.2%
B. 75% and 25%
C. 62.5% and 37.5%
D. 46.2% and 53.8%
E. Cannot be determined.
11% = w1(17%) + (1 – w1)(4%); 11% = 17%w1 + 4% – 4%w1; 7% = 13%w1; w1 = 0.538; 1 –
w1 = 0.462; 0.538(17%) + 0.462(4%) = 11.0%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
60. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
T-bill with a rate of return of 0.04.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to
form a portfolio with a standard deviation of 0.20?
A. 30% and 70%
B. 50% and 50%
C. 60% and 40%
D. 40% and 60%
E. Cannot be determined.
0.20 = x(0.40); x = 50% in risky asset.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
61. You invest $1,000 in a risky asset with an expected rate of return of 0.17 and a standard deviation of 0.40 and a
T-bill with a rate of return of 0.04.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.325.
B. 0.675.
C. 0.912.
D. 0.407.
E. Cannot be determined.
(0.17 – 0.04)/0.40 = 0.325.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
62. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
T-bill with a rate of return of 0.045.
6-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to
form a portfolio with an expected return of 0.13?
A. 130.77% and –30.77%
B. –30.77% and 130.77%
C. 67.67% and 33.33%
D. 57.75% and 42.25%
E. Cannot be determined.
13% = w1(11%) + (1 – w1)(4.5%); 13% = 11%w1 + 4.5% – 4.5%w1; 8.5% = 6.5%w1; w1 = 1.3077; 1 – w1 =
0.3077; 1.308(11%) + (–0.3077)(4.5%) = 13.00%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
63. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
T-bill with a rate of return of 0.045.
What percentages of your money must be invested in the risk-free asset and the risky asset, respectively, to
form a portfolio with a standard deviation of 0.08?
A. 30.1% and 69.9%
B. 50.5% and 49.50%
C. 60.0% and 40.0%
D. 61.9% and 38.1%
E. Cannot be determined.
0.08 = x(0.21); x = 38.1% in risky asset.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Portfolio weights
64. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
T-bill with a rate of return of 0.045.
A portfolio that has an expected outcome of $114 is formed by
A. investing $100 in the risky asset.
B. investing $80 in the risky asset and $20 in the risk-free asset.
C. borrowing $46 at the risk-free rate and investing the total amount ($146) in the risky asset.
D. investing $43 in the risky asset and $57 in the risk-free asset.
E. Such a portfolio cannot be formed.
For $100: (114 – 100)/100 = 14%; 0.14 = w1(0.11) + (1 – w1)(0.045); 0.14 = 0.11w1
+ 0.045 – 0.045w1; 0.095 = 0.065w1; w1 = 1.46($100) = $146; (1 – w1)$100 = –$46.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Portfolio weights
65. You invest $100 in a risky asset with an expected rate of return of 0.11 and a standard deviation of 0.21 and a
6-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
T-bill with a rate of return of 0.045.
The slope of the capital allocation line formed with the risky asset and the risk-free asset is equal to
A. 0.4667.
B. 0.8000.
C. 0.3095.
D. 0.41667.
E. Cannot be determined.
(0.11 – 0.045)/0.21 = 0.3095.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
6-38
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 06 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
36
AACSB: Reflective Thinking
29
Accessibility: Keyboard Navigation
65
Blooms: Apply
35
Blooms: Remember
8
Blooms: Understand
22
Difficulty: 1 Basic
10
Difficulty: 2 Intermediate
42
Difficulty: 3 Challenge
13
Topic: Capital allocation line
10
Topic: Capital market line
0
Topic: Diversification
0
Topic: Expected return
0
Topic: Indifference curves
7
Topic: Portfolio weights
16
Topic: Risk and return
5
Topic: Risk aversion
2
Topic: Risk-adjusted performance measures (Sharpe, Treynor, Jensen, Information ratio, M2, etc.)
1
Topic: Standard deviation and variance
7
Topic: U.S. Treasury and agency securities
1
Topic: Utility values
7
6-39
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 07 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Market risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or nondiversifiable risk.
C. unique risk or nondiversifiable risk.
D. unique risk or diversifiable risk.
2. Systematic risk is also referred to as
A. market risk or nondiversifiable risk.
B. market risk or diversifiable risk.
C. unique risk or nondiversifiable risk.
D. unique risk or diversifiable risk.
E. None of the options are correct.
3. Nondiversifiable risk is also referred to as
A. systematic risk or unique risk.
B. systematic risk or market risk.
C. unique risk or market risk.
D. unique risk or firm-specific risk.
4. Diversifiable risk is also referred to as
A. systematic risk or unique risk.
B. systematic risk or market risk.
C. unique risk or market risk.
D. unique risk or firm-specific risk.
5. Unique risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or firm-specific risk.
E. None of the options are correct.
6. Firm-specific risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or unique risk.
7. Nonsystematic risk is also referred to as
A. market risk or diversifiable risk.
B. firm-specific risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or unique risk.
7-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
8. The risk that can be diversified away is
A. firm-specific risk.
B. beta.
C. systematic risk.
D. market risk.
9. The risk that cannot be diversified away is
A. firm-specific risk.
B. unique.
C. nonsystematic risk.
D. market risk.
10. The variance of a portfolio of risky securities
A. is a weighted sum of the securities' variances.
B. is the sum of the securities' variances.
C. is the weighted sum of the securities' variances and covariances.
D. is the sum of the securities' covariances.
E. None of the options are correct.
11. The standard deviation of a portfolio of risky securities is
A. the square root of the weighted sum of the securities' variances.
B. the square root of the sum of the securities' variances.
C. the square root of the weighted sum of the securities' variances and covariances.
D. the square root of the sum of the securities' covariances.
12. The expected return of a portfolio of risky securities
A. is a weighted average of the securities' returns.
B. is the sum of the securities' returns.
C. is the weighted sum of the securities' variances and covariances.
D. is a weighted average of the securities' returns and the weighted sum of the securities' variances and
covariances.
E. None of the options are correct.
13. Other things equal, diversification is most effective when
A. securities' returns are uncorrelated.
B. securities' returns are positively correlated.
C. securities' returns are high.
D. securities' returns are negatively correlated.
E. securities' returns are positively correlated and high.
14. The efficient frontier of risky assets is
A. the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio.
B. the portion of the minimum-variance portfolio that represents the highest standard deviations.
C. the portion of the minimum-variance portfolio that includes the portfolios with the lowest standard deviation.
D. the set of portfolios that have zero standard deviation.
7-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
15. The capital allocation line provided by a risk-free security and N risky securities is
A. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities.
B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected
return on the efficient frontier.
C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.
D. the horizontal line drawn from the risk-free rate.
16. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The
global-minimum variance portfolio has a standard deviation that is always
A. greater than zero.
B. equal to zero.
C. equal to the sum of the securities' standard deviations.
D. equal to 1.
17. Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between
securities.
A. I only
B. II only
C. III only
D. I and II
E. I and III
18. Which of the following statement(s) is(are) false regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between
securities.
A. I only
B. II only
C. III only
D. I and II
E. I and III
19. Efficient portfolios of N risky securities are portfolios that
A. are formed with the securities that have the highest rates of return regardless of their standard deviations.
B. have the highest rates of return for a given level of risk.
C. are selected from those securities with the lowest standard deviations regardless of their returns.
D. have the highest risk and rates of return and the highest standard deviations.
E. have the lowest standard deviations and the lowest rates of return.
20. Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the
capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than
more risk-averse investors.
7-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than
less risk-averse investors.
III) Investors choose the portfolio that maximizes their expected utility.
A. I only
B. II only
C. III only
D. I and III
E. II and III
21. Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the
capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than
more risk-averse investors.
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than
less risk-averse investors.
III) Investors choose the portfolio that maximizes their expected utility.
A. I only
B. II only
C. III only
D. I and II
E. I and III
22. Consider the following probability distribution for stocks A and B:
The expected rates of return of stocks A and B are _____ and _____, respectively.
A. 13.2%; 9%
B. 14%; 10%
C. 13.2%; 7.7%
D. 7.7%; 13.2%
23. Consider the following probability distribution for stocks A and B:
The standard deviations of stocks A and B are _____ and _____, respectively.
7-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 1.5%; 1.9%
B. 2.5%; 1.1%
C. 3.2%; 2.0%
D. 1.5%; 1.1%
24. Consider the following probability distribution for stocks A and B:
The variances of stocks A and B are _____ and _____, respectively.
A. 1.5%; 1.9%
B. 2.2%; 1.2%
C. 3.2%; 2.0%
D. 1.5%; 1.1%
25. Consider the following probability distribution for stocks A and B:
The coefficient of correlation between A and B is
A. 0.46.
B. 0.60.
C. 0.58.
D. 1.20.
26. Consider the following probability distribution for stocks A and B:
If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.9%; 3%
B. 9.9%; 1.1%
7-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 11%; 1.1%
D. 11%; 3%
E. None of the options are correct.
27. Consider the following probability distribution for stocks A and B:
Let G be the global minimum variance portfolio. The weights of A and B in G are __________ and __________,
respectively.
A. 0.40; 0.60
B. 0.66; 0.34
C. 0.34; 0.66
D. 0.77; 0.23
E. 0.23; 0.77
28. Consider the following probability distribution for stocks A and B:
The expected rate of return and standard deviation of the global minimum variance portfolio, G, are __________
and __________, respectively.
A. 10.07%; 1.05%
B. 8.97%; 2.03%
C. 10.07%; 3.01%
D. 8.97%; 1.05%
29. Consider the following probability distribution for stocks A and B:
Which of the following portfolio(s) is(are) on the efficient frontier?
A. The portfolio with 20 percent in A and 80 percent in B.
7-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. The portfolio with 15 percent in A and 85 percent in B.
C. The portfolio with 26 percent in A and 74 percent in B.
D. The portfolio with 10 percent in A and 90 percent in B.
E. A and B are both on the efficient frontier.
30. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10%
and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.
The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.57; 0.43
D. 0.43; 0.57
E. 0.76; 0.24
31. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10%
and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.
The risk-free portfolio that can be formed with the two securities will earn a(n) _____ rate of return.
A. 8.5%
B. 9.0%
C. 8.9%
D. 9.9%
32. Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and a risk free rate of
3%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.39
C. 0.08
D. 0.13
E. 0.36
33. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital
allocation line must
A. lend some of her money at the risk-free rate.
B. borrow some money at the risk-free rate and invest in the optimal risky portfolio.
C. invest only in risky securities.
D. borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities
E. Such a portfolio cannot be formed.
34. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
A. Only portfolio W cannot lie on the efficient frontier.
B. Only portfolio X cannot lie on the efficient frontier.
C. Only portfolio Y cannot lie on the efficient frontier.
7-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. Only portfolio Z cannot lie on the efficient frontier.
E. Cannot be determined from the information given.
35. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
A. Only portfolio A cannot lie on the efficient frontier.
B. Only portfolio B cannot lie on the efficient frontier.
C. Only portfolio C cannot lie on the efficient frontier.
D. Only portfolio D cannot lie on the efficient frontier.
E. Cannot be determined from the information given.
36. Portfolio theory as described by Markowitz is most concerned with
A. the elimination of systematic risk.
B. the effect of diversification on portfolio risk.
C. the identification of unsystematic risk.
D. active portfolio management to enhance returns.
37. The measure of risk in a Markowitz efficient frontier is
A. specific risk.
B. standard deviation of returns.
C. reinvestment risk.
D. beta.
38. A statistic that measures how the returns of two risky assets move together is:
A. variance.
B. standard deviation.
C. covariance.
D. correlation.
E. covariance and correlation.
39. The unsystematic risk of a specific security
A. is likely to be higher in an increasing market.
B. results from factors unique to the firm.
C. depends on market volatility.
D. cannot be diversified away.
40. Which statement about portfolio diversification is correct?
A. Proper diversification can eliminate systematic risk.
B. The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities
have been purchased.
C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.
7-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing
rate.
E. None of the statements are correct.
41. The individual investor's optimal portfolio is designated by
A. the point of tangency with the indifference curve and the capital allocation line.
B. the point of highest reward to variability ratio in the opportunity set.
C. the point of tangency with the opportunity set and the capital allocation line.
D. the point of the highest reward to variability ratio in the indifference curve.
E. None of the options are correct.
42. For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks?
A. +1.00
B. +0.50
C. 0.00
D. –1.00
E. None of the options are correct.
43. In a two-security minimum variance portfolio where the correlation between securities is greater than 1.0,
A. the security with the higher standard deviation will be weighted more heavily.
B. the security with the higher standard deviation will be weighted less heavily.
C. the two securities will be equally weighted.
D. the risk will be zero.
E. the return will be zero.
44. Which of the following is not a source of systematic risk?
A. The business cycle
B. Interest rates
C. Personnel changes
D. The inflation rate
E. Exchange rates
45. The global minimum variance portfolio formed from two risky securities will be riskless when the correlation
coefficient between the two securities is
A. 0.0.
B. 1.0.
C. 0.5.
D. –1.0.
E. any negative number.
46. Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15%
and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their covariance?
A. 0.038
B. 0.070
C. 0.018
D. 0.033
E. 0.054
47. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio,
7-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. the portfolio standard deviation will be greater than the weighted average of the individual security standard
deviations.
B. the portfolio standard deviation will be less than the weighted average of the individual security standard
deviations.
C. the portfolio standard deviation will be equal to the weighted average of the individual security standard
deviations.
D. the portfolio standard deviation will always be equal to the securities' covariance.
48. The line representing all combinations of portfolio expected returns and standard deviations that can be
constructed from two available assets is called the
A. risk/reward tradeoff line.
B. capital allocation line.
C. efficient frontier.
D. portfolio opportunity set.
E. Security Market Line.
49. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of
5%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.27
C. 0.08
D. 0.33
E. 0.36
50. Given an optimal risky portfolio with expected return of 20%, standard deviation of 24%, and a risk free rate of
7%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.14
C. 0.62
D. 0.33
E. 0.54
51. The risk that can be diversified away in a portfolio is referred to as ___________.
I) diversifiable risk
II) unique risk
III) systematic risk
IV) firm-specific risk
A. I, III, and IV
B. II, III, and IV
C. III and IV
D. I, II, and IV
E. I, II, III, and IV
52. As the number of securities in a portfolio is increased, what happens to the average portfolio standard deviation?
A. It increases at an increasing rate.
B. It increases at a decreasing rate.
C. It decreases at an increasing rate.
D. It decreases at a decreasing rate.
E. It first decreases, then starts to increase as more securities are added.
7-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
53. In words, the covariance considers the probability of each scenario happening and the interaction between
A. securities' returns relative to their variances.
B. securities' returns relative to their mean returns.
C. securities' returns relative to other securities' returns.
D. the level of return a security has in that scenario and the overall portfolio return.
E. the variance of the security's return in that scenario and the overall portfolio variance.
54. The standard deviation of a two-asset portfolio is a linear function of the assets' weights when
A. the assets have a correlation coefficient less than zero.
B. the assets have a correlation coefficient equal to zero.
C. the assets have a correlation coefficient greater than zero.
D. the assets have a correlation coefficient equal to one.
E. the assets have a correlation coefficient less than one.
55. A two-asset portfolio with a standard deviation of zero can be formed when
A. the assets have a correlation coefficient less than zero.
B. the assets have a correlation coefficient equal to zero.
C. the assets have a correlation coefficient greater than zero.
D. the assets have a correlation coefficient equal to one.
E. the assets have a correlation coefficient equal to negative one.
56. When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the
investor choose to combine with the efficient frontier?
I) The one with the highest reward-to-variability ratio.
II) The one that will maximize his utility.
III) The one with the steepest slope.
IV) The one with the lowest slope.
A. I and III
B. I and IV
C. II and IV
D. I only
E. I, II, and III
57. Given an optimal risky portfolio with expected return of 13%, standard deviation of 26%, and a risk free rate of
5%, what is the slope of the best feasible CAL?
A. 0.60
B. 0.14
C. 0.08
D. 0.36
E. 0.31
58. The separation property refers to the conclusion that
A. the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is
subjective.
B. the choice of the best complete portfolio is objective, and the determination of the best risky portfolio is
objective.
C. the choice of inputs to be used to determine the efficient frontier is objective, and the choice of the best CAL is
subjective.
7-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. the determination of the best CAL is objective, and the choice of the inputs to be used to determine the efficient
frontier is subjective.
E. investors are separate beings and will, therefore, have different preferences regarding the risk-return tradeoff.
59. Consider the following probability distribution for stocks A and B:
The expected rates of return of stocks A and B are _____ and _____, respectively.
A. 13.2%; 9%
B. 13%; 8.4%
C. 13.2%; 7.7%
D. 7.7%; 13.2%
60. Consider the following probability distribution for stocks A and B:
The standard deviations of stocks A and B are _____ and _____, respectively.
A. 1.56%; 1.99%
B. 2.45%; 1.66%
C. 3.22%; 2.01%
D. 1.54%; 1.11%
61. Consider the following probability distribution for stocks A and B:
The coefficient of correlation between A and B is
A. 0.474.
B. 0.612.
C. 0.590.
D. 1.206.
7-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
62. Consider the following probability distribution for stocks A and B:
If you invest 35% of your money in A and 65% in B, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.9%; 3%
B. 9.9%; 1.1%
C. 10%; 1.7%
D. 10%; 3%
63. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12%
and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%.
The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.57; 0.43
D. 0.45; 0.55
E. 0.76; 0.24
64. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12%
and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%.
The risk-free portfolio that can be formed with the two securities will earn _____ rate of return.
A. 9.5%
B. 10.4%
C. 10.9%
D. 9.9%
65. Security X has expected return of 14% and standard deviation of 22%. Security Y has expected return of 16%
and standard deviation of 28%. If the two securities have a correlation coefficient of 0.8, what is their covariance?
A. 0.038
B. 0.049
C. 0.018
D. 0.013
E. 0.054
66. Given an optimal risky portfolio with expected return of 16%, standard deviation of 20%, and a risk-free rate of
4%, what is the slope of the best feasible CAL?
A. 0.60
B. 0.14
C. 0.08
D. 0.36
7-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
E. 0.31
67. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of
3%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.14
C. 0.08
D. 0.35
E. 0.36
68. Consider the following probability distribution for stocks C and D:
The expected rates of return of stocks C and D are _____ and _____, respectively.
A. 4.4%; 9.5%
B. 9.5%; 4.4%
C. 6.3%; 8.7%
D. 8.7%; 6.2%
E. None of the options are correct.
69. Consider the following probability distribution for stocks C and D:
The standard deviations of stocks C and D are _____ and _____, respectively.
A. 7.62%; 11.24%
B. 11.24%; 7.62%
C. 10.35%; 12.93%
D. 12.93%; 10.35%
70. Consider the following probability distribution for stocks C and D:
The coefficient of correlation between C and D is
A. 0.67.
B. 0.50.
C. –0.50.
7-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. –0.67.
E. None of the options are correct.
71. Consider the following probability distribution for stocks C and D:
If you invest 25% of your money in C and 75% in D, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.891%; 8.70%
B. 9.945%; 11.12%
C. 8.225%; 8.70%
D. 10.275%; 11.12%
72. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13%
and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%.
The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.46; 0.54
D. 0.45; 0.55
E. 0.76; 0.24
73. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13%
and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%.
The risk-free portfolio that can be formed with the two securities will earn _____ rate of return.
A. 9.5%
B. 11.4%
C. 10.9%
D. 9.9%
E. None of the options are correct.
74. Security M has expected return of 17% and standard deviation of 32%. Security S has expected return of 13%
and standard deviation of 19%. If the two securities have a correlation coefficient of 0.78, what is their covariance?
A. 0.038
B. 0.049
C. 0.047
D. 0.045
E. 0.054
75. Security X has expected return of 7% and standard deviation of 14%. Security Y has expected return of 11% and
standard deviation of 22%. If the two securities have a correlation coefficient of 0.45, what is their covariance?
A. 0.0388
7-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. –0.0108
C. 0.0184
D. –0.0139
E. –0.1512
76. Security X has expected return of 9% and standard deviation of 18%. Security Y has expected return of 12% and
standard deviation of 21%. If the two securities have a correlation coefficient of 0.4, what is their covariance?
A. 0.0388
B. 0.0706
C. 0.0184
D. –0.0133
E. –0.0151
Chapter 07 Test Bank - Static Key
Multiple Choice Questions
1. Market risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or nondiversifiable risk.
C. unique risk or nondiversifiable risk.
D. unique risk or diversifiable risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
2. Systematic risk is also referred to as
A. market risk or nondiversifiable risk.
B. market risk or diversifiable risk.
C. unique risk or nondiversifiable risk.
D. unique risk or diversifiable risk.
E. None of the options are correct.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
3. Nondiversifiable risk is also referred to as
7-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. systematic risk or unique risk.
B. systematic risk or market risk.
C. unique risk or market risk.
D. unique risk or firm-specific risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
4. Diversifiable risk is also referred to as
A. systematic risk or unique risk.
B. systematic risk or market risk.
C. unique risk or market risk.
D. unique risk or firm-specific risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
5. Unique risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or firm-specific risk.
E. None of the options are correct.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
6. Firm-specific risk is also referred to as
A. systematic risk or diversifiable risk.
B. systematic risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or unique risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
7-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
7. Nonsystematic risk is also referred to as
A. market risk or diversifiable risk.
B. firm-specific risk or market risk.
C. diversifiable risk or market risk.
D. diversifiable risk or unique risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
8. The risk that can be diversified away is
A. firm-specific risk.
B. beta.
C. systematic risk.
D. market risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
9. The risk that cannot be diversified away is
A. firm-specific risk.
B. unique.
C. nonsystematic risk.
D. market risk.
Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from
the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that
can be eliminated from the portfolio by diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
10. The variance of a portfolio of risky securities
7-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. is a weighted sum of the securities' variances.
B. is the sum of the securities' variances.
C. is the weighted sum of the securities' variances and covariances.
D. is the sum of the securities' covariances.
E. None of the options are correct.
The variance of a portfolio of risky securities is a weighted sum taking into account both the variance of the
individual securities and the covariances between securities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
11. The standard deviation of a portfolio of risky securities is
A. the square root of the weighted sum of the securities' variances.
B. the square root of the sum of the securities' variances.
C. the square root of the weighted sum of the securities' variances and covariances.
D. the square root of the sum of the securities' covariances.
The standard deviation is the square root of the variance which is a weighted sum of the variance of the
individual securities and the covariances between securities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
12. The expected return of a portfolio of risky securities
A. is a weighted average of the securities' returns.
B. is the sum of the securities' returns.
C. is the weighted sum of the securities' variances and covariances.
D. is a weighted average of the securities' returns and the weighted sum of the securities' variances and
covariances.
E. None of the options are correct.
The expected return of a portfolio of risky securities is a weighted average of the securities' returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Expected return
13. Other things equal, diversification is most effective when
A. securities' returns are uncorrelated.
B. securities' returns are positively correlated.
C. securities' returns are high.
D. securities' returns are negatively correlated.
E. securities' returns are positively correlated and high.
Negative correlation among securities results in the greatest reduction of portfolio risk, which is the goal of
diversification.
7-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification
14. The efficient frontier of risky assets is
A. the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio.
B. the portion of the minimum-variance portfolio that represents the highest standard deviations.
C. the portion of the minimum-variance portfolio that includes the portfolios with the lowest standard deviation.
D. the set of portfolios that have zero standard deviation.
Portfolios on the efficient frontier are those providing the greatest expected return for a given amount of risk.
Only those portfolios above the global minimum variance portfolio meet this criterion.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Efficient frontier
15. The capital allocation line provided by a risk-free security and N risky securities is
A. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities.
B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected
return on the efficient frontier.
C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.
D. the horizontal line drawn from the risk-free rate.
The capital allocation line represents the most efficient combinations of the risk-free asset and risky securities.
Only C meets that definition.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital allocation line
16. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The
global-minimum variance portfolio has a standard deviation that is always
A. greater than zero.
B. equal to zero.
C. equal to the sum of the securities' standard deviations.
D. equal to 1.
If two securities were perfectly negatively correlated, the weights for the minimum variance portfolio for those
securities could be calculated, and the standard deviation of the resulting portfolio would be zero.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
17. Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
7-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between
securities.
A. I only
B. II only
C. III only
D. I and II
E. I and III
The lower the correlation between the returns of the securities, the more portfolio risk is reduced.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
18. Which of the following statement(s) is(are) false regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between
securities.
A. I only
B. II only
C. III only
D. I and II
E. I and III
The lower the correlation between the returns of the securities, the more portfolio risk is reduced.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
19. Efficient portfolios of N risky securities are portfolios that
A. are formed with the securities that have the highest rates of return regardless of their standard deviations.
B. have the highest rates of return for a given level of risk.
C. are selected from those securities with the lowest standard deviations regardless of their returns.
D. have the highest risk and rates of return and the highest standard deviations.
E. have the lowest standard deviations and the lowest rates of return.
Portfolios that are efficient are those that provide the highest expected return for a given level of risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Efficient frontier
20. Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the
capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than
7-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
more risk-averse investors.
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than
less risk-averse investors.
III) Investors choose the portfolio that maximizes their expected utility.
A. I only
B. II only
C. III only
D. I and III
E. II and III
All rational investors select the portfolio that maximizes their expected utility; for investors who are relatively
more risk-averse, doing so means investing less in the optimal risky portfolio and more in the risk-free asset.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
21. Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the
capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than
more risk-averse investors.
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than
less risk-averse investors.
III) Investors choose the portfolio that maximizes their expected utility.
A. I only
B. II only
C. III only
D. I and II
E. I and III
All rational investors select the portfolio that maximizes their expected utility; for investors who are relatively
more risk-averse, doing so means investing less in the optimal risky portfolio and more in the risk-free asset.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
22. Consider the following probability distribution for stocks A and B:
7-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The expected rates of return of stocks A and B are _____ and _____, respectively.
A. 13.2%; 9%
B. 14%; 10%
C. 13.2%; 7.7%
D. 7.7%; 13.2%
E(RA) = 0.1(10%) + 0.2(13%) + 0.2(12%) + 0.3(14%) + 0.2(15%) = 13.2%; E(RB) = 0.1(8%) + 0.2(7%) + 0.2(6%)
+ 0.3(9%) + 0.2(8%) = 7.7%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
23. Consider the following probability distribution for stocks A and B:
The standard deviations of stocks A and B are _____ and _____, respectively.
A. 1.5%; 1.9%
B. 2.5%; 1.1%
C. 3.2%; 2.0%
D. 1.5%; 1.1%
sA = [0.1(10% – 13.2%)2 + 0.2(13% – 13.2%)2 + 0.2(12% – 13.2%)2 + 0.3(14% – 13.2%)2 + 0.2(15% – 13.2%)2]1/2
= 1.5%; sB = [0.1(8% – 7.7%)2 + 0.2(7% – 7.7%)2 + 0.2(6% – 7.7%)2 + 0.3(9% – 7.7%)2 + 0.2(8% – 7.7%)2]1/2 =
1.1%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
24. Consider the following probability distribution for stocks A and B:
7-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The variances of stocks A and B are _____ and _____, respectively.
A. 1.5%; 1.9%
B. 2.2%; 1.2%
C. 3.2%; 2.0%
D. 1.5%; 1.1%
varA = [0.1(10% – 13.2%)2 + 0.2(13% – 13.2%)2 + 0.2(12% – 13.2%)2 + 0.3(14% – 13.2%)2 + 0.2(15% – 13.2%)2]
= 2.16%; varB = [0.1(8% – 7.7%)2 + 0.2(7% – 7.7%)2 + 0.2(6% – 7.7%)2 + 0.3(9% – 7.7%)2 + 0.2(8% – 7.7%)2] =
1.21%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
25. Consider the following probability distribution for stocks A and B:
The coefficient of correlation between A and B is
A. 0.46.
B. 0.60.
C. 0.58.
D. 1.20.
covA,B = 0.1(10% – 13.2%)(8% – 7.7%) + 0.2(13% – 13.2%)(7% – 7.7%) + 0.2(12% – 13.2%)(6% – 7.7%) +
0.3(14% – 13.2%)(9% – 7.7%) + 0.2(15% – 13.2%)(8% – 7.7%) = 0.76; rA,B = 0.76/[(1.1)(1.5)] = 0.46.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Diversification measures
26. Consider the following probability distribution for stocks A and B:
7-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.9%; 3%
B. 9.9%; 1.1%
C. 11%; 1.1%
D. 11%; 3%
E. None of the options are correct.
E(RP) = 0.4(13.2%) + 0.6(7.7%) = 9.9%; sP = [(0.4)2(1.5)2 + (0.6)2(1.1)2 + 2(0.4) (0.6)(1.5)(1.1)(0.46)]1/2 = 1.1%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
27. Consider the following probability distribution for stocks A and B:
Let G be the global minimum variance portfolio. The weights of A and B in G are __________ and __________,
respectively.
A. 0.40; 0.60
B. 0.66; 0.34
C. 0.34; 0.66
D. 0.77; 0.23
E. 0.23; 0.77
wA = [(1.1)2 – (1.5)(1.1)(0.46)]/[(1.5)2 + (1.1)2 – (2)(1.5)(1.1)(0.46) = 0.23; wB = 1 – 0.23 = 0.77.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
28. Consider the following probability distribution for stocks A and B:
7-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The expected rate of return and standard deviation of the global minimum variance portfolio, G, are
__________ and __________, respectively.
A. 10.07%; 1.05%
B. 8.97%; 2.03%
C. 10.07%; 3.01%
D. 8.97%; 1.05%
E(RG) = 0.23(13.2%) + 0.77(7.7%) = 8.965%; sG = [(0.23)2(1.5)2 + (0.77)2(1.1) +
(2)(0.23)(0.77)(1.5)(1.1)(0.46)]1/2 = 1.05%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
29. Consider the following probability distribution for stocks A and B:
Which of the following portfolio(s) is(are) on the efficient frontier?
A. The portfolio with 20 percent in A and 80 percent in B.
B. The portfolio with 15 percent in A and 85 percent in B.
C. The portfolio with 26 percent in A and 74 percent in B.
D. The portfolio with 10 percent in A and 90 percent in B.
E. A and B are both on the efficient frontier.
The Portfolio's E(Rp), sp, Reward/volatility ratios are 20A/80B: 8.8%, 1.05%, 8.38; 15A/85B: 8.53%, 1.06%,
8.07; 26A/74B: 9.13%, 1.05%, 8.70; 10A/90B: 8.25%, 1.07%, 7.73. The portfolio with 26% in A and 74% in B
dominates all of the other portfolios by the mean-variance criterion.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Efficient frontier
30. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10%
and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.
The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively.
7-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.57; 0.43
D. 0.43; 0.57
E. 0.76; 0.24
wA = 12/(16 + 12) = 0.4286; wB = 1 0.4286 = 0.5714.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Minimum-variance portfolio and frontier
31. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10%
and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.
The risk-free portfolio that can be formed with the two securities will earn a(n) _____ rate of return.
A. 8.5%
B. 9.0%
C. 8.9%
D. 9.9%
E(RP) = 0.43(10%) + 0.57(8%) = 8.86%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
32. Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and a risk free rate of
3%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.39
C. 0.08
D. 0.13
E. 0.36
Slope = (6 – 3)/23 = 0.1304
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
33. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital
allocation line must
A. lend some of her money at the risk-free rate.
B. borrow some money at the risk-free rate and invest in the optimal risky portfolio.
C. invest only in risky securities.
D. borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky
securities
E. Such a portfolio cannot be formed.
7-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The only way that an investor can create a portfolio that lies to the right of the capital allocation line is to create
a borrowing portfolio (buy stocks on margin). In this case, the investor will not hold any of the risk-free security,
but will hold only risky securities.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
34. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
A. Only portfolio W cannot lie on the efficient frontier.
B. Only portfolio X cannot lie on the efficient frontier.
C. Only portfolio Y cannot lie on the efficient frontier.
D. Only portfolio Z cannot lie on the efficient frontier.
E. Cannot be determined from the information given.
When plotting the above portfolios, only W lies below the efficient frontier as described by Markowitz. It has a
higher standard deviation than Z with a lower expected return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Efficient frontier
35. Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz?
A. Only portfolio A cannot lie on the efficient frontier.
B. Only portfolio B cannot lie on the efficient frontier.
C. Only portfolio C cannot lie on the efficient frontier.
D. Only portfolio D cannot lie on the efficient frontier.
E. Cannot be determined from the information given.
When plotting the above portfolios, only D lies below the efficient frontier as described by Markowitz. It has a
higher standard deviation than C with a lower expected return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
7-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Topic: Efficient frontier
36. Portfolio theory as described by Markowitz is most concerned with
A. the elimination of systematic risk.
B. the effect of diversification on portfolio risk.
C. the identification of unsystematic risk.
D. active portfolio management to enhance returns.
Markowitz was concerned with reducing portfolio risk by combining risky securities with differing return patterns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Efficient frontier
37. The measure of risk in a Markowitz efficient frontier is
A. specific risk.
B. standard deviation of returns.
C. reinvestment risk.
D. beta.
Markowitz was interested in eliminating diversifiable risk (and thus lessening total risk) and thus was interested
in decreasing the standard deviation of the returns of the portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Efficient frontier
38. A statistic that measures how the returns of two risky assets move together is:
A. variance.
B. standard deviation.
C. covariance.
D. correlation.
E. covariance and correlation.
Covariance measures whether security returns move together or in opposition; however, only the sign, not the
magnitude, of covariance may be interpreted. Correlation, which is covariance standardized by the product
of the standard deviations of the two securities, may assume values only between +1 and 1; thus, both the
sign and the magnitude may be interpreted regarding the movement of one security's return relative to that of
another security.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification measures
39. The unsystematic risk of a specific security
A. is likely to be higher in an increasing market.
B. results from factors unique to the firm.
C. depends on market volatility.
D. cannot be diversified away.
7-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Unsystematic (or diversifiable or firm-specific) risk refers to factors unique to the firm. Such risk may be
diversified away; however, market risk will remain.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Systematic and unsystematic risk
40. Which statement about portfolio diversification is correct?
A. Proper diversification can eliminate systematic risk.
B. The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities
have been purchased.
C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.
D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a
decreasing rate.
E. None of the statements are correct.
Diversification can eliminate only nonsystematic risk; relatively few securities are required to reduce this risk,
thus diminishing returns result quickly.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification
41. The individual investor's optimal portfolio is designated by
A. the point of tangency with the indifference curve and the capital allocation line.
B. the point of highest reward to variability ratio in the opportunity set.
C. the point of tangency with the opportunity set and the capital allocation line.
D. the point of the highest reward to variability ratio in the indifference curve.
E. None of the options are correct.
The indifference curve represents what is acceptable to the investor; the capital allocation line represents what
is available in the market. The point of tangency represents where the investor can obtain the greatest utility
from what is available.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Indifference curves
42. For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks?
A. +1.00
B. +0.50
C. 0.00
D. –1.00
E. None of the options are correct.
The correlation coefficient of –1.00 provides the greatest diversification benefits.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
7-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Difficulty: 2 Intermediate
Topic: Diversification measures
43. In a two-security minimum variance portfolio where the correlation between securities is greater than 1.0,
A. the security with the higher standard deviation will be weighted more heavily.
B. the security with the higher standard deviation will be weighted less heavily.
C. the two securities will be equally weighted.
D. the risk will be zero.
E. the return will be zero.
The security with the higher standard deviation will be weighted less heavily to produce minimum variance. The
return will not be zero; the risk will not be zero unless the correlation coefficient is 1.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
44. Which of the following is not a source of systematic risk?
A. The business cycle
B. Interest rates
C. Personnel changes
D. The inflation rate
E. Exchange rates
Personnel changes are a firm-specific event that is a component of nonsystematic risk. The others are all
sources of systematic risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Systematic and unsystematic risk
45. The global minimum variance portfolio formed from two risky securities will be riskless when the correlation
coefficient between the two securities is
A. 0.0.
B. 1.0.
C. 0.5.
D. –1.0.
E. any negative number.
The global minimum variance portfolio will have a standard deviation of zero whenever the two securities are
perfectly negatively correlated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Minimum-variance portfolio and frontier
46. Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of
15% and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their
7-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
covariance?
A. 0.038
B. 0.070
C. 0.018
D. 0.033
E. 0.054
Cov(r X, r Y) = (0.7)(0.18)(0.26) = 0.0327
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Diversification measures
47. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio,
A. the portfolio standard deviation will be greater than the weighted average of the individual security standard
deviations.
B. the portfolio standard deviation will be less than the weighted average of the individual security standard
deviations.
C. the portfolio standard deviation will be equal to the weighted average of the individual security standard
deviations.
D. the portfolio standard deviation will always be equal to the securities' covariance.
Whenever two securities are less than perfectly positively correlated, the standard deviation of the portfolio of
the two assets will be less than the weighted average of the two securities' standard deviations. There is some
benefit to diversification in this case.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification measures
48. The line representing all combinations of portfolio expected returns and standard deviations that can be
constructed from two available assets is called the
A. risk/reward tradeoff line.
B. capital allocation line.
C. efficient frontier.
D. portfolio opportunity set.
E. Security Market Line.
The portfolio opportunity set is the line describing all combinations of expected returns and standard deviations
that can be achieved by a portfolio of risky assets.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Opportunity sets
49. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of
5%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.27
7-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 0.08
D. 0.33
E. 0.36
Slope = (12 – 5)/26 = 0.2692
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
50. Given an optimal risky portfolio with expected return of 20%, standard deviation of 24%, and a risk free rate of
7%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.14
C. 0.62
D. 0.33
E. 0.54
Slope = (20 – 7)/24 = .5417
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation line
51. The risk that can be diversified away in a portfolio is referred to as ___________.
I) diversifiable risk
II) unique risk
III) systematic risk
IV) firm-specific risk
A. I, III, and IV
B. II, III, and IV
C. III and IV
D. I, II, and IV
E. I, II, III, and IV
All of these terms are used interchangeably to refer to the risk that can be removed from a portfolio through
diversification.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Systematic and unsystematic risk
52. As the number of securities in a portfolio is increased, what happens to the average portfolio standard
deviation?
A. It increases at an increasing rate.
B. It increases at a decreasing rate.
C. It decreases at an increasing rate.
D. It decreases at a decreasing rate.
E. It first decreases, then starts to increase as more securities are added.
7-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Statman's study showed that the risk of the portfolio would decrease as random stocks were added. At first the
risk decreases quickly, but then the rate of decrease slows substantially, as shown in Figure 7.2. The minimum
portfolio risk in the study was 19.2%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification
53. In words, the covariance considers the probability of each scenario happening and the interaction between
A. securities' returns relative to their variances.
B. securities' returns relative to their mean returns.
C. securities' returns relative to other securities' returns.
D. the level of return a security has in that scenario and the overall portfolio return.
E. the variance of the security's return in that scenario and the overall portfolio variance.
As written in equation 7.4, the covariance of the returns between two securities is the sum over all scenarios of
the product of three things. The first item is the probability that the scenario will happen. The second and third
terms represent the deviations of the securities' returns in that scenario from their own expected returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Diversification measures
54. The standard deviation of a two-asset portfolio is a linear function of the assets' weights when
A. the assets have a correlation coefficient less than zero.
B. the assets have a correlation coefficient equal to zero.
C. the assets have a correlation coefficient greater than zero.
D. the assets have a correlation coefficient equal to one.
E. the assets have a correlation coefficient less than one.
When there is a perfect positive correlation (or a perfect negative correlation), the equation for the portfolio
variance simplifies to a perfect square. The result is that the portfolio's standard deviation is linear relative to
the assets' weights in the portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification measures
55. A two-asset portfolio with a standard deviation of zero can be formed when
A. the assets have a correlation coefficient less than zero.
B. the assets have a correlation coefficient equal to zero.
C. the assets have a correlation coefficient greater than zero.
D. the assets have a correlation coefficient equal to one.
E. the assets have a correlation coefficient equal to negative one.
When there is a perfect negative correlation, the equation for the portfolio variance simplifies to a perfect
square. The result is that the portfolio's standard deviation equals |wA A wB B|, which can be set equal to
zero. The solution wA = B/( A + B) and wB = 1 wA will yield a zero-standard deviation portfolio.
7-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Diversification measures
56. When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the
investor choose to combine with the efficient frontier?
I) The one with the highest reward-to-variability ratio.
II) The one that will maximize his utility.
III) The one with the steepest slope.
IV) The one with the lowest slope.
A. I and III
B. I and IV
C. II and IV
D. I only
E. I, II, and III
The optimal CAL is the one that is tangent to the efficient frontier. This CAL offers the highest reward-tovariability
ratio, which is the slope of the CAL. It will also allow the investor to reach his highest feasible level of
utility.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Capital allocation line
57. Given an optimal risky portfolio with expected return of 13%, standard deviation of 26%, and a risk free rate of
5%, what is the slope of the best feasible CAL?
A. 0.60
B. 0.14
C. 0.08
D. 0.36
E. 0.31
Slope = (13 – 5)/26 = 0.31
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
58. The separation property refers to the conclusion that
A. the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is
subjective.
B. the choice of the best complete portfolio is objective, and the determination of the best risky portfolio is
objective.
C. the choice of inputs to be used to determine the efficient frontier is objective, and the choice of the best CAL
is subjective.
D. the determination of the best CAL is objective, and the choice of the inputs to be used to determine the
efficient frontier is subjective.
E. investors are separate beings and will, therefore, have different preferences regarding the risk-return
tradeoff.
7-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
The determination of the optimal risky portfolio is purely technical and can be done by a manager. The
complete portfolio, which consists of the optimal risky portfolio and the risk-free asset, must be chosen by each
investor based on preferences.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Optimal risky portfolio with a risk-free asset
59. Consider the following probability distribution for stocks A and B:
The expected rates of return of stocks A and B are _____ and _____, respectively.
A. 13.2%; 9%
B. 13%; 8.4%
C. 13.2%; 7.7%
D. 7.7%; 13.2%
E(RA) = 0.15(8%) + 0.2(13%) + 0.15(12%) + 0.3(14%) + 0.2(16%) = 13%; E(RB) = 0.15(8%) + 0.2(7%) + 0.15(6%)
+ 0.3(9%) + 0.2(11%) = 8.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
60. Consider the following probability distribution for stocks A and B:
The standard deviations of stocks A and B are _____ and _____, respectively.
A. 1.56%; 1.99%
B. 2.45%; 1.66%
C. 3.22%; 2.01%
D. 1.54%; 1.11%
sA = [0.15(8% – 13%)2 + 0.2(13% – 13%)2 + 0.15(12% – 13%)2 + 0.3(14% – 13%)2 + 0.2(16% – 13%)2]1/2 =
2.449%; sB = [0.15(8% – 8.4%)2 + 0.2(7% – 8.4%)2 + 0.15(6% – 8.4%)2 + 0.3(9% – 8.4%)2 + 0.2(11% – 8.4%)2]1/2
= 1.655%.
7-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
61. Consider the following probability distribution for stocks A and B:
The coefficient of correlation between A and B is
A. 0.474.
B. 0.612.
C. 0.590.
D. 1.206.
covA, B = 0.15(8% – 13%)(8% – 8.4%) + 0.2(13% – 13%)(7% – 8.4%) + 0.15(12% – 13%) (6% – 8.4%) + 0.3(14%
– 13%)(9% – 8.4%) + 0.2(16% – 13%)(11% – 8.4%) = 2.40; A, B = 2.40/[(2.45)(1.66)] = 0.590.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Diversification measures
62. Consider the following probability distribution for stocks A and B:
If you invest 35% of your money in A and 65% in B, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.9%; 3%
B. 9.9%; 1.1%
C. 10%; 1.7%
D. 10%; 3%
E(RP) = 0.35(13%) + 0.65(8.4%) = 10.01%; sP = [(0.35)2(2.45%)2 + (0.65)2(1.66)2
+2(0.35)(0.65)(2.45)(1.66)(0.590)]1/2 = 1.7%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
7-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Topic: Standard deviation and variance
63. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12%
and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%.
The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.57; 0.43
D. 0.45; 0.55
E. 0.76; 0.24
wA = 14/(17 + 14) = 0.45; wB = 1 0.45 = 0.55.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Minimum-variance portfolio and frontier
64. Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12%
and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%.
The risk-free portfolio that can be formed with the two securities will earn _____ rate of return.
A. 9.5%
B. 10.4%
C. 10.9%
D. 9.9%
E(RP) = 0.45(12%) + 0.55(9%) = 10.35%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
65. Security X has expected return of 14% and standard deviation of 22%. Security Y has expected return of
16% and standard deviation of 28%. If the two securities have a correlation coefficient of 0.8, what is their
covariance?
A. 0.038
B. 0.049
C. 0.018
D. 0.013
E. 0.054
Cov(r X, r Y) = (0.8)(0.22)(0.28) = 0.04928.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Diversification measures
7-38
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
66. Given an optimal risky portfolio with expected return of 16%, standard deviation of 20%, and a risk-free rate of
4%, what is the slope of the best feasible CAL?
A. 0.60
B. 0.14
C. 0.08
D. 0.36
E. 0.31
Slope = (16 – 4)/20 = .6.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
67. Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of
3%, what is the slope of the best feasible CAL?
A. 0.64
B. 0.14
C. 0.08
D. 0.35
E. 0.36
Slope = (12 – 3)/26 = 0.346.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital allocation line
68. Consider the following probability distribution for stocks C and D:
The expected rates of return of stocks C and D are _____ and _____, respectively.
A. 4.4%; 9.5%
B. 9.5%; 4.4%
C. 6.3%; 8.7%
D. 8.7%; 6.2%
E. None of the options are correct.
E(RC) = 0.30(7%) + 0.5(11%) + 0.20(–16%) = 4.4%; E(RD) = 0.30(–9%) + 0.5(14%) + 0.20(26%) = 9.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
7-39
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
69. Consider the following probability distribution for stocks C and D:
The standard deviations of stocks C and D are _____ and _____, respectively.
A. 7.62%; 11.24%
B. 11.24%; 7.62%
C. 10.35%; 12.93%
D. 12.93%; 10.35%
sC = [0.30(7% – 4.4%)2 + 0.5(11% – 4.4%)2 + 0.20(–16% – 4.4%)2]1/2 = 10.35%; sD = [0.30(–9% – 9.5%)2 +
0.50(14% – 9.5%)2 + 0.20(26% – 9.5%)2]1/2 = 12.93%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Standard deviation and variance
70. Consider the following probability distribution for stocks C and D:
The coefficient of correlation between C and D is
A. 0.67.
B. 0.50.
C. –0.50.
D. –0.67.
E. None of the options are correct.
CovC, D = 0.30(7% – 4.4%)(–9% – 9.5%) + 0.50(11% – 4.4%)(14% – 9.5%) + 0.20(–16% – 4.4%)(26% – 9.5%) = –
66.9; A, B = –66.90/[(10.35)(12.93)] = –0.50.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Diversification measures
71. Consider the following probability distribution for stocks C and D:
7-40
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
If you invest 25% of your money in C and 75% in D, what would be your portfolio's expected rate of return and
standard deviation?
A. 9.891%; 8.70%
B. 9.945%; 11.12%
C. 8.225%; 8.70%
D. 10.275%; 11.12%
E(RP) = 0.25(4.4%) + 0.75(9.5%) = 8.225%; sP = [(0.25)2(10.35)2 + (0.75)2(12.93)2 + 2(0.25)(0.75)(10.35)(12.93)(0.50)]1/2 = 8.70%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Standard deviation and variance
72. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13%
and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%.
The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.46; 0.54
D. 0.45; 0.55
E. 0.76; 0.24
wK = 16/(19 + 16) = 0.46; wB = 1 0.46 = 0.54.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Minimum-variance portfolio and frontier
73. Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13%
and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%.
The risk-free portfolio that can be formed with the two securities will earn _____ rate of return.
A. 9.5%
B. 11.4%
C. 10.9%
D. 9.9%
E. None of the options are correct.
E(RP) = 0.46(13%) + 0.54(10%) = 11.38%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
7-41
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Difficulty: 3 Challenge
Topic: Minimum-variance portfolio and frontier
74. Security M has expected return of 17% and standard deviation of 32%. Security S has expected return of
13% and standard deviation of 19%. If the two securities have a correlation coefficient of 0.78, what is their
covariance?
A. 0.038
B. 0.049
C. 0.047
D. 0.045
E. 0.054
Cov(r X, r Y) = (0.78)(0.32)(0.19) = 0.0474.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Diversification measures
75. Security X has expected return of 7% and standard deviation of 14%. Security Y has expected return of
11% and standard deviation of 22%. If the two securities have a correlation coefficient of 0.45, what is their
covariance?
A. 0.0388
B. –0.0108
C. 0.0184
D. –0.0139
E. –0.1512
Cov(r X, r Y) = (–0.45)(0.14)(0.22) = –.01386.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Diversification measures
76. Security X has expected return of 9% and standard deviation of 18%. Security Y has expected return of
12% and standard deviation of 21%. If the two securities have a correlation coefficient of 0.4, what is their
covariance?
A. 0.0388
B. 0.0706
C. 0.0184
D. –0.0133
E. –0.0151
Cov(r X, r Y) = (–0.4)(0.18)(0.21) = 0.0151.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Diversification measures
7-42
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 07 Test Bank Static - Summary
Category
AACSB: Knowledge Application
# of Questions
34
AACSB: Reflective Thinking
42
Accessibility: Keyboard Navigation
76
Blooms: Apply
34
Blooms: Remember
15
Blooms: Understand
27
Difficulty: 1 Basic
15
Difficulty: 2 Intermediate
44
Difficulty: 3 Challenge
17
Topic: Capital allocation line
11
Topic: Diversification
3
Topic: Diversification measures
14
Topic: Efficient frontier
7
Topic: Expected return
4
Topic: Indifference curves
1
Topic: Minimum-variance portfolio and frontier
11
Topic: Opportunity sets
1
Topic: Optimal risky portfolio with a risk-free asset
1
Topic: Standard deviation and variance
11
Topic: Systematic and unsystematic risk
12
7-43
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
7-44
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 08 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. As diversification increases, the total variance of a portfolio approaches
A. 0.
B. 1.
C. the variance of the market portfolio.
D. infinity.
E. None of the options are correct.
2. As diversification increases, the standard deviation of a portfolio approaches
A. 0.
B. 1.
C. infinity.
D. the standard deviation of the market portfolio.
E. None of the options are correct.
3. As diversification increases, the firm-specific risk of a portfolio approaches
A. 0.
B. 1.
C. infinity.
D. (n – 1) × n.
4. As diversification increases, the unsystematic risk of a portfolio approaches
A. 1.
B. 0.
C. infinity.
D. (n – 1) × n.
5. As diversification increases, the unique risk of a portfolio approaches
A. 1.
B. 0.
C. infinity.
D. (n – 1) × n.
6. The index model was first suggested by
A. Graham.
B. Markowitz.
C. Miller.
D. Sharpe.
7. A single-index model uses __________ as a proxy for the systematic risk factor.
A. a market index, such as the S&P 500
B. the current account deficit
C. the growth rate in GNP
D. the unemployment rate.
8. Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters.
A. 12
B. 36
C. 60
D. 120
9. The index model has been estimated for stocks A and B with the following results:
RA = 0.03 + 0.7RM + eA.
RB = 0.01 + 0.9RM + eB.
σM = 0.35; σ(eA) = 0.20; σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0772.
E. 0.4000.
10. According to the index model, covariances among security pairs are
A. due to the influence of a single common factor represented by the market index return.
B. extremely difficult to calculate.
C. related to industry-specific events.
D. usually positive.
E. due to the influence of a single common factor represented by the market index return and usually positive.
11. The intercept in the regression equations calculated by beta books is equal to
A. α in the CAPM.
B. α + rf(1 + β).
C. α + rf(1 – β).
D. 1 – α.
12. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the slope of the regression line is an
estimate of
A. the α of the asset.
B. the β of the asset.
C. the σ of the asset.
D. the δ of the asset.
13. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the intercept of the regression line is
an estimate of
A. the α of the asset.
B. the β of the asset.
C. the σ of the asset.
D. the δ of the asset.
14. In a factor model, the return on a stock in a particular period will be related to
A. firm-specific events.
B. macroeconomic events.
C. the error term.
D. both firm-specific events and macroeconomic events.
E. neither firm-specific events nor macroeconomic events.
15. Rosenberg and Guy found that __________ helped to predict a firm's beta.
A. the firm's financial characteristics
B. the firm's industry group
C. firm size
D. the firm's financial characteristics and the firm's industry group
E. All of the options are correct.
16. If the index model is valid, _________ would be helpful in determining the covariance between assets GM and GE.
A. βGM
B. βGE
C. σM
D. all of the options
E. None of the options are correct.
17. If the index model is valid, _________ would be helpful in determining the covariance between assets HPQ and KMP.
A. βHPQ
B. βKMP
C. σM
D. all of the options
E. None of the options are correct.
18. If the index model is valid, _________ would be helpful in determining the covariance between assets K and L.
A. βk
B. βL
C. σM
D. all of the options
E. None of the options are correct.
19. Rosenberg and Guy found that ___________ helped to predict firms' betas.
A. debt/asset ratios
B. market capitalization
C. variance of earnings
D. all of the options
E. None of the options are correct.
20. If a firm's beta was calculated as 0.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.6 but greater than zero.
B. between 0.6 and 1.0.
C. between 1.0 and 1.6.
D. greater than 1.6.
E. zero or less.
21. If a firm's beta was calculated as 0.8 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.8 but greater than zero.
B. between 1.0 and 1.8.
C. between 0.8 and 1.0.
D. greater than 1.8.
E. zero or less.
22. If a firm's beta was calculated as 1.3 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 1.0 but greater than zero.
B. between 0.3 and 0.9.
C. between 1.0 and 1.3.
D. greater than 1.3.
E. zero or less.
23. The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.32.
C. 1.13.
D. 1.40.
24. The beta of Apple stock has been estimated as 2.3 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 2.20.
B. 1.87.
C. 2.13.
D. 1.66.
25. The beta of JCP stock has been estimated as 1.2 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.32.
C. 1.13.
D. 1.0.
26. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to
construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 150; 150
B. 150; 22500
C. 22500; 150
D. 22500; 22500
27. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to
construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 100; 100
B. 100; 4950
C. 4950; 100
D. 4950; 4950
28. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to
construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate ____________ covariances.
A. 12
B. 150
C. 22,500
D. 11,175
29. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to
construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ____________ covariances.
A. 125
B. 7,750
C. 15,625
D. 11,750
30. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to
construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate ____________ covariances.
A. 45
B. 100
C. 4,950
D. 10,000
31. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 175 stocks in order to construct
a mean-variance efficient portfolio constrained by 175 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 175; 15,225
B. 175; 175
C. 15,225; 175
D. 15,225; 15,225
32. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 125 stocks in order to construct
a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 125; 15,225
B. 15,625; 125
C. 7,750; 125
D. 125; 125
33. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 200 stocks in order to construct
a mean-variance efficient portfolio constrained by 200 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 200; 19,900
B. 200; 200
C. 19,900; 200
D. 19,900; 19.900
34. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 500 stocks in order to construct
a mean-variance efficient portfolio constrained by 500 investments. They will need to calculate ________ estimates of firm-specific
variances and ________ estimate/estimates for the variance of the macroeconomic factor.
A. 500; 1
B. 500; 500
C. 124,750; 1
D. 124,750; 500
E. 250,000; 500
35. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 16%. The risk-free rate of return is
5%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 0.67.
B. 0.75.
C. 1.0.
D. 1.33.
E. 1.50.
36. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.20 and σM was 0.16, the β of the portfolio would be approximately
A. 0.64.
B. 0.80.
C. 1.25.
D. 1.56.
37. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.22 and σM was 0.19, the β of the portfolio would be approximately
A. 1.34.
B. 1.16.
C. 1.25.
D. 1.56.
38. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.18 and σM was 0.24, the β of the portfolio would be approximately
A. 0.75.
B. 0.56.
C. 0.07.
D. 1.03.
39. Suppose the following equation best describes the evolution of β over time:
βt = 0.25 + 0.75βt – 1.
If a stock had a β of 0.6 last year, you would forecast the β to be _______ in the coming year.
A. 0.45
B. 0.60
C. 0.70
D. 0.75
40. Suppose the following equation best describes the evolution of β over time:
βt = 0.31 + 0.82βt – 1.
If a stock had a β of 0.88 last year, you would forecast the β to be _______ in the coming year.
A. 0.88
B. 0.82
C. 0.31
D. 1.03
41. Suppose the following equation best describes the evolution of β over time:
t = 0.18 + 0.63βt – 1.
If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming year.
A. 0.87
B. 0.18
C. 0.63
D. 0.81
42. An analyst estimates the index model for a stock using regression analysis involving total returns. The estimated intercept in the
regression equation is 6% and the β is 0.5. The risk-free rate of return is 12%. The true β of the stock is
A. 0%.
B. 3%.
C. 6%.
D. 9%.
43. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.9RM + eA.
If σM = 0.25 and R2A = 0.25, the standard deviation of return of stock A is
A. 0.2025.
B. 0.2500.
C. 0.4500.
D. 0.8100.
44. The index model for stock B has been estimated with the following result:
RB = 0.01 + 1.1RM + eB.
If σM = 0.20 and R2B = 0.50, the standard deviation of the return on stock B is
A. 0.1111.
B. 0.2111.
C. 0.3111.
D. 0.4111.
45. Suppose you forecast that the market index will earn a return of 15% in the coming year. Treasury bills are yielding 6%. The
unadjusted β of Mobil stock is 1.30. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a
common method to derive adjusted betas.
A. 15.0%
B. 15.5%
C. 16.0%
D. 16.8%
46. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.5RM + eA.
RB = 0.02 + 1.3RM + eB.
σM = 0.25; σ(eA) = 0.20; σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0050.
E. 0.4000.
47. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.8RM + eA.
RB = 0.02 + 1.2RM + eB.
σM = 0.20; σ(eA) = 0.20; σ(eB) = 0.10.
The standard deviation for stock A is
A. 0.0656.
B. 0.0676.
C. 0.2561.
D. 0.2600.
48. The index model has been estimated for stock A with the following results:
RA = 0.01 + 0.8RM + eA.
σM = 0.20; σ(eA) = 0.10.
The standard deviation of the return for stock A is
A. 0.0356.
B. 0.1887.
C. 0.1600.
D. 0.6400.
49. Security returns
A. are based on both macro events and firm-specific events.
B. are based on firm-specific events only.
C. are usually positively correlated with each other.
D. are based on firm-specific events only and are usually positively correlated with each other.
E. are based on both macro events and firm-specific events and are usually positively correlated with each other.
50. The single-index model
A. greatly reduces the number of required calculations relative to those required by the Markowitz model.
B. enhances the understanding of systematic versus nonsystematic risk.
C. greatly increases the number of required calculations relative to those required by the Markowitz model.
D. greatly reduces the number of required calculations relative to those required by the Markowitz model and enhances the
understanding of systematic versus nonsystematic risk.
E. enhances the understanding of systematic versus nonsystematic risk and greatly increases the number of required calculations
relative to those required by the Markowitz model.
51. The security characteristic line (SCL)
A. plots the excess return on a security as a function of the excess return on the market.
B. allows one to estimate the beta of the security.
C. allows one to estimate the alpha of the security.
D. All of the options.
E. None of the options are correct.
52. The expected impact of unanticipated macroeconomic events on a security's return during the period is
A. included in the security's expected return.
B. zero.
C. equal to the risk-free rate.
D. proportional to the firm's beta.
E. infinite.
53. Covariances between security returns tend to be
A. positive because of SEC regulations.
B. positive because of Exchange regulations.
C. positive because of economic forces that affect many firms.
D. negative because of SEC regulations.
E. negative because of economic forces that affect many firms.
54. In the single-index model represented by the equation ri = E(ri) + βiF + ei, the term ei represents
A. the impact of unanticipated macroeconomic events on security i's return.
B. the impact of unanticipated firm-specific events on security i's return.
C. the impact of anticipated macroeconomic events on security i's return.
D. the impact of anticipated firm-specific events on security i's return.
E. the impact of changes in the market on security i's return.
55. Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE. Using a single-index model rather than the
Markowitz model
A. increases the number of inputs needed from about 1,400 to more than 1.4 million.
B. increases the number of inputs needed from about 10,000 to more than 125,000.
C. reduces the number of inputs needed from more than 125,000 to about 10,000.
D. reduces the number of inputs needed from more than 5 million to about 10,000.
E. increases the number of inputs needed from about 150 to more than 1,500.
56. One "cost" of the single-index model is that it
A. is virtually impossible to apply.
B. prohibits specialization of efforts within the security analysis industry.
C. requires forecasts of the money supply.
D. is legally prohibited by the SEC.
E. allows for only two kinds of risk—macro risk and micro risk.
57. The security characteristic line (SCL) associated with the single-index model is a plot of
A. the security's returns on the vertical axis and the market index's returns on the horizontal axis.
B. the market index's returns on the vertical axis and the security's returns on the horizontal axis.
C. the security's excess returns on the vertical axis and the market index's excess returns on the horizontal axis.
D. the market index's excess returns on the vertical axis and the security's excess returns on the horizontal axis.
E. the security's returns on the vertical axis and Beta on the horizontal axis.
58. The idea that there is a limit to the reduction of portfolio risk due to diversification is
A. contradicted by both the CAPM and the single-index model.
B. contradicted by the CAPM.
C. contradicted by the single-index model.
D. supported in theory, but not supported empirically.
E. supported both in theory and by empirical evidence.
59. In their study about predicting beta coefficients, which of the following did Rosenberg and Guy find to be factors that influence
beta?
I) Industry group
II) Variance of cash flow
III) Dividend yield
IV) Growth in earnings per share
A. I and II
B. I and III
C. I, II, and III
D. I, II, and IV
E. I, II, III, and IV
60. If a firm's beta was calculated as 1.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.6 but greater than zero.
B. between 0.6 and 1.0.
C. between 1.0 and 1.6.
D. greater than 1.6.
E. zero or less.
61. The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.53.
C. 1.13.
D. 1.0.
62. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to
construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 100; 100
B. 40; 40
C. 4950; 100
D. 4950; 4950
E. None of the options are correct.
63. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to
construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate ____________ covariances.
A. 45
B. 780
C. 4,950
D. 10,000
64. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 60 stocks in order to construct a
mean-variance efficient portfolio constrained by 60 investments. They will need to calculate ________ estimates of expected returns
and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 200; 19,900
B. 200; 200
C. 60; 60
D. 19,900; 19.900
E. None of the options are correct.
65. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is
3%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 1.57.
B. 0.75.
C. 1.17.
D. 1.33.
E. 1.50.
66. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.25 and σM was 0.21, the β of the portfolio would be approximately ________.
A. 0.64
B. 1.19
C. 1.25
D. 1.56
67. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.18 and σM was 0.22, the β of the portfolio would be approximately
A. 0.64.
B. 1.19.
C. 0.82.
D. 1.56.
68. Suppose the following equation best describes the evolution of β over time:
βt = 0.4 + 0.6βt – 1.
If a stock had a β of 0.9 last year, you would forecast the β to be _______ in the coming year.
A. 0.45
B. 0.60
C. 0.70
D. 0.94
69. Suppose the following equation best describes the evolution of β over time:
βt = 0.3 + 0.2βt – 1
If a stock had a β of 0.8 last year, you would forecast the β to be _______ in the coming year.
A. 0.46
B. 0.60
C. 0.70
D. 0.94
70. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.94RM + eA
If σM = 0.30 and R2A = 0.28, the standard deviation of return of stock A is
A. 0.2025.
B. 0.2500.
C. 0.4500.
D. 0.5329.
71. Suppose you forecast that the market index will earn a return of 12% in the coming year. Treasury bills are yielding 4%. The
unadjusted β of Mobil stock is 1.50. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a
common method to derive adjusted betas.
A. 15.0%
B. 15.5%
C. 16.0%
D. 14.7%
72. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.8RM + eA.
RB = 0.02 + 1.1RM + eB.
σM = 0.30 σ(eA) = 0.20 σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0050.
E. 0.0792.
73. If a firm's beta was calculated as 1.35 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. equal to 1.35.
B. between 0.0 and 1.0.
C. between 1.0 and 1.35.
D. greater than 1.35.
E. zero or less.
74. The beta of a stock has been estimated as 1.4 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.27.
B. 1.32.
C. 1.13.
D. 1.0.
75. The beta of a stock has been estimated as 0.85 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.01.
B. 0.95.
C. 1.13.
D. 0.90.
76. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to
construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 125; 125
B. 125; 15,625
C. 15,625; 125
D. 15,625; 15,625
E. None of the options are correct.
77. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 132 stocks in order to
construct a mean-variance efficient portfolio constrained by 132 investments. They will need to calculate ____________ covariances.
A. 100
B. 132
C. 4,950
D. 8,646
78. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 217 stocks in order to construct
a mean-variance efficient portfolio constrained by 217 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 217; 47,089
B. 217; 217
C. 47,089; 217
D. 47,089; 47,089
E. None of the options are correct.
79. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 750 stocks in order to construct
a mean-variance efficient portfolio constrained by 750 investments. They will need to calculate ________ estimates of firm-specific
variances and ________ estimate/estimate(s) for the variance of the macroeconomic factor.
A. 750; 1
B. 750; 750
C. 124,750; 1
D. 124,750; 750
E. 562,500; 750
80. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is
5%. The stock earns a return that exceeds the risk-free rate by 5%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 0.67.
B. 0.75.
C. 1.0.
D. 1.33.
E. 1.50.
81. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.24 and σM was 0.18, the β of the portfolio would be approximately
A. 0.64.
B. 1.33.
C. 1.25.
D. 1.56.
82. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.14 and σM was 0.19, the β of the portfolio would be approximately
A. 0.74.
B. 0.80.
C. 1.25.
D. 1.56.
83. Suppose the following equation best describes the evolution of β over time:
βt = 0.30 + 0.70βt – 1
If a stock had a β of 0.82 last year, you would forecast the β to be _______ in the coming year.
A. 0.91
B. 0.77
C. 0.63
D. 0.87
Chapter 08 Test Bank - Static Key
Multiple Choice Questions
1. As diversification increases, the total variance of a portfolio approaches
A. 0.
B. 1.
C. the variance of the market portfolio.
D. infinity.
E. None of the options are correct.
As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as
measured by the variance of the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
2. As diversification increases, the standard deviation of a portfolio approaches
A. 0.
B. 1.
C. infinity.
D. the standard deviation of the market portfolio.
E. None of the options are correct.
As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as
measured by the variance (or standard deviation) of the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
3. As diversification increases, the firm-specific risk of a portfolio approaches
A. 0.
B. 1.
C. infinity.
D. (n – 1) × n.
As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as
measured by the variance (or standard deviation) of the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
4. As diversification increases, the unsystematic risk of a portfolio approaches
A. 1.
B. 0.
C. infinity.
D. (n – 1) × n.
As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as
measured by the variance (or standard deviation) of the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
5. As diversification increases, the unique risk of a portfolio approaches
A. 1.
B. 0.
C. infinity.
D. (n – 1) × n.
As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as
measured by the variance (or standard deviation) of the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Diversification
6. The index model was first suggested by
A. Graham.
B. Markowitz.
C. Miller.
D. Sharpe.
William Sharpe, building on the work of Harry Markowitz, developed the index model.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-index model
7. A single-index model uses __________ as a proxy for the systematic risk factor.
A. a market index, such as the S&P 500
B. the current account deficit
C. the growth rate in GNP
D. the unemployment rate.
The single-index model uses a market index, such as the S&P 500, as a proxy for the market and thus for systematic risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-index model
8. Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters.
A. 12
B. 36
C. 60
D. 120
Most published betas and other regression parameters are based on five years of monthly return data.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-index model
9. The index model has been estimated for stocks A and B with the following results:
RA = 0.03 + 0.7RM + eA.
RB = 0.01 + 0.9RM + eB.
σM = 0.35; σ(eA) = 0.20; σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0772.
E. 0.4000.
Cov(RA, RB) = bAbBs2M = 0.7(0.9)(0.35)2 = 0.0772.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-factor security market
10. According to the index model, covariances among security pairs are
A. due to the influence of a single common factor represented by the market index return.
B. extremely difficult to calculate.
C. related to industry-specific events.
D. usually positive.
E. due to the influence of a single common factor represented by the market index return and usually positive.
Most securities move together most of the time and move with a market index, or market proxy.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-index model
11. The intercept in the regression equations calculated by beta books is equal to
A. α in the CAPM.
B. α + rf(1 + β).
C. α + rf(1 – β).
D. 1 – α.
The intercept that beta books call alpha is really, using the parameters of the CAPM, an estimate of a + rf (1 – b). The apparent
justification for this procedure is that, on a monthly basis, rf(1 – b) is small and is apt to be swamped by the volatility of actual stock
returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model
12. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the slope of the regression line is an
estimate of
A. the α of the asset.
B. the β of the asset.
C. the σ of the asset.
D. the δ of the asset.
The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the market, and the α estimates the
intercept.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model
13. Analysts may use regression analysis to estimate the index model for a stock. When doing so, the intercept of the regression line is
an estimate of
A. the α of the asset.
B. the β of the asset.
C. the σ of the asset.
D. the δ of the asset.
The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the market, and the α estimates the
intercept.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model
14. In a factor model, the return on a stock in a particular period will be related to
A. firm-specific events.
B. macroeconomic events.
C. the error term.
D. both firm-specific events and macroeconomic events.
E. neither firm-specific events nor macroeconomic events.
The return on a stock is related to both firm-specific and macroeconomic events.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-factor security market
15. Rosenberg and Guy found that __________ helped to predict a firm's beta.
A. the firm's financial characteristics
B. the firm's industry group
C. firm size
D. the firm's financial characteristics and the firm's industry group
E. All of the options are correct.
Rosenberg and Guy found that after controlling for the firm's financial characteristics, the firm's industry group was a significant
predictor of the firm's beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Index model portfolio management
16. If the index model is valid, _________ would be helpful in determining the covariance between assets GM and GE.
A. βGM
B. βGE
C. σM
D. all of the options
E. None of the options are correct.
If the index model is valid βGM, βGE, and σM are determinants of the covariance between GE and GM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
17. If the index model is valid, _________ would be helpful in determining the covariance between assets HPQ and KMP.
A. βHPQ
B. βKMP
C. σM
D. all of the options
E. None of the options are correct.
If the index model is valid βHPQ, βKMP, and σM are determinants of the covariance between HPQ and KMP.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
18. If the index model is valid, _________ would be helpful in determining the covariance between assets K and L.
A. βk
B. βL
C. σM
D. all of the options
E. None of the options are correct.
I
f the index model is valid βk, βL, and σM are determinants of the covariance between K and L.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
19. Rosenberg and Guy found that ___________ helped to predict firms' betas.
A. debt/asset ratios
B. market capitalization
C. variance of earnings
D. all of the options
E. None of the options are correct.
Rosenberg and Guy found that debt/asset ratios, market capitalization, and variance of earnings were determinants of firms' betas.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model estimation
20. If a firm's beta was calculated as 0.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.6 but greater than zero.
B. between 0.6 and 1.0.
C. between 1.0 and 1.6.
D. greater than 1.6.
E. zero or less.
Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are less than 1, adjusted
betas are between 1 and the calculated beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
21. If a firm's beta was calculated as 0.8 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.8 but greater than zero.
B. between 1.0 and 1.8.
C. between 0.8 and 1.0.
D. greater than 1.8.
E. zero or less.
Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are less than 1, adjusted
betas are between 1 and the calculated beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
22. If a firm's beta was calculated as 1.3 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 1.0 but greater than zero.
B. between 0.3 and 0.9.
C. between 1.0 and 1.3.
D. greater than 1.3.
E. zero or less.
Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are greater than 1,
adjusted betas are between 1 and the calculated beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
23. The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.32.
C. 1.13.
D. 1.40.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.6) + 1/3 = 1.40.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
24. The beta of Apple stock has been estimated as 2.3 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 2.20.
B. 1.87.
C. 2.13.
D. 1.66.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(2.3) + 1/3 = 1.867.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
25. The beta of JCP stock has been estimated as 1.2 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.32.
C. 1.13.
D. 1.0.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.2) + 1/3 = 1.13.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
26. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to
construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 150; 150
B. 150; 22500
C. 22500; 150
D. 22500; 22500
The expected returns of each of the 150 securities must be calculated. In addition, the 150 variances around these returns must be
calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
27. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to
construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 100; 100
B. 100; 4950
C. 4950; 100
D. 4950; 4950
The expected returns of each of the 100 securities must be calculated. In addition, the 100 variances around these returns must be
calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
28. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 150 stocks in order to
construct a mean-variance efficient portfolio constrained by 150 investments. They will need to calculate ____________ covariances.
A. 12
B. 150
C. 22,500
D. 11,175
(n2 – n)/2 = (22,500 – 150)/2 = 11,175 covariances must be calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
29. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to
construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ____________ covariances.
A. 125
B. 7,750
C. 15,625
D. 11,750
(n2 – n)/2 = (15,625 – 125)/2 = 7,750 covariances must be calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
30. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to
construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate ____________ covariances.
A. 45
B. 100
C. 4,950
D. 10,000
(n2 – n)/2 = (10,000 – 100)/2 = 4,950 covariances must be calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
31. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 175 stocks in order to construct
a mean-variance efficient portfolio constrained by 175 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 175; 15,225
B. 175; 175
C. 15,225; 175
D. 15,225; 15,225
For a single-index model, n(175), expected returns and n(175) sensitivity coefficients to the macroeconomic factor must be estimated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
32. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 125 stocks in order to construct
a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 125; 15,225
B. 15,625; 125
C. 7,750; 125
D. 125; 125
For a single-index model, n(125), expected returns and n(125) sensitivity coefficients to the macroeconomic factor must be estimated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
33. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 200 stocks in order to construct
a mean-variance efficient portfolio constrained by 200 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 200; 19,900
B. 200; 200
C. 19,900; 200
D. 19,900; 19.900
For a single-index model, n(200), expected returns and n(200) sensitivity coefficients to the macroeconomic factor must be estimated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
34. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 500 stocks in order to construct
a mean-variance efficient portfolio constrained by 500 investments. They will need to calculate ________ estimates of firm-specific
variances and ________ estimate/estimates for the variance of the macroeconomic factor.
A. 500; 1
B. 500; 500
C. 124,750; 1
D. 124,750; 500
E. 250,000; 500
For the single-index model, n(500) estimates of firm-specific variances must be calculated and 1 estimate for the variance of the
common macroeconomic factor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
35. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 16%. The risk-free rate of return is
5%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 0.67.
B. 0.75.
C. 1.0.
D. 1.33.
E. 1.50.
11% = 0% + b(11%); b = 1.0.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model
36. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.20 and σM was 0.16, the β of the portfolio would be approximately
A. 0.64.
B. 0.80.
C. 1.25.
D. 1.56.
s2p/s2m = b2; (0.2)2/(0.16)2 = 1.56; b = 1.25.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model
37. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.22 and σM was 0.19, the β of the portfolio would be approximately
A. 1.34.
B. 1.16.
C. 1.25.
D. 1.56.
s2p/s2m = b2; (0.22)2/(0.19)2 = 1.34; b = 1.16.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model
38. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.18 and σM was 0.24, the β of the portfolio would be approximately
A. 0.75.
B. 0.56.
C. 0.07.
D. 1.03.
s2p/s2m = b2; (0.18)2/(0.24)2 = 0.5625; b = 0.75.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model
39. Suppose the following equation best describes the evolution of β over time:
βt = 0.25 + 0.75βt – 1.
If a stock had a β of 0.6 last year, you would forecast the β to be _______ in the coming year.
A. 0.45
B. 0.60
C. 0.70
D. 0.75
0.25 + 0.75(0.6) = 0.70.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
40. Suppose the following equation best describes the evolution of β over time:
βt = 0.31 + 0.82βt – 1.
If a stock had a β of 0.88 last year, you would forecast the β to be _______ in the coming year.
A. 0.88
B. 0.82
C. 0.31
D. 1.03
0.31 + 0.82(0.88) = 1.0316.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
41. Suppose the following equation best describes the evolution of β over time:
t = 0.18 + 0.63βt – 1.
If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming year.
A. 0.87
B. 0.18
C. 0.63
D. 0.81
0.18 + 0.63(1.09) = 0.8667.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
42. An analyst estimates the index model for a stock using regression analysis involving total returns. The estimated intercept in the
regression equation is 6% and the β is 0.5. The risk-free rate of return is 12%. The true β of the stock is
A. 0%.
B. 3%.
C. 6%.
D. 9%.
6% = a + 12% (1 – 0.5); a = 0%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
43. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.9RM + eA.
If σM = 0.25 and R2A = 0.25, the standard deviation of return of stock A is
A. 0.2025.
B. 0.2500.
C. 0.4500.
D. 0.8100.
R2 = b2s2M/s2; 0.25 = [(0.81)(0.25)2]/s2; s = 0.4500.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
44. The index model for stock B has been estimated with the following result:
RB = 0.01 + 1.1RM + eB.
If σM = 0.20 and R2B = 0.50, the standard deviation of the return on stock B is
A. 0.1111.
B. 0.2111.
C. 0.3111.
D. 0.4111.
R2 = b2s2M/s2; 0.5 = [(1.1)2(0.2)2]/s2; s = 0.3111.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
45. Suppose you forecast that the market index will earn a return of 15% in the coming year. Treasury bills are yielding 6%. The
unadjusted β of Mobil stock is 1.30. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a
common method to derive adjusted betas.
A. 15.0%
B. 15.5%
C. 16.0%
D. 16.8%
Adjusted beta = 2/3(1.3) + 1/3 = 1.20; E(rM) = 6% + 1.20(9%) = 16.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
46. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.5RM + eA.
RB = 0.02 + 1.3RM + eB.
σM = 0.25; σ(eA) = 0.20; σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0050.
E. 0.4000.
Cov(RA, RB) = bAbBs2M = 0.5(1.3)(0.25)2 = 0.0406.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
47. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.8RM + eA.
RB = 0.02 + 1.2RM + eB.
σM = 0.20; σ(eA) = 0.20; σ(eB) = 0.10.
The standard deviation for stock A is
A. 0.0656.
B. 0.0676.
C. 0.2561.
D. 0.2600.
σA = [(0.8)2(0.2)2 + (0.2)2]1/2 = 0.2561.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
48. The index model has been estimated for stock A with the following results:
RA = 0.01 + 0.8RM + eA.
σM = 0.20; σ(eA) = 0.10.
The standard deviation of the return for stock A is
A. 0.0356.
B. 0.1887.
C. 0.1600.
D. 0.6400.
σB = [(0.8)2(0.2)2 + (0.1)2]1/2 = 0.1887.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
49. Security returns
A. are based on both macro events and firm-specific events.
B. are based on firm-specific events only.
C. are usually positively correlated with each other.
D. are based on firm-specific events only and are usually positively correlated with each other.
E. are based on both macro events and firm-specific events and are usually positively correlated with each other.
Stock returns are usually highly positively correlated with each other. Stock returns are affected by both macroeconomic events and
firm-specific events.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-factor security market
50. The single-index model
A. greatly reduces the number of required calculations relative to those required by the Markowitz model.
B. enhances the understanding of systematic versus nonsystematic risk.
C. greatly increases the number of required calculations relative to those required by the Markowitz model.
D. greatly reduces the number of required calculations relative to those required by the Markowitz model and enhances the
understanding of systematic versus nonsystematic risk.
E. enhances the understanding of systematic versus nonsystematic risk and greatly increases the number of required calculations
relative to those required by the Markowitz model.
The single index model both greatly reduces the number of calculations and enhances the understanding of the relationship between
systematic and unsystematic risk on security returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Single-index model
51. The security characteristic line (SCL)
A. plots the excess return on a security as a function of the excess return on the market.
B. allows one to estimate the beta of the security.
C. allows one to estimate the alpha of the security.
D. All of the options.
E. None of the options are correct.
The security characteristic line, which plots the excess return of the security as a function of the excess return of the market, allows
one to estimate both the alpha and the beta of the security.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Security characteristic line
52. The expected impact of unanticipated macroeconomic events on a security's return during the period is
A. included in the security's expected return.
B. zero.
C. equal to the risk-free rate.
D. proportional to the firm's beta.
E. infinite.
The expected value of unanticipated macroeconomic events is zero, because by definition it must average to zero or it would be
incorporated into the expected return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-factor security market
53. Covariances between security returns tend to be
A. positive because of SEC regulations.
B. positive because of Exchange regulations.
C. positive because of economic forces that affect many firms.
D. negative because of SEC regulations.
E. negative because of economic forces that affect many firms.
Economic forces, such as business cycles, interest rates, and technological changes, tend to have similar impacts on many firms.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-factor security market
54. In the single-index model represented by the equation ri = E(ri) + βiF + ei, the term ei represents
A. the impact of unanticipated macroeconomic events on security i's return.
B. the impact of unanticipated firm-specific events on security i's return.
C. the impact of anticipated macroeconomic events on security i's return.
D. the impact of anticipated firm-specific events on security i's return.
E. the impact of changes in the market on security i's return.
The textbook discusses a model in which macroeconomic events are used as a single index for security returns. The ei term represents
the impact of unanticipated firm-specific events. The ei term has an expected value of zero. Only unanticipated events would affect the
return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model
55. Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE. Using a single-index model rather than the
Markowitz model
A. increases the number of inputs needed from about 1,400 to more than 1.4 million.
B. increases the number of inputs needed from about 10,000 to more than 125,000.
C. reduces the number of inputs needed from more than 125,000 to about 10,000.
D. reduces the number of inputs needed from more than 5 million to about 10,000.
E. increases the number of inputs needed from about 150 to more than 1,500.
This example is discussed in the textbook. The main point for the students to remember is that the single-index model drastically
reduces the number of inputs required.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
56. One "cost" of the single-index model is that it
A. is virtually impossible to apply.
B. prohibits specialization of efforts within the security analysis industry.
C. requires forecasts of the money supply.
D. is legally prohibited by the SEC.
E. allows for only two kinds of risk—macro risk and micro risk.
One "cost" of the single-index model is that it allows for only two kinds of risk—macro risk and micro risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
57. The security characteristic line (SCL) associated with the single-index model is a plot of
A. the security's returns on the vertical axis and the market index's returns on the horizontal axis.
B. the market index's returns on the vertical axis and the security's returns on the horizontal axis.
C. the security's excess returns on the vertical axis and the market index's excess returns on the horizontal axis.
D. the market index's excess returns on the vertical axis and the security's excess returns on the horizontal axis.
E. the security's returns on the vertical axis and Beta on the horizontal axis.
The student needs to remember that it is the excess returns that are plotted and that the security's returns are plotted as a dependent
variable.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Security characteristic line
58. The idea that there is a limit to the reduction of portfolio risk due to diversification is
A. contradicted by both the CAPM and the single-index model.
B. contradicted by the CAPM.
C. contradicted by the single-index model.
D. supported in theory, but not supported empirically.
E. supported both in theory and by empirical evidence.
The benefits of diversification are limited to the level of systematic risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-factor security market
59. In their study about predicting beta coefficients, which of the following did Rosenberg and Guy find to be factors that influence
beta?
I) Industry group
II) Variance of cash flow
III) Dividend yield
IV) Growth in earnings per share
A. I and II
B. I and III
C. I, II, and III
D. I, II, and IV
E. I, II, III, and IV
All of the factors mentioned, as well as variance of earnings, firm size, and debt-to-asset ratio, were found to help predict betas.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-index model estimation
60. If a firm's beta was calculated as 1.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. less than 0.6 but greater than zero.
B. between 0.6 and 1.0.
C. between 1.0 and 1.6.
D. greater than 1.6.
E. zero or less.
Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are more than 1, adjusted
betas are between 1 and the calculated beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
61. The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.20.
B. 1.53.
C. 1.13.
D. 1.0.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.8) + 1/3 = 1.53.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
62. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to
construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 100; 100
B. 40; 40
C. 4950; 100
D. 4950; 4950
E. None of the options are correct.
The expected returns of each of the 40 securities must be calculated. In addition, the 40 variances around these returns must be
calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
63. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to
construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate ____________ covariances.
A. 45
B. 780
C. 4,950
D. 10,000
(n2 – n)/2 = (1,600 – 40)/2 = 780 covariances must be calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Single-factor security market
64. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 60 stocks in order to construct a
mean-variance efficient portfolio constrained by 60 investments. They will need to calculate ________ estimates of expected returns
and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 200; 19,900
B. 200; 200
C. 60; 60
D. 19,900; 19.900
E. None of the options are correct.
For a single-index model, n(60), expected returns and n(60) sensitivity coefficients to the macroeconomic factor must be estimated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model
65. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is
3%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 1.57.
B. 0.75.
C. 1.17.
D. 1.33.
E. 1.50.
11% = 0% + b(7%); b = 1.571.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model
66. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.25 and σM was 0.21, the β of the portfolio would be approximately ________.
A. 0.64
B. 1.19
C. 1.25
D. 1.56
s2p/s2m = b2; (0.25)2/(0.21)2 = 1.417; b = 1.19.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model
67. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.18 and σM was 0.22, the β of the portfolio would be approximately
A. 0.64.
B. 1.19.
C. 0.82.
D. 1.56.
s2p/s2m = b2; (0.18)2/(0.22)2 = 0.669; b = 0.82.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model
68. Suppose the following equation best describes the evolution of β over time:
βt = 0.4 + 0.6βt – 1.
If a stock had a β of 0.9 last year, you would forecast the β to be _______ in the coming year.
A. 0.45
B. 0.60
C. 0.70
D. 0.94
0.4 + 0.6(0.9) = 0.94.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
69. Suppose the following equation best describes the evolution of β over time:
βt = 0.3 + 0.2βt – 1
If a stock had a β of 0.8 last year, you would forecast the β to be _______ in the coming year.
A. 0.46
B. 0.60
C. 0.70
D. 0.94
0.3 + 0.2(0.8) = 0.46.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
70. The index model for stock A has been estimated with the following result:
RA = 0.01 + 0.94RM + eA
If σM = 0.30 and R2A = 0.28, the standard deviation of return of stock A is
A. 0.2025.
B. 0.2500.
C. 0.4500.
D. 0.5329.
R2 = b2s2M/s2; s2 = [(0.94) 2(0.30) 2]/0.28; s2 = 0.284; s = 0.5329.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
71. Suppose you forecast that the market index will earn a return of 12% in the coming year. Treasury bills are yielding 4%. The
unadjusted β of Mobil stock is 1.50. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a
common method to derive adjusted betas.
A. 15.0%
B. 15.5%
C. 16.0%
D. 14.7%
Adjusted beta = 2/3(1.5) + 1/3 = 1.33; E(rM) = 4% + 1.33(8%) = 14.66%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
72. The index model has been estimated for stocks A and B with the following results:
RA = 0.01 + 0.8RM + eA.
RB = 0.02 + 1.1RM + eB.
σM = 0.30 σ(eA) = 0.20 σ(eB) = 0.10.
The covariance between the returns on stocks A and B is
A. 0.0384.
B. 0.0406.
C. 0.1920.
D. 0.0050.
E. 0.0792.
Cov(RA, RB) = bAbBs2M = 0.8(1.1)(0.30)2 = 0.0792.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
73. If a firm's beta was calculated as 1.35 in a regression equation, a commonly-used adjustment technique would provide an adjusted
beta of
A. equal to 1.35.
B. between 0.0 and 1.0.
C. between 1.0 and 1.35.
D. greater than 1.35.
E. zero or less.
Betas, on average, equal one; thus, betas over time regress toward the mean, or 1. Therefore, if historic betas are more than 1, adjusted
betas are between 1 and the calculated beta.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
74. The beta of a stock has been estimated as 1.4 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.27.
B. 1.32.
C. 1.13.
D. 1.0.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.4) + 1/3 = 1.27.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
75. The beta of a stock has been estimated as 0.85 using regression analysis on a sample of historical returns. A commonly-used
adjustment technique would provide an adjusted beta of
A. 1.01.
B. 0.95.
C. 1.13.
D. 0.90.
Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(0.85) + 1/3 = 0.90.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
76. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to
construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate _____________ expected
returns and ___________ variances of returns.
A. 125; 125
B. 125; 15,625
C. 15,625; 125
D. 15,625; 15,625
E. None of the options are correct.
The expected returns of each of the 125 securities must be calculated. In addition, the 125 variances around these returns must be
calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
77. Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 132 stocks in order to
construct a mean-variance efficient portfolio constrained by 132 investments. They will need to calculate ____________ covariances.
A. 100
B. 132
C. 4,950
D. 8,646
(n2 – n)/2 = (17,424 – 132)/2 = 8,646 covariances must be calculated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-factor security market
78. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 217 stocks in order to construct
a mean-variance efficient portfolio constrained by 217 investments. They will need to calculate ________ estimates of expected
returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A. 217; 47,089
B. 217; 217
C. 47,089; 217
D. 47,089; 47,089
E. None of the options are correct.
For a single-index model, n(217), expected returns and n(217) sensitivity coefficients to the macroeconomic factor must be estimated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
79. Assume that stock market returns do follow a single-index structure. An investment fund analyzes 750 stocks in order to construct
a mean-variance efficient portfolio constrained by 750 investments. They will need to calculate ________ estimates of firm-specific
variances and ________ estimate/estimate(s) for the variance of the macroeconomic factor.
A. 750; 1
B. 750; 750
C. 124,750; 1
D. 124,750; 750
E. 562,500; 750
For the single-index model, n(750) estimates of firm-specific variances must be calculated and 1 estimate for the variance of the
common macroeconomic factor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Single-index model estimation
80. Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is
5%. The stock earns a return that exceeds the risk-free rate by 5%, and there are no firm-specific events affecting the stock
performance. The β of the stock is
A. 0.67.
B. 0.75.
C. 1.0.
D. 1.33.
E. 1.50.
5% = 0% + b(5%); b = 1.0.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Single-index model estimation
81. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.24 and σM was 0.18, the β of the portfolio would be approximately
A. 0.64.
B. 1.33.
C. 1.25.
D. 1.56.
s2p/s2m = b2; (0.24)2/(0.18)2 = 1.78; b = 1.33.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
82. Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ
of your portfolio was 0.14 and σM was 0.19, the β of the portfolio would be approximately
A. 0.74.
B. 0.80.
C. 1.25.
D. 1.56.
s2p/s2m = b2; (0.14)2/(0.19)2 = 0.54; b = 0.74.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Single-index model estimation
83. Suppose the following equation best describes the evolution of β over time:
βt = 0.30 + 0.70βt – 1
If a stock had a β of 0.82 last year, you would forecast the β to be _______ in the coming year.
A. 0.91
B. 0.77
C. 0.63
D. 0.87
0.30 + 0.70(0.82) = 0.874.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Single-index model estimation
Chapter 08 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Difficulty: 3 Challenge
Topic: Diversification
Topic: Index model portfolio management
Topic: Security characteristic line
Topic: Single-factor security market
Topic: Single-index model
Topic: Single-index model estimation
# of Questions
34
49
83
34
20
29
18
47
18
5
1
2
15
22
38
Chapter 09 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is
A. unique risk.
B. beta.
C. standard deviation of returns.
D. variance of returns.
2. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A. unique risk.
B. systematic risk.
C. standard deviation of returns.
D. variance of returns.
3. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A. unique risk.
B. market risk.
C. standard deviation of returns.
D. variance of returns.
4. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A. market risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
E. None of the options are correct.
5. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A. beta risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
E. None of the options are correct.
6. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A. systematic risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
7. The market portfolio has a beta of
A. 0.
B. 1.
C. –1.
D. 0.5.
9-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
8. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital
asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to
A. 0.06.
B. 0.144.
C. 0.12.
D. 0.132.
E. 0.18.
9. The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the
capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to
A. 0.142.
B. 0.144.
C. 0.153.
D. 0.134.
E. 0.117.
10. Which statement is not true regarding the market portfolio?
A. It includes all publicly-traded financial assets.
B. It lies on the efficient frontier.
C. All securities in the market portfolio are held in proportion to their market values.
D. It is the tangency point between the capital market line and the indifference curve.
E. All of the options are true.
11. Which statement is true regarding the market portfolio?
I) It includes all publicly traded financial assets.
II) It lies on the efficient frontier.
III) All securities in the market portfolio are held in proportion to their market values.
IV) It is the tangency point between the capital market line and the indifference curve.
A. I only
B. II only
C. III only
D. IV only
E. I, II, and III
12. Which statement is not true regarding the capital market line (CML)?
A. The CML is the line from the risk-free rate through the market portfolio.
B. The CML is the best attainable capital allocation line.
C. The CML is also called the security market line.
D. The CML always has a positive slope.
E. The risk measure for the CML is standard deviation.
13. Which statement is true regarding the capital market line (CML)?
I) The CML is the line from the risk-free rate through the market portfolio.
II) The CML is the best attainable capital allocation line.
III) The CML is also called the security market line.
IV) The CML always has a positive slope.
A. I only
9-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. II only
C. III only
D. IV only
E. I, II, and IV
14. The market risk, beta, of a security is equal to
A. the covariance between the security's return and the market return divided by the variance of the market's
returns.
B. the covariance between the security and market returns divided by the standard deviation of the market's
returns.
C. the variance of the security's returns divided by the covariance between the security and market returns.
D. the variance of the security's returns divided by the variance of the market's returns.
15. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to
A. r f + [E(r M)].
B. r f + [E(r M) – r f ].
C. [E(rM) – r f ].
D. E(r M) + r f .
16. The security market line (SML) is
A. the line that describes the expected return-beta relationship for well-diversified portfolios only.
B. also called the capital allocation line.
C. the line that is tangent to the efficient frontier of all risky assets.
D. the line that represents the expected return-beta relationship.
E. All of the options.
17. According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have
A. positive betas.
B. zero alphas.
C. negative betas.
D. positive alphas.
18. According to the Capital Asset Pricing Model (CAPM), underpriced securities have
A. positive betas.
B. zero alphas.
C. negative betas.
D. positive alphas.
E. None of the options are correct.
19. According to the Capital Asset Pricing Model (CAPM), overpriced securities have
A. positive betas.
B. zero alphas.
C. negative alphas.
D. positive alphas.
20. According to the Capital Asset Pricing Model (CAPM), a security with a
A. positive alpha is considered overpriced.
B. zero alpha is considered to be a good buy.
9-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. negative alpha is considered to be a good buy.
D. positive alpha is considered to be underpriced.
21. According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false?
A. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
B. The expected rate of return on a security increases as its beta increases.
C. A fairly priced security has an alpha of zero.
D. In equilibrium, all securities lie on the security market line.
E. All of the statements are true.
22. In a well-diversified portfolio,
A. market risk is negligible.
B. systematic risk is negligible.
C. unsystematic risk is negligible.
D. nondiversifiable risk is negligible.
23. Empirical results regarding betas estimated from historical data indicate that betas
A. are constant over time.
B. are always greater than one.
C. are always near zero.
D. appear to regress toward one over time.
E. are always positive.
24. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free
rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this
security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
25. The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to
offer a rate of return of 12%, you should
A. buy the stock because it is overpriced.
B. sell short the stock because it is overpriced.
C. sell the stock short because it is underpriced.
D. buy the stock because it is underpriced.
E. None of the options, as the stock is fairly priced.
26. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the
resulting portfolio is
A. 1.40.
B. 1.00.
C. 0.36.
D. 1.08.
E. 0.80.
9-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
27. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08,
and the risk-free rate is 0.05. The alpha of the stock is
A. 1.7%.
B. –1.7%.
C. 8.3%.
D. 5.5%.
28. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04
and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
29. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04
and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
30. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04
and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
E. None of the options are correct.
31. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The risk-free rate is
0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
32. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate is
0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
33. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. The risk-free rate is 0.04
and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is
A. underpriced.
9-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
34. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the
IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected
market rate of return is 11%. Your company has a beta of 1.0, and the project that you are evaluating is considered
to have risk equal to the average project that the company has accepted in the past. According to CAPM, the
appropriate hurdle rate would be
A. 4%.
B. 7%.
C. 15%.
D. 11%.
E. 1%.
35. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the
IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected
market rate of return is 11%. Your company has a beta of 1.4, and the project that you are evaluating is considered
to have risk equal to the average project that the company has accepted in the past. According to CAPM, the
appropriate hurdle rate would be
A. 13.8%.
B. 7%.
C. 15%.
D. 4%.
E. 1.4%.
36. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the
IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected
market rate of return is 11%. Your company has a beta of 0.75, and the project that you are evaluating is
considered to have risk equal to the average project that the company has accepted in the past. According to
CAPM, the appropriate hurdle rate would be
A. 4%.
B. 9.25%.
C. 15%.
D. 11%.
E. 0.75%.
37. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the
IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected
market rate of return is 11%. Your company has a beta of 0.67, and the project that you are evaluating is
considered to have risk equal to the average project that the company has accepted in the past. According to
CAPM, the appropriate hurdle rate would be
A. 4%.
B. 8.69%.
C. 15%.
D. 11%.
E. 0.75%.
38. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the
IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 5%, and the expected
market rate of return is 10%. Your company has a beta of 0.67, and the project that you are evaluating is
considered to have risk equal to the average project that the company has accepted in the past. According to
9-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
CAPM, the appropriate hurdle rate would be
A. 10%.
B. 5%.
C. 8.35%.
D. 28.35%.
E. 0.67%.
39. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 10%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
40. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 11%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
41. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 13%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
42. You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a
beta of 0.9. The beta of the resulting portfolio is
A. 1.466.
B. 1.157.
C. 0.968.
D. 1.082.
E. 1.175.
43. Given are the following two stocks A and B:
If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered the
better buy, and why?
9-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. A because it offers an expected excess return of 1.2%.
B. B because it offers an expected excess return of 1.8%.
C. A because it offers an expected excess return of 2.2%.
D. B because it offers an expected return of 14%.
E. B because it has a higher beta.
44. Capital asset pricing theory asserts that portfolio returns are best explained by
A. reinvestment risk.
B. specific risk.
C. systematic risk.
D. diversification.
45. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases
A. directly with alpha.
B. inversely with alpha.
C. directly with beta.
D. inversely with beta.
E. in proportion to its standard deviation.
46. What is the expected return of a zero-beta security?
A. The market rate of return
B. Zero rate of return
C. A negative rate of return
D. The risk-free rate
47. Standard deviation and beta both measure risk, but they are different in that beta measures
A. both systematic and unsystematic risk.
B. only systematic risk, while standard deviation is a measure of total risk.
C. only unsystematic risk, while standard deviation is a measure of total risk.
D. both systematic and unsystematic risk, while standard deviation measures only systematic risk.
E. total risk, while standard deviation measures only nonsystematic risk.
48. The expected return-beta relationship
A. is the most familiar expression of the CAPM to practitioners.
B.refers to the way in which the covariance between the returns on a stock and returns on the market measures the
contribution of the stock to the variance of the market portfolio, which is beta.
C. assumes that investors hold well-diversified portfolios.
D. All of the options are true.
E. None of the options are true.
49. The security market line (SML)
A. can be portrayed graphically as the expected return-beta relationship.
B. can be portrayed graphically as the expected return-standard deviation of market-returns relationship.
C. provides a benchmark for evaluation of investment performance.
D.can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of
investment performance.
E.can be portrayed graphically as the expected return-standard deviation of market-returns relationship and
provides a benchmark for evaluation of investment performance.
50. Studies of liquidity spreads in security markets have shown that
9-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. liquid stocks earn higher returns than illiquid stocks.
B. illiquid stocks earn higher returns than liquid stocks.
C. both liquid and illiquid stocks earn the same returns.
D. illiquid stocks are good investments for frequent, short-term traders.
51. An underpriced security will plot
A. on the security market line.
B. below the security market line.
C. above the security market line.
D. either above or below the security market line depending on its covariance with the market.
E. either above or below the security-market line depending on its standard deviation.
52. An overpriced security will plot
A. on the security market line.
B. below the security market line.
C. above the security market line.
D. either above or below the security market line depending on its covariance with the market.
E. either above or below the security-market line depending on its standard deviation.
53. The risk premium on the market portfolio will be proportional to
A. the average degree of risk aversion of the investor population.
B. the risk of the market portfolio as measured by its variance.
C. the risk of the market portfolio as measured by its beta.
D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured
by its variance.
E. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured
by its beta.
54. In equilibrium, the marginal price of risk for a risky security must be
A. equal to the marginal price of risk for the market portfolio.
B. greater than the marginal price of risk for the market portfolio.
C. less than the marginal price of risk for the market portfolio.
D. adjusted by its degree of nonsystematic risk.
E. None of the options are true.
55. The capital asset pricing model assumes
A. all investors are price takers.
B. all investors have the same holding period.
C. investors pay taxes on capital gains.
D. all investors are price takers and have the same holding period.
E. all investors are price takers, have the same holding period, and pay taxes on capital gains.
56. The capital asset pricing model assumes
A. all investors are price takers.
B. all investors have the same holding period.
C. investors have homogeneous expectations.
D. all investors are price takers and have the same holding period.
E. all investors are price takers, have the same holding period, and have homogeneous expectations.
9-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
57. The capital asset pricing model assumes
A. all investors are rational.
B. all investors have the same holding period.
C. investors have heterogeneous expectations.
D. all investors are rational and have the same holding period.
E. all investors are rational, have the same holding period, and have heterogeneous expectations.
58. The capital asset pricing model assumes
A. all investors are fully informed.
B. all investors are rational.
C. all investors are mean-variance optimizers.
D. taxes are an important consideration.
E. all investors are fully informed, are rational, and are mean-variance optimizers.
59. If investors do not know their investment horizons for certain,
A. the CAPM is no longer valid.
B. the CAPM underlying assumptions are not violated.
C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
D. the implications of the CAPM are no longer useful.
60. Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of
return is 0.11, and the risk-free rate is 0.04. The beta of the stock is
A. 1.25.
B. 1.86.
C. 1.
D. 0.95.
61. The amount that an investor allocates to the market portfolio is negatively related to
I) the expected return on the market portfolio.
II) the investor's risk aversion coefficient.
III) the risk-free rate of return.
IV) the variance of the market portfolio.
A. I and II.
B. II and III.
C. II and IV.
D. II, III, and IV.
E. I, III, and IV.
62. One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean?
A. They plan for one identical holding period.
B. They are price takers who can't affect market prices through their trades.
C. They are mean-variance optimizers.
9-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
D. They have the same economic view of the world.
E. They pay no taxes or transactions costs.
63. The CAPM applies to
A. portfolios of securities only.
B. individual securities only.
C. efficient portfolios of securities only.
D. efficient portfolios and efficient individual securities only.
E. all portfolios and individual securities.
64. Which of the following statements about the mutual-fund theorem is true?
I) It is similar to the separation property.
II) It implies that a passive investment strategy can be efficient.
III) It implies that efficient portfolios can be formed only through active strategies.
IV) It means that professional managers have superior security-selection strategies.
A. I and IV
B. I, II, and IV
C. I and II
D. III and IV
E. II and IV
65. The expected return-beta relationship of the CAPM is graphically represented by
A. the security-market line.
B. the capital-market line.
C. the capital-allocation line.
D. the efficient frontier with a risk-free asset.
E. the efficient frontier without a risk-free asset.
66. A "fairly-priced" asset lies
A. above the security-market line.
B. on the security-market line.
C. on the capital-market line.
D. above the capital-market line.
E. below the security-market line.
67. For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common
systematic risk factors, the illiquidity premium on asset i is a function of
A. the market's volatility.
B. asset i's volatility.
C. the trading costs of security i.
D. the risk-free rate.
E. the money supply.
68. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is
0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
9-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. fairly priced.
D. Cannot be determined from data provided.
69. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is
0.04, and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
70. The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to
offer a rate of return of 10%, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell short stock X because it is underpriced.
D. buy stock X because it is underpriced.
E. None of the options, as the stock is fairly priced.
71. The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to
offer a rate of return of 15%, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell short stock X because it is underpriced.
D. buy stock X because it is underpriced.
E. None of the options, as the stock is fairly priced.
72. You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a
beta of 0.7. The beta of the resulting portfolio is
A. 1.40.
B. 1.15.
C. 0.36.
D. 1.08.
E. 0.80.
73. You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the
resulting portfolio is
A. 1.40.
B. 1.00.
C. 0.52.
D. 1.08.
E. 0.80.
74. Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10,
and the risk-free rate is 0.04. The alpha of the stock is
A. 1.7%.
B. –1.8%.
C. 8.3%.
D. 5.5%.
9-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
75. A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10,
and the risk-free rate is 0.04. The alpha of the stock is
A. 1.7%.
B. –1.7%.
C. 8.3%.
D. 3.5%.
76. A security has an expected rate of return of 0.13 and a beta of 2.1. The market expected rate of return is 0.09,
and the risk-free rate is 0.045. The alpha of the stock is
A. –0.95%.
B. –1.7%.
C. 8.3%.
D. 5.5%.
77. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of
return is 0.13, and the risk-free rate is 0.04. The beta of the stock is
A. 1.25.
B. 1.7.
C. 1.
D. 0.95.
Chapter 09 Test Bank - Static Key
Multiple Choice Questions
1. In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is
A. unique risk.
B. beta.
C. standard deviation of returns.
D. variance of returns.
Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
2. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A. unique risk.
B. systematic risk.
C. standard deviation of returns.
D. variance of returns.
9-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
3. In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A. unique risk.
B. market risk.
C. standard deviation of returns.
D. variance of returns.
Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
4. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function
Of
A. market risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
E. None of the options are correct.
With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that
influences return according to the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
5. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function
Of
A. beta risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
E. None of the options are correct.
With a diversified portfolio, the only risk remaining is market, beta, or systematic, risk. This is the only risk that
influences return according to the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
9-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
6. According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function
Of
A. systematic risk.
B. unsystematic risk.
C. unique risk.
D. reinvestment risk.
With a diversified portfolio, the only risk remaining is market, beta, or systematic, risk. This is the only risk that
influences return according to the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
7. The market portfolio has a beta of
A. 0.
B. 1.
C. –1.
D. 0.5.
By definition, the beta of the market portfolio is 1.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
8. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital
asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to
A. 0.06.
B. 0.144.
C. 0.12.
D. 0.132.
E. 0.18.
E(R) = 6% + 1.2(12 – 6) = 13.2%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Capital asset pricing model
9. The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the
capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to
A. 0.142.
B. 0.144.
C. 0.153.
D. 0.134.
E. 0.117.
E(R) = 5.6% + 1.25(12.5 – 5.6) = 14.225%.
9-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Capital asset pricing model
10. Which statement is not true regarding the market portfolio?
A. It includes all publicly-traded financial assets.
B. It lies on the efficient frontier.
C. All securities in the market portfolio are held in proportion to their market values.
D. It is the tangency point between the capital market line and the indifference curve.
E. All of the options are true.
The tangency point between the capital market line and the indifference curve is the optimal portfolio for a
particular investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
11. Which statement is true regarding the market portfolio?
I) It includes all publicly traded financial assets.
II) It lies on the efficient frontier.
III) All securities in the market portfolio are held in proportion to their market values.
IV) It is the tangency point between the capital market line and the indifference curve.
A. I only
B. II only
C. III only
D. IV only
E. I, II, and III
The tangency point between the capital market line and the indifference curve is the optimal portfolio for a
particular investor.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
12. Which statement is not true regarding the capital market line (CML)?
A. The CML is the line from the risk-free rate through the market portfolio.
B. The CML is the best attainable capital allocation line.
C. The CML is also called the security market line.
D. The CML always has a positive slope.
E. The risk measure for the CML is standard deviation.
Both the capital market line and the security market line depict risk/return relationships. However, the risk
measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also
9-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
called the security market line; the other statements are true).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital market line
13. Which statement is true regarding the capital market line (CML)?
I) The CML is the line from the risk-free rate through the market portfolio.
II) The CML is the best attainable capital allocation line.
III) The CML is also called the security market line.
IV) The CML always has a positive slope.
A. I only
B. II only
C. III only
D. IV only
E. I, II, and IV
Both the capital market line and the security market line depict risk/return relationships. However, the risk
measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also
called the security market line; the other statements are true).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital market line
14. The market risk, beta, of a security is equal to
A. the covariance between the security's return and the market return divided by the variance of the market's
returns.
B. the covariance between the security and market returns divided by the standard deviation of the market's
returns.
C. the variance of the security's returns divided by the covariance between the security and market returns.
D. the variance of the security's returns divided by the variance of the market's returns.
Beta is a measure of how a security's return covaries with the market returns, normalized by the market
variance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
15. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal
To
A. r f + [E(r M)].
B. r f + [E(r M) – r f ].
C. [E(rM) – r f ].
D. E(r M) + r f .
The expected rate of return on any security is equal to the risk-free rate plus the systematic risk of the security
(beta) times the market risk premium, E(rM – rf ).
9-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
16. The security market line (SML) is
A. the line that describes the expected return-beta relationship for well-diversified portfolios only.
B. also called the capital allocation line.
C. the line that is tangent to the efficient frontier of all risky assets.
D. the line that represents the expected return-beta relationship.
E. All of the options.
The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Security market line
17. According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have
A. positive betas.
B. zero alphas.
C. negative betas.
D. positive alphas.
A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
18. According to the Capital Asset Pricing Model (CAPM), underpriced securities have
A. positive betas.
B. zero alphas.
C. negative betas.
D. positive alphas.
E. None of the options are correct.
According to the Capital Asset Pricing Model (CAPM), underpriced securities have positive alphas.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
19. According to the Capital Asset Pricing Model (CAPM), overpriced securities have
9-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. positive betas.
B. zero alphas.
C. negative alphas.
D. positive alphas.
According to the Capital Asset Pricing Model (CAPM), overpriced securities have negative alphas.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
20. According to the Capital Asset Pricing Model (CAPM), a security with a
A. positive alpha is considered overpriced.
B. zero alpha is considered to be a good buy.
C. negative alpha is considered to be a good buy.
D. positive alpha is considered to be underpriced.
A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the
perceived risk of the security, and thus is underpriced.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
21. According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false?
A. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
B. The expected rate of return on a security increases as its beta increases.
C. A fairly priced security has an alpha of zero.
D. In equilibrium, all securities lie on the security market line.
E. All of the statements are true.
"The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate" is
false.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
22. In a well-diversified portfolio,
A. market risk is negligible.
B. systematic risk is negligible.
C. unsystematic risk is negligible.
D. nondiversifiable risk is negligible.
Market, systematic, or nondiversifiable, risk is present in a diversified portfolio; the unsystematic risk has been
eliminated.
AACSB: Reflective Thinking
9-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Diversification
23. Empirical results regarding betas estimated from historical data indicate that betas
A. are constant over time.
B. are always greater than one.
C. are always near zero.
D. appear to regress toward one over time.
E. are always positive.
Betas vary over time, betas may be negative or less than one, and betas are not always near zero; however,
betas do appear to regress toward one over time.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model - academic and industry considerations
24. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free
rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this
security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
11% = 5% + 1.5(9% – 5%) = 11.0%; therefore, the security is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
25. The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to
offer a rate of return of 12%, you should
A. buy the stock because it is overpriced.
B. sell short the stock because it is overpriced.
C. sell the stock short because it is underpriced.
D. buy the stock because it is underpriced.
E. None of the options, as the stock is fairly priced.
12% < 7% + 1.3(15% – 7%) = 17.40%; therefore, stock is overpriced and should be shorted.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
26. You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the
resulting portfolio is
A. 1.40.
B. 1.00.
9-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 0.36.
D. 1.08.
E. 0.80.
0.6(1.2) + 0.4(0.90) = 1.08.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Beta
27. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08,
and the risk-free rate is 0.05. The alpha of the stock is
A. 1.7%.
B. –1.7%.
C. 8.3%.
D. 5.5%.
10% – [5% +1.1(8% – 5%)] = 1.7%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
28. Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04
and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
13% – [4% + 1.3(11.5% – 4%)] = –0.75%; therefore, the security is overpriced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
29. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is
0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
13.75% – [4% + 1.3(11.5% – 4%)] = 0.0%; therefore, the security is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
9-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
30. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04
and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security
is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
E. None of the options are correct.
15% – [4% + 1.3(11.5% – 4%)] = 1.25%; therefore, the security is underpriced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
31. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The risk-free rate is
0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
11.2% – [4% + 0.92(10% – 4%)] = 1.68%; therefore, the security is underpriced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
32. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate is
0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
9.52% – [4% + 0.92(10% – 4%)] = 0.0%; therefore, the security is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
33. Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. The risk-free rate is
0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
9-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
8.0% – [4% + 0.92(10% – 4%)] = –1.52%; therefore, the security is overpriced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
34. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use
the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the
expected market rate of return is 11%. Your company has a beta of 1.0, and the project that you are evaluating
is considered to have risk equal to the average project that the company has accepted in the past. According to
CAPM, the appropriate hurdle rate would be
A. 4%.
B. 7%.
C. 15%.
D. 11%.
E. 1%.
The hurdle rate should be the required return from CAPM, or R = 4% + 1.0(11% – 4%) = 11%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
35. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use
the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the
expected market rate of return is 11%. Your company has a beta of 1.4, and the project that you are evaluating
is considered to have risk equal to the average project that the company has accepted in the past. According to
CAPM, the appropriate hurdle rate would be
A. 13.8%.
B. 7%.
C. 15%.
D. 4%.
E. 1.4%.
The hurdle rate should be the required return from CAPM, or R = 4% + 1.4(11% – 4%) = 13.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
36. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to
use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and
the expected market rate of return is 11%. Your company has a beta of 0.75, and the project that you are
evaluating is considered to have risk equal to the average project that the company has accepted in the past.
According to CAPM, the appropriate hurdle rate would be
A. 4%.
B. 9.25%.
9-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
C. 15%.
D. 11%.
E. 0.75%.
The hurdle rate should be the required return from CAPM, or R = 4% + 0.75(11% – 4%) = 9.25%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
37. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to
use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and
the expected market rate of return is 11%. Your company has a beta of 0.67, and the project that you are
evaluating is considered to have risk equal to the average project that the company has accepted in the past.
According to CAPM, the appropriate hurdle rate would be
A. 4%.
B. 8.69%.
C. 15%.
D. 11%.
E. 0.75%.
The hurdle rate should be the required return from CAPM, or R = 4% + 0.67(11% – 4%) = 8.69%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
38. As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to
use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 5%, and
the expected market rate of return is 10%. Your company has a beta of 0.67, and the project that you are
evaluating is considered to have risk equal to the average project that the company has accepted in the past.
According to CAPM, the appropriate hurdle rate would be
A. 10%.
B. 5%.
C. 8.35%.
D. 28.35%.
E. 0.67%.
The hurdle rate should be the required return from CAPM, or R = 5% + 0.67(10% – 5%) = 8.35%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
39. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 10%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
9-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
10% < 4% + 1.0(11% – 4%) = 11.0%; therefore, CAT is overpriced and should be shorted.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
40. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 11%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
11% = 4% + 1.0(11% – 4%) = 11.0%; therefore, CAT is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
41. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer
a rate of return of 13%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
13% > 4% + 1.0(11% – 4%) = 11.0%; therefore, CAT is underpriced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
42. You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a
beta of 0.9. The beta of the resulting portfolio is
A. 1.466.
B. 1.157.
C. 0.968.
D. 1.082.
E. 1.175.
0.55(1.4) + 0.45(0.90) = 1.175.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Beta
9-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
43. Given are the following two stocks A and B:
If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered
the better buy, and why?
A. A because it offers an expected excess return of 1.2%.
B. B because it offers an expected excess return of 1.8%.
C. A because it offers an expected excess return of 2.2%.
D. B because it offers an expected return of 14%.
E. B because it has a higher beta.
A's excess return is expected to be 12% – [5% + 1.2(9% – 5%)] = 2.2%. B's excess return is expected to be
14% – [5% + 1.8(9% – 5%)] = 1.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
44. Capital asset pricing theory asserts that portfolio returns are best explained by
A. reinvestment risk.
B. specific risk.
C. systematic risk.
D. diversification.
The risk remaining in diversified portfolios is systematic risk; thus, portfolio returns are commensurate with
systematic risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
45. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases
A. directly with alpha.
B. inversely with alpha.
C. directly with beta.
D. inversely with beta.
E. in proportion to its standard deviation.
The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or
portfolio varies directly with beta.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
9-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Topic: Capital asset pricing model
46. What is the expected return of a zero-beta security?
A. The market rate of return
B. Zero rate of return
C. A negative rate of return
D. The risk-free rate
E(RS) = rf + 0(RM – rf) = rf.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
47. Standard deviation and beta both measure risk, but they are different in that beta measures
A. both systematic and unsystematic risk.
B. only systematic risk, while standard deviation is a measure of total risk.
C. only unsystematic risk, while standard deviation is a measure of total risk.
D. both systematic and unsystematic risk, while standard deviation measures only systematic risk.
E. total risk, while standard deviation measures only nonsystematic risk.
Standard deviation and beta both measure risk, but they are different in that beta measures only systematic risk
while standard deviation is a measure of total risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Beta
48. The expected return-beta relationship
A. is the most familiar expression of the CAPM to practitioners.
B. refers to the way in which the covariance between the returns on a stock and returns on the market measures
the contribution of the stock to the variance of the market portfolio, which is beta.
C. assumes that investors hold well-diversified portfolios.
D. All of the options are true.
E. None of the options are true.
All of the statements describe the expected return-beta relationship.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
49. The security market line (SML)
A. can be portrayed graphically as the expected return-beta relationship.
B. can be portrayed graphically as the expected return-standard deviation of market-returns relationship.
C. provides a benchmark for evaluation of investment performance.
D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for
9-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
evaluation of investment performance.
E. can be portrayed graphically as the expected return-standard deviation of market-returns relationship and
provides a benchmark for evaluation of investment performance.
The SML is a measure of the expected return-beta relationship (the CML is a measure of expected return
standard deviation of market returns). The SML provides the expected return-beta relationship for "fairly priced"
securities; thus if a portfolio manager selects securities that are underpriced and produces a portfolio with a
positive alpha, this portfolio manager would receive a positive evaluation.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Security market line
50. Studies of liquidity spreads in security markets have shown that
A. liquid stocks earn higher returns than illiquid stocks.
B. illiquid stocks earn higher returns than liquid stocks.
C. both liquid and illiquid stocks earn the same returns.
D. illiquid stocks are good investments for frequent, short-term traders.
Studies of liquidity spreads in security markets have shown that illiquid stocks earn higher returns than liquid
stocks.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Capital asset pricing model - academic and industry considerations
51. An underpriced security will plot
A. on the security market line.
B. below the security market line.
C. above the security market line.
D. either above or below the security market line depending on its covariance with the market.
E. either above or below the security-market line depending on its standard deviation.
An underpriced security will have a higher expected return than the SML would predict; therefore it will plot
above the SML.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Security market line
52. An overpriced security will plot
A. on the security market line.
B. below the security market line.
C. above the security market line.
D. either above or below the security market line depending on its covariance with the market.
E. either above or below the security-market line depending on its standard deviation.
An overpriced security will have a lower expected return than the SML would predict; therefore it will plot below
the SML.
9-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Security market line
53. The risk premium on the market portfolio will be proportional to
A. the average degree of risk aversion of the investor population.
B. the risk of the market portfolio as measured by its variance.
C. the risk of the market portfolio as measured by its beta.
D. the average degree of risk aversion of the investor population and the risk of the market portfolio as
measured by its variance.
E. the average degree of risk aversion of the investor population and the risk of the market portfolio as
measured by its beta.
The risk premium on the market portfolio is proportional to the average degree of risk aversion of the investor
population and the risk of the market portfolio measured by its variance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Risk premiums
54. In equilibrium, the marginal price of risk for a risky security must be
A. equal to the marginal price of risk for the market portfolio.
B. greater than the marginal price of risk for the market portfolio.
C. less than the marginal price of risk for the market portfolio.
D. adjusted by its degree of nonsystematic risk.
E. None of the options are true.
In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the
market. If not, investors will buy or sell the security until they are equal.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Risk premiums
55. The capital asset pricing model assumes
A. all investors are price takers.
B. all investors have the same holding period.
C. investors pay taxes on capital gains.
D. all investors are price takers and have the same holding period.
E. all investors are price takers, have the same holding period, and pay taxes on capital gains.
The CAPM assumes that investors are price takers with the same single holding period and that there are no
taxes or transaction costs.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
56. The capital asset pricing model assumes
9-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. all investors are price takers.
B. all investors have the same holding period.
C. investors have homogeneous expectations.
D. all investors are price takers and have the same holding period.
E. all investors are price takers, have the same holding period, and have homogeneous expectations.
The CAPM assumes that investors are price takers with the same single holding period and that there are no
taxes or transaction costs.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
57. The capital asset pricing model assumes
A. all investors are rational.
B. all investors have the same holding period.
C. investors have heterogeneous expectations.
D. all investors are rational and have the same holding period.
E. all investors are rational, have the same holding period, and have heterogeneous expectations.
The CAPM assumes that investors are rational price takers with the same single holding period and that they
have homogeneous expectations.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
58. The capital asset pricing model assumes
A. all investors are fully informed.
B. all investors are rational.
C. all investors are mean-variance optimizers.
D. taxes are an important consideration.
E. all investors are fully informed, are rational, and are mean-variance optimizers.
The CAPM assumes that investors are fully informed, rational, mean-variance optimizers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Capital asset pricing model
59. If investors do not know their investment horizons for certain,
A. the CAPM is no longer valid.
B. the CAPM underlying assumptions are not violated.
C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
D. the implications of the CAPM are no longer useful.
If investors do not know their investment horizons for certain the implications of the CAPM are not violated as
long as investors' liquidity needs are not priced.
AACSB: Reflective Thinking
9-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Accessibility: Keyboard Navigation
Blooms: Remember
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital asset pricing model - assumptions and extensions
60. Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of
return is 0.11, and the risk-free rate is 0.04. The beta of the stock is
A. 1.25.
B. 1.86.
C. 1.
D. 0.95.
17% = [4% + (11% – 4%)]; 13% = (7%); = 1.86.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
61. The amount that an investor allocates to the market portfolio is negatively related to
I) the expected return on the market portfolio.
II) the investor's risk aversion coefficient.
III) the risk-free rate of return.
IV) the variance of the market portfolio.
A. I and II.
B. II and III.
C. II and IV.
D. II, III, and IV.
E. I, III, and IV.
The optimal proportion is given by y = (E(RM) – rf )/(0.01 × A 2 M). This amount will decrease as rf , A, and
2 Mdecrease.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital allocation
62. One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean?
A. They plan for one identical holding period.
B. They are price takers who can't affect market prices through their trades.
C. They are mean-variance optimizers.
D. They have the same economic view of the world.
E. They pay no taxes or transactions costs.
Myopic behavior is shortsighted, with no concern for medium-term or long-term implications.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
9-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
63. The CAPM applies to
A. portfolios of securities only.
B. individual securities only.
C. efficient portfolios of securities only.
D. efficient portfolios and efficient individual securities only.
E. all portfolios and individual securities.
The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient
and the risk premium on the market portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
64. Which of the following statements about the mutual-fund theorem is true?
I) It is similar to the separation property.
II) It implies that a passive investment strategy can be efficient.
III) It implies that efficient portfolios can be formed only through active strategies.
IV) It means that professional managers have superior security-selection strategies.
A. I and IV
B. I, II, and IV
C. I and II
D. III and IV
E. II and IV
The mutual fund theorem is similar to the separation property. The technical task of creating mutual funds
can be delegated to professional managers; then individuals combine the mutual funds with risk-free assets
according to their preferences. The passive strategy of investing in a market index fund is efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Capital asset pricing model - academic and industry considerations
65. The expected return-beta relationship of the CAPM is graphically represented by
A. the security-market line.
B. the capital-market line.
C. the capital-allocation line.
D. the efficient frontier with a risk-free asset.
E. the efficient frontier without a risk-free asset.
The security market line shows expected return on the vertical axis and beta on the horizontal axis. It has an
intercept of rf and a slope of E(RM) rf .
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
9-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Difficulty: 1 Basic
Topic: Security market line
66. A "fairly-priced" asset lies
A. above the security-market line.
B. on the security-market line.
C. on the capital-market line.
D. above the capital-market line.
E. below the security-market line.
Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are
proportional to their beta coefficients and they have alphas equal to zero.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Security market line
67. For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common
systematic risk factors, the illiquidity premium on asset i is a function of
A. the market's volatility.
B. asset i's volatility.
C. the trading costs of security i.
D. the risk-free rate.
E. the money supply.
The formula for this extension to the CAPM relaxes the assumption that trading is costless.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Capital asset pricing model - assumptions and extensions
68. Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is
0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security
Is
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
14.5% = 4% + 1.5(11% – 4%) = 14.5%; therefore, the security is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
69. Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is
0.04, and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security
Is
9-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
A. underpriced.
B. overpriced.
C. fairly priced.
D. Cannot be determined from data provided.
4% + 1.1(10% – 4%) = 10.6%; therefore, the security is fairly priced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
70. The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to
offer a rate of return of 10%, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell short stock X because it is underpriced.
D. buy stock X because it is underpriced.
E. None of the options, as the stock is fairly priced.
10% < 4% + 1.0(12% – 4%) = 12.0%; therefore, stock is overpriced and should be shorted.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
71. The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to
offer a rate of return of 15%, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell short stock X because it is underpriced.
D. buy stock X because it is underpriced.
E. None of the options, as the stock is fairly priced.
15% < 5% + 2.1(11% – 5%) = 17.6%; therefore, stock is overpriced and should be shorted.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
72. You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a
beta of 0.7. The beta of the resulting portfolio is
A. 1.40.
B. 1.15.
C. 0.36.
D. 1.08.
E. 0.80.
0.5(1.6) + 0.5(0.70) = 1.15.
9-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Beta
73. You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the
resulting portfolio is
A. 1.40.
B. 1.00.
C. 0.52.
D. 1.08.
E. 0.80.
0.2(1.4) + 0.8(0.3) = 0.52.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Beta
74. Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10,
and the risk-free rate is 0.04. The alpha of the stock is
A. 1.7%.
B. –1.8%.
C. 8.3%.
D. 5.5%.
10% – [4% + 1.3(10% – 4%)] = –1.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
75. A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10,
and the risk-free rate is 0.04. The alpha of the stock is
A. 1.7%.
B. –1.7%.
C. 8.3%.
D. 3.5%.
15% – [4% + 1.25(10% – 4%)] = 3.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
76. A security has an expected rate of return of 0.13 and a beta of 2.1. The market expected rate of return is 0.09,
and the risk-free rate is 0.045. The alpha of the stock is
A. –0.95%.
9-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
B. –1.7%.
C. 8.3%.
D. 5.5%.
13% – [4.5% + 2.1(9% – 4.5%)] = –0.95%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
77. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of
return is 0.13, and the risk-free rate is 0.04. The beta of the stock is
A. 1.25.
B. 1.7.
C. 1.
D. 0.95.
13% = [4% + (13% – 4%)]; 9% = (9%); = 1.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Capital asset pricing model
9-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 09 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
33
AACSB: Reflective Thinking
44
Accessibility: Keyboard Navigation
77
Blooms: Apply
33
Blooms: Remember
36
Blooms: Understand
9
Difficulty: 1 Basic
20
Difficulty: 2 Intermediate
56
Difficulty: 3 Challenge
1
Topic: Beta
5
Topic: Capital allocation
1
Topic: Capital asset pricing model
55
Topic: Capital asset pricing model - academic and industry considerations
3
Topic: Capital asset pricing model - assumptions and extensions
2
Topic: Capital market line
2
Topic: Diversification
1
Topic: Risk premiums
2
Topic: Security market line
6
9-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education
Chapter 10 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. ___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has been found.
2. Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1, and a beta of
.86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on
factor 2 if no arbitrage opportunities exist?
A. 9.26%
B. 3%
C. 4%
D. 7.75%
3. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk.
B. factor sensitivities.
C. idiosyncratic risk.
D. factor betas.
E. factor sensitivities and factor betas.
4. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk.
B. firm-specific risk.
C. idiosyncratic risk.
D. factor betas.
5. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk
B. firm-specific risk.
C. idiosyncratic risk.
D. factor loadings.
6. Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the options are correct.
7. An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit.
A. positive
B. negative
C. zero
D. All of the options.
E. None of the options are correct.
10-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8. The APT was developed in 1976 by
A. Lintner.
B. Modigliani and Miller.
C. Ross.
D. Sharpe.
9. A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any
other factor.
A. factor
B. market
C. index
D. factor and market
E. factor, market, and index
10. The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called
A. arbitrage.
B. capital-asset pricing.
C. factoring.
D. fundamental analysis.
E. None of the options are correct.
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor.
B. firm-specific factors.
C. pricing error.
D. a common macroeconomic factor and firm-specific factors.
12. The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the
_____________ implies that this relationship holds for all but perhaps a small number of securities.
A. APT; CAPM
B. APT; OPM
C. CAPM; APT
D. CAPM; OPM
13. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B has a beta of 0.8 and an
expected return of 12%. The risk-free rate of return is 6%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio __________ and a long position in portfolio
_______.
A. A; A
B. A; B
C. B; A
D. B; B
E. A; the riskless asset
14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and
an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you
should take a short position in portfolio _________ and a long position in portfolio
_________.
A. A; A
B. A; B
C. B; A
D. B; B
10-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a well-diversified portfolio on
the factor is 1.1. The variance of returns on the well-diversified portfolio is approximately
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 10.1%.
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on
the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.56.
17. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of
return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of
A. 0.67.
B. 1.00.
C. 1.30.
D. 1.69.
E. 0.75.
18. Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1, and a beta of
.8 on factor 2. The risk premium on the factor-1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on
factor 2 if no arbitrage opportunities exist?
A. 2%
B. 3%
C. 4%
D. 7.75%
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2.
The risk premiums on the factor-1 and factor-2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The
expected return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 15.0%
C. 16.5%
D. 23.0%
20. Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%,
respectively. Stock A has a beta of 1.2 on factor-1, and a beta of 0.7 on factor-2. The expected return on stock A is 17%. If no
arbitrage opportunities exist, the risk-free rate of return is
A. 6.0%.
B. 6.5%.
C. 6.8%.
D. 7.4%.
21. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor, and portfolio B has a beta of 2.0 on the factor. The
expected returns on portfolios A and B are 11% and 17%, respectively. Assume that the risk-free rate is 6%, and that arbitrage
opportunities exist. Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short $200,000 of
portfolio A. Your expected profit from this strategy would be
A. –$1,000.
B. $0.
C. $1,000.
D. $2,000.
22. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B are 1.0
and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage
opportunities exist, the risk-free rate of return must be
10-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. 4.0%.
B. 9.0%.
C. 14.0%.
D. 16.5%.
23. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The riskfree rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of
A. 1.33.
B. 1.50.
C. 1.67.
D. 2.00.
24. Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of
return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of
A. 0.45.
B. 1.00.
C. 1.10.
D. 1.22.
E. None of the options are corrct.
25. There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of
nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or
weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
If you invested in an equally-weighted portfolio of stocks A and B, your portfolio return would be ___________ if economic growth
were moderate.
A. 3.0%
B. 14.5%
C. 15.5%
D. 16.0%
26. There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of
nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or
weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
If you invested in an equally-weighted portfolio of stocks A and C, your portfolio return would be ____________ if economic
growth was strong.
A. 17.0%
B. 22.5%
C. 30.0%
D. 30.5%
27. If you invested in an equally-weighted portfolio of stocks B and C, your portfolio return would be _____________ if economic
growth was weak.
10-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature
for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The
returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
A. -2.5%
B. 0.5%
C. 3.0%
D. 11.0%
28. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The
following information is available about two well-diversified portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
29. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The
following information is available about two well-diversified portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
30. A zero-investment portfolio with a positive expected return arises when
A. an investor has downside risk only.
B. the law of prices is not violated.
C. the opportunity set is not tangent to the capital-allocation line.
D. a risk-free arbitrage opportunity exists.
31. An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of
A. a dominance argument.
B. the mean-variance efficiency frontier.
C. a risk-free arbitrage.
D. the capital asset pricing model.
32. The APT differs from the CAPM because the APT
10-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. places more emphasis on market risk.
B. minimizes the importance of diversification.
C. recognizes multiple unsystematic risk factors.
D. recognizes multiple systematic risk factors.
33. The feature of the APT that offers the greatest potential advantage over the CAPM is the
A. use of several factors instead of a single market index to explain the risk-return relationship.
B. identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return
relationship.
C. superior measurement of the risk-free rate of return over historical time periods.
D. variability of coefficients of sensitivity to the APT factors for a given asset over time.
E. None of the options are correct.
34. In terms of the risk/return relationship in the APT,
A. only factor risk commands a risk premium in market equilibrium.
B. only systematic risk is related to expected returns.
C. only nonsystematic risk is related to expected returns.
D. only factor risk commands a risk premium in market equilibrium, and only systematic risk is related to expected returns.
E. only factor risk commands a risk premium in market equilibrium, and only nonsystematic risk . is related to expected returns.
35. Which of the following factors might affect stock returns?
A. the business cycle
B. interest rate fluctuations
C. inflation rates
D. All of the options.
36. Advantage(s) of the APT is(are)
A. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios.
B. that the model does not require a specific benchmark market portfolio.
C. that risk need not be considered.
D. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios, and that the
model does not require a specific benchmark market portfolio.
E. that the model does not require a specific benchmark market portfolio, and that risk need not be considered.
37. An important difference between CAPM and APT is
A. CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition.
B. CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are
required to bring the market back to equilibrium.
C. implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments.
D. Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small
changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market
back to equilibrium.
E. All of the options are true.
38. A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather than one who seeks
strict (risk-free) arbitrage opportunities is engaged in
A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.
39. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger, its nonsystematic risk approaches
A. one.
B. infinity.
C. zero.
D. negative one.
40. A well-diversified portfolio is defined as
10-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A.one that is diversified over a large enough number of securities that the nonsystematic variance is essentially zero.
B. one that contains securities from at least three different industry sectors.
C. a portfolio whose factor beta equals 1.0.
D. a portfolio that is equally weighted.
41. The APT requires a benchmark portfolio
A. that is equal to the true market portfolio.
B. that contains all securities in proportion to their market values.
C. that need not be well-diversified.
D. that is well-diversified and lies on the SML.
E. that is unobservable.
42. Imposing the no-arbitrage condition on a single-factor security market implies which of the following statements?
I) The expected return-beta relationship is maintained for all but a small number of well-diversified portfolios.
II) The expected return-beta relationship is maintained for all well-diversified portfolios.
III) The expected return-beta relationship is maintained for all but a small number of individual securities.
IV) The expected return-beta relationship is maintained for all individual securities.
A. I and III
B. I and IV
C. II and III
D. II and IV
E. Only I is correct.
43. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk premium on the first factor
portfolio is 4%, and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8
on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 9.2%
D. 13.0%
E. 13.2%
44. The term "arbitrage" refers to
A. buying low and selling high.
B. short selling high and buying low.
C. earning risk-free economic profits.
D. negotiating for favorable brokerage fees.
E. hedging your portfolio through the use of options.
45. To take advantage of an arbitrage opportunity, an investor would
I) construct a zero-investment portfolio that will yield a sure profit.
II) construct a zero-beta-investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.
A. I and IV
B. I and III
C. II and III
D. I, III, and IV
E. II, III, and IV
46. The factor F in the APT model represents
A. firm-specific risk.
B. the sensitivity of the firm to that factor.
C. a factor that affects all security returns.
D. the deviation from its expected value of a factor that affects all security returns.
E. a random amount of return attributable to firm events.
47. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an
10-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
average value of σ (ei ) equal to 25% and 50 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 14.59%
48. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of (ei
) equal to 20% and 20 securities?
A. 12.5%
B. 625%
C. 4.47%
D. 3.54%
E. 14.59%
49. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of (ei
) equal to 20% and 40 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
50. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of (ei
) equal to 18% and 250 securities?
A. 1.14%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
51. Which of the following is true about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML is not relevant for the APT.
52. Which of the following is false about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
EThe SML has a downward slope, shows expected return in relation to portfolio standard . deviation, and has an intercept equal to
the expected return on the market portfolio.
53. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return must be
A. inversely proportional to the risk-free rate.
B. inversely proportional to its standard deviation.
C. proportional to its weight in the market portfolio.
D. proportional to its standard deviation.
E. proportional to its beta coefficient.
54. Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios have expected returns of 15%
and 6%, respectively. Based on this information, what would be the expected return on well-diversified portfolio A, if A has a beta
of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.
A. 15.2%
10-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. 14.1%
C. 13.3%
D. 10.7%
E. 8.4%
55. Which of the following is(are) true regarding the APT?
I) The security market line does not apply to the APT.
II) More than one factor can be important in determining returns.
III) Almost all individual securities satisfy the APT relationship.
IV) It doesn't rely on the market portfolio that contains all assets.
A. II, III, and IV
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
56. In a factor model, the return on a stock in a particular period will be related to
A. factor risk.
B. nonfactor risk.
C. standard deviation of returns.
D. factor risk and nonfactor risk.
E. None of the options are true.
57. Which of the following factors did Chen, Roll, and Ross not include in their multifactor model?
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
E. All of the factors are included in the Chen, Roll, and Ross multifactor model.
58. Which of the following factors did Chen, Roll, and Ross include in their multifactor model?
A. Change in industrial waste
B. Change in expected inflation
C. Change in unanticipated inflation
D. Change in expected inflation and unanticipated inflation
E. All of the factors were included in their model.
59. Which of the following factors were used by Fama and French in their multifactor model?
A. Return on the market index
B. Excess return of small stocks over large stocks
C. Excess return of high book-to-market stocks over low book-to-market stocks
D. All of the factors were included in their model.
E. None of the factors were included in their model.
60. Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively. The risk-free rate of
return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of
A. 0.67.
B. 0.93.
C. 1.30.
D. 1.69.
61. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 19%. The standard deviation on
the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately
A. 1.58.
B. 1.13.
C. 1.25.
D. 0.76.
10-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
62. Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are
problematic because
A. they may result from data snooping.
B. they are sources of systematic risk.
C. they can be explained by security characteristic lines.
D. they are more appropriate for a single-factor model.
E. they are macroeconomic factors.
63.
Multifactor models seek to improve the performance of the single-index model by
A. modeling the systematic component of firm returns in greater detail.
B. incorporating firm-specific components into the pricing model.
C. allowing for multiple economic factors to have differential effects.
D. All of the options are correct.
E. None of the options are correct.
64. Multifactor models, such as the one constructed by Chen, Roll, and Ross, can better describe assets'returns by
A. expanding beyond one factor to represent sources of systematic risk.
B. using variables that are easier to forecast ex ante.
C. calculating beta coefficients by an alternative method.
D. using only stocks with relatively stable returns.
E. ignoring firm-specific risk.
65. Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta of 1.1 on factor 2, and a
beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free
rate of return is 3%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 13.4%
C. 16.5%
D. 23.0%
66. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%, respectively. The riskfree rate of return is 4%. Stock A has an expected return of 16% and a beta on factor-1 of 1.3. Stock A has a beta on factor-2 of
A. 1.33.
B. 1.05.
C. 1.67.
D. 2.00.
67. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk premium on the first-factor
portfolio is 4%, and the risk premium on the second-factor portfolio is 6%. If portfolio A has a beta of 0.6 on the first factor and 1.8
on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 18.2%
D. 13.0%
E. 13.2%
68. Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an
expected return of 17%. The risk-free rate of return is 4%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio __________ and a long position in portfolio
_______.
A. A; A
B. A; B
C. B; A
D. B; B
E. A; the riskless asset
10-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
69. Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an
expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio _________ and a long position in portfolio
_________.
A. A; A
B. A; B
C. B; A
D. B; B
70. Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a well-diversified portfolio on
the factor is 1.25. The variance of returns on the well-diversified portfolio is approximately
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
71. Consider the one-factor APT. The variance of returns on the factor portfolio is 11%. The beta of a well-diversified portfolio on
the factor is 1.45. The variance of returns on the well-diversified portfolio is approximately
A. 23.1%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
72. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%. The standard deviation on
the factor portfolio is 14%. The beta of the well-diversified portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.57.
Chapter 10 Test Bank - Static Key
Multiple Choice Questions
1. ___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has been found.
Both models attempt to explain asset pricing based on risk/return relationships.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
2. Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1, and a beta of
.86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on
factor 2 if no arbitrage opportunities exist?
A. 9.26%
B. 3%
C. 4%
D. 7.75%
17.6% = 1.45(3.2%) + 0.86x + 5%; x = 9.26.
10-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Arbitrage pricing theory
3. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk.
B. factor sensitivities.
C. idiosyncratic risk.
D. factor betas.
E. factor sensitivities and factor betas.
The coefficients are called factor betas, factor sensitivities, or factor loadings.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Multifactor models
4. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk.
B. firm-specific risk.
C. idiosyncratic risk.
D. factor betas.
The coefficients are called factor betas, factor sensitivities, or factor loadings.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Multifactor models
5. In a multifactor APT model, the coefficients on the macro factors are often called
A. systematic risk
B. firm-specific risk.
C. idiosyncratic risk.
D. factor loadings.
The coefficients are called factor betas, factor sensitivities, or factor loadings.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Multifactor models
6. Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the options are correct.
The multifactor APT provides no guidance as to the determination of the risk premium on the various factors. The CAPM assumes
that the excess market return over the risk-free rate is the market premium in the single factor CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
7. An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit.
10-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. positive
B. negative
C. zero
D. All of the options.
E. None of the options are correct.
If the investor can construct a portfolio without the use of the investor's own funds and the portfolio yields a positive profit,
arbitrage opportunities exist.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
8. The APT was developed in 1976 by
A. Lintner.
B. Modigliani and Miller.
C. Ross.
D. Sharpe.
Ross developed this model in 1976.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
9. A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any
other factor.
A. factor
B. market
C. index
D. factor and market
E. factor, market, and index
A factor model portfolio has a beta of 1 one factor, with zero betas on other factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
10. The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called
A. arbitrage.
B. capital-asset pricing.
C. factoring.
D. fundamental analysis.
E. None of the options are correct.
Arbitrage is earning of positive profits with a zero (risk-free) investment.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor.
B. firm-specific factors.
C. pricing error.
D. a common macroeconomic factor and firm-specific factors.
10-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
12. The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the
_____________ implies that this relationship holds for all but perhaps a small number of securities.
A. APT; CAPM
B. APT; OPM
C. CAPM; APT
D. CAPM; OPM
The CAPM is an asset-pricing model based on the risk/return relationship of all assets. The APT implies that this relationship holds
for all well-diversified portfolios, and for all but perhaps a few individual securities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
13. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B has a beta of 0.8 and an
expected return of 12%. The risk-free rate of return is 6%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio __________ and a long position in portfolio _______.
A. A; A
B. A; B
C. B; A
D. B; B
E. A; the riskless asset
A: 16% = 1.0F + 6%; F = 10%;
B: 12% = 0.8F + 6%: F = 7.5%; thus, short B and take a long position in A.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an
expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio _________ and a long position in portfolio _________.
A. A; A
B. A; B
C. B; A
D. B; B
A:
13% = 10% + 0.2F; F = 15%;
B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and take a long position in A.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a well-diversified portfolio on
the factor is 1.1. The variance of returns on the well-diversified portfolio is approximately
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 10.1%.
10-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
s 2P = (1.1)2(6%) = 7.26%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on
the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.56.
(18%)2 = (16%)2 b2; b = 1.125.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
17. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of
return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of
A. 0.67.
B. 1.00.
C. 1.30.
D. 1.69.
E. 0.75.
Stock B’s E(RP) = 1 × (0.18 – 0.06) = 0.12 or 12%. Stock A’s E(RM) = (0.15 – 0.06) = 0.09 or 9%. Therefore stock A’s beta must
equal 0.09/0.12 = 0.75.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
18. Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1, and a beta of
.8 on factor 2. The risk premium on the factor-1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on
factor 2 if no arbitrage opportunities exist?
A. 2%
B. 3%
C. 4%
D. 7.75%
16.4% = 1.4(3%) + 0.8x + 6%; x = 7.75.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Arbitrage pricing theory
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2.
The risk premiums on the factor-1 and factor-2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The
expected return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 15.0%
C. 16.5%
D. 23.0%
10-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7% + 0.75(1%) + 1.25(7%) = 16.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
20. Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%,
respectively. Stock A has a beta of 1.2 on factor-1, and a beta of 0.7 on factor-2. The expected return on stock A is 17%. If no
arbitrage opportunities exist, the risk-free rate of return is
A. 6.0%.
B. 6.5%.
C. 6.8%.
D. 7.4%.
17% = x% + 1.2(5%) + 0.7(6%); x = 6.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
21. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor, and portfolio B has a beta of 2.0 on the factor. The
expected returns on portfolios A and B are 11% and 17%, respectively. Assume that the risk-free rate is 6%, and that arbitrage
opportunities exist. Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short $200,000 of
portfolio A. Your expected profit from this strategy would be
A. –$1,000.
B. $0.
C. $1,000.
D. $2,000.
$100,000(0.06) = $6,000 (risk-free position); $100,000(0.17) = $17,000 (portfolio B); –$200,000(0.11) = – $22,000 (short position,
portfolio A); 1,000 profit.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
22. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B are 1.0
and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage
opportunities exist, the risk-free rate of return must be
A. 4.0%.
B. 9.0%.
C. 14.0%.
D. 16.5%.
A: 19% = rf + 1(F); B: 24% = rf + 1.5(F); 5% = .5(F); F = 10%; 24% = rf + 1.5(10); rf = 9%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
23. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The riskfree rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of
A. 1.33.
B. 1.50.
C. 1.67.
D. 2.00.
19% = 10% + 5%(0.8) + 3%(x); x = 1.67.
10-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
24. Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of
return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of
A. 0.45.
B. 1.00.
C. 1.10.
D. 1.22.
E. None of the options are corrct.
A: 14% = 7% + 0.7F; F = 10; B: 18% = 7% + 10b; b = 1.10.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
25. There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of
nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or
weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
If you invested in an equally-weighted portfolio of stocks A and B, your portfolio return would be ___________ if economic growth
were moderate.
A. 3.0%
B. 14.5%
C. 15.5%
D. 16.0%
E(Rp) = 0.5(17%) + 0.5(15%) = 16%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
26. There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of
nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or
weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
If you invested in an equally-weighted portfolio of stocks A and C, your portfolio return would be ____________ if economic
growth was strong.
10-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. 17.0%
B. 22.5%
C. 30.0%
D. 30.5%
0.5(39%) + 0.5(6%) = 22.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
27. If you invested in an equally-weighted portfolio of stocks B and C, your portfolio return would be _____________ if economic
growth was weak.
There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature
for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The
returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:
A. -2.5%
B. 0.5%
C. 3.0%
D. 11.0%
0.5(0%) + 0.5(22%) = 11%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Expected return
10-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
28. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The
following information is available about two well-diversified portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) + 0.0(RP2); 26% = 6% + 4.0(RP2); RP2 = 5;
A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Multifactor models
29. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The
following information is available about two well-diversified portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) + 0.0(RP2); 26% = 6% + 4.0(RP2); RP2 = 5;
A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Multifactor models
30. A zero-investment portfolio with a positive expected return arises when
A. an investor has downside risk only.
B. the law of prices is not violated.
C. the opportunity set is not tangent to the capital-allocation line.
D. a risk-free arbitrage opportunity exists.
When an investor can create a zero-investment portfolio (by using none of the investor's own funds) with a possibility of a positive
profit, a risk-free arbitrage opportunity exists.
10-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
31. An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of
A. a dominance argument.
B. the mean-variance efficiency frontier.
C. a risk-free arbitrage.
D. the capital asset pricing model.
When the equilibrium price is violated, the investor will buy the lower priced asset and simultaneously place an order to sell the
higher priced asset. Such transactions result in risk-free arbitrage. The larger the positions, the greater the risk-free arbitrage profits.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
32. The APT differs from the CAPM because the APT
A. places more emphasis on market risk.
B. minimizes the importance of diversification.
C. recognizes multiple unsystematic risk factors.
D. recognizes multiple systematic risk factors.
The CAPM assumes that market returns represent systematic risk. The APT recognizes that other macroeconomic factors may be
systematic risk factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
33. The feature of the APT that offers the greatest potential advantage over the CAPM is the
A. use of several factors instead of a single market index to explain the risk-return relationship.
B. identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return
relationship.
C. superior measurement of the risk-free rate of return over historical time periods.
D. variability of coefficients of sensitivity to the APT factors for a given asset over time.
E. None of the options are correct.
The advantage of the APT is the use of multiple factors, rather than a single market index, to explain the risk-return relationship.
However, APT does not identify the specific factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
34. In terms of the risk/return relationship in the APT,
A. only factor risk commands a risk premium in market equilibrium.
B. only systematic risk is related to expected returns.
C. only nonsystematic risk is related to expected returns.
D. only factor risk commands a risk premium in market equilibrium, and only systematic risk is . related to expected returns.
E. only factor risk commands a risk premium in market equilibrium, and only nonsystematic risk is related to expected returns.
Nonfactor risk may be diversified away; thus, only factor risk commands a risk premium in market equilibrium. Nonsystematic risk
across firms cancels out in well-diversified portfolios; thus, only systematic risk is related to expected returns.
AACSB: Reflective Thinking
10-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
35. Which of the following factors might affect stock returns?
A. the business cycle
B. interest rate fluctuations
C. inflation rates
D. All of the options.
All of the options are likely to affect stock returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Multifactor models
36. Advantage(s)
of the APT is(are)
A. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios.
B. that the model does not require a specific benchmark market portfolio.
C. that risk need not be considered.
D. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios, and that the
model does not require a specific benchmark market portfolio.
E. that the model does not require a specific benchmark market portfolio, and that risk need not be considered.
The APT provides no guidance concerning the determination of the risk premiums on the factor portfolios. Risk must be considered
in both the CAPM and APT. A major advantage of APT over the CAPM is that a specific benchmark market portfolio is not
required.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
37. An important difference between CAPM and APT is
A. CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition.
B. CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are
required to bring the market back to equilibrium.
C. implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments.
D. Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small
changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market
back to equilibrium.
E. All of the options are true.
Under the risk-return dominance argument of CAPM, when an equilibrium price is violated many investors will make small
portfolio changes, depending on their risk tolerance, until equilibrium is restored. Under the no-arbitrage argument of APT, each
investor will take as large a position as possible so only a few investors must act to restore equilibrium. Implications derived from
APT are much stronger than those derived from CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Arbitrage pricing theory
38. A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather than one who seeks
strict (risk-free) arbitrage opportunities is engaged in
A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.
10-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Risk arbitrage involves searching for mispricing based on speculative information that may or may not materialize.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
39. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger, its nonsystematic risk approaches
A. one.
B. infinity.
C. zero.
D. negative one.
As the number of securities, n, increases, the nonsystematic risk of a well-diversified portfolio approaches zero.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
40. A well-diversified portfolio is defined as
A.one that is diversified over a large enough number of securities that the nonsystematic variance is essentially zero.
B. one that contains securities from at least three different industry sectors.
C. a portfolio whose factor beta equals 1.0.
D. a portfolio that is equally weighted.
A well-diversified portfolio is one that contains a large number of securities, each having a small (but not necessarily equal) weight,
so that nonsystematic variance is negligible.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
41. The APT requires a benchmark portfolio
A. that is equal to the true market portfolio.
B. that contains all securities in proportion to their market values.
C. that need not be well-diversified.
D. that is well-diversified and lies on the SML.
E. that is unobservable.
Any well-diversified portfolio lying on the SML can serve as the benchmark portfolio for the APT. The true (and unobservable)
market portfolio is only a requirement for the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
42. Imposing the no-arbitrage condition on a single-factor security market implies which of the following statements?
I) The expected return-beta relationship is maintained for all but a small number of well-diversified portfolios.
II) The expected return-beta relationship is maintained for all well-diversified portfolios.
III) The expected return-beta relationship is maintained for all but a small number of individual securities.
IV) The expected return-beta relationship is maintained for all individual securities.
A. I and III
B. I and IV
C. II and III
D. II and IV
10-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. Only I is correct.
The expected return-beta relationship must hold for all well-diversified portfolios and for all but a few individual securities;
otherwise arbitrage opportunities will be available.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
43. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk premium on the first factor
portfolio is 4%, and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8
on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 9.2%
D. 13.0%
E. 13.2%
0.06 + 1.2 (0.04) + 0.8 (0.03) = 0.132.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Multifactor models
44. The term "arbitrage" refers to
A. buying low and selling high.
B. short selling high and buying low.
C. earning risk-free economic profits.
D. negotiating for favorable brokerage fees.
E. hedging your portfolio through the use of options.
Arbitrage is exploiting security mispricing by the simultaneous purchase and sale to gain economic profits without taking any risk.
A capital market in equilibrium rules out arbitrage opportunities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Arbitrage pricing theory
45. To take advantage of an arbitrage opportunity, an investor would
I) construct a zero-investment portfolio that will yield a sure profit.
II) construct a zero-beta-investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.
A. I and IV
B. I and III
C. II and III
D. I, III, and IV
E. II, III, and IV
Only I and III are correct. II is incorrect because the beta of the portfolio does not need to be zero. IV is incorrect because the
opposite is true.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Arbitrage pricing theory
10-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
46. The factor F in the APT model represents
A. firm-specific risk.
B. the sensitivity of the firm to that factor.
C. a factor that affects all security returns.
D. the deviation from its expected value of a factor that affects all security returns.
E. a random amount of return attributable to firm events.
F measures the unanticipated portion of a factor that is common to all security returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
47. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an
average value of σ(ei ) equal to 25% and 50 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 14.59%
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
48. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an
average value of
(ei ) equal to 20% and 20 securities?
A. 12.5%
B. 625%
C. 4.47%
D. 3.54%
E. 14.59%
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
49. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an
average value of σ(ei ) equal to 20% and 40 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
10-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Topic: Arbitrage pricing theory
50. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an
average value of σ(ei ) equal to 18% and 250 securities?
A. 1.14%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
51. Which of the following is true about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML is not relevant for the APT.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the APT, but can be any well-diversified
portfolio. The intercept still equals the risk-free rate.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
52. Which of the following is false about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML has a downward slope, shows expected return in relation to portfolio standard . deviation, and has an intercept equal to
the expected return on the market portfolio.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the APT, but can be any well-diversified
portfolio. The intercept still equals the risk-free rate.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
53. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return must be
A. inversely proportional to the risk-free rate.
B. inversely proportional to its standard deviation.
C. proportional to its weight in the market portfolio.
D. proportional to its standard deviation.
E. proportional to its beta coefficient.
For each well-diversified portfolio (P and Q, for example), it must be true that [E(rp) – rf ]/ßp = [E(rQ) – rf ]/
Q.
AACSB: Reflective Thinking
10-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
54. Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios have expected returns of 15%
and 6%, respectively. Based on this information, what would be the expected return on well-diversified portfolio A, if A has a beta
of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.
A. 15.2%
B. 14.1%
C. 13.3%
D. 10.7%
E. 8.4%
E(RA) = 3 + 0.8 × (15 – 3) + 0.5 × (6 – 3) = 14.1.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Multifactor models
55. Which of the following is(are) true regarding the APT?
I) The security market line does not apply to the APT.
II) More than one factor can be important in determining returns.
III) Almost all individual securities satisfy the APT relationship. IV) It doesn't rely on the market portfolio that contains all assets.
A. II, III, and IV
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
All except the first item are true. There is a security market line associated with the APT.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
56. In a factor model, the return on a stock in a particular period will be related to
A. factor risk.
B. nonfactor risk.
C. standard deviation of returns.
D. factor risk and nonfactor risk.
E. None of the options are true.
Factor models explain firm returns based on both factor risk and nonfactor risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Multifactor models
57. Which of the following factors did Chen, Roll, and Ross not include in their multifactor model?
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
10-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. All of the factors are included in the Chen, Roll, and Ross multifactor model.
Chen, Roll, and Ross included the four listed factors as well as the excess return of long-term corporate bonds over long-term
government bonds in their model.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Multifactor models
58. Which of the following factors did Chen, Roll, and Ross include in their multifactor model?
A. Change in industrial waste
B. Change in expected inflation
C. Change in unanticipated inflation
D. Change in expected inflation and unanticipated inflation
E. All of the factors were included in their model.
Chen, Roll, and Ross included the change in expected inflation and the change in unanticipated inflation as well as the excess return
of long-term corporate bonds over long-term government bonds in their model.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Multifactor models
59. Which of the following factors were used by Fama and French in their multifactor model?
A. Return on the market index
B. Excess return of small stocks over large stocks
C. Excess return of high book-to-market stocks over low book-to-market stocks
D. All of the factors were included in their model.
E. None of the factors were included in their model.
Fama and French included all three of the factors listed.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fama-French three-factor model
60. Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively. The risk-free rate of
return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of
A. 0.67.
B. 0.93.
C. 1.30.
D. 1.69.
A: 12% = 5% + bF; B: 14% = 5% + 1.2F; F = 7.5%; Thus, beta of A = 7/7.5 = 0.93.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
61. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 19%. The standard deviation on
the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately
A. 1.58.
B. 1.13.
C. 1.25.
D. 0.76.
10-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
(19%)2 = (12%)2b2; b = 1.58.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
62. Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are
problematic because
A. they may result from data snooping.
B. they are sources of systematic risk.
C. they can be explained by security characteristic lines.
D. they are more appropriate for a single-factor model.
E. they are macroeconomic factors.
Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are problematic
because they may result from data snooping.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Fama-French three-factor model
63. Multifactor models seek to improve the performance of the single-index model by
A. modeling the systematic component of firm returns in greater detail.
B. incorporating firm-specific components into the pricing model.
C. allowing for multiple economic factors to have differential effects.
D. All of the options are correct.
E. None of the options are correct.
Multifactor models seek to improve the performance of the single-index model by modeling the systematic component of firm
returns in greater detail, incorporating firm-specific components into the pricing model, and allowing for multiple economic factors
to have differential effects.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Multifactor models
64. Multifactor models, such as the one constructed by Chen, Roll, and Ross, can better describe assets'returns by
A. expanding beyond one factor to represent sources of systematic risk.
B. using variables that are easier to forecast ex ante.
C. calculating beta coefficients by an alternative method.
D. using only stocks with relatively stable returns.
E. ignoring firm-specific risk.
The study used five different factors to explain security returns, allowing for several sources of risk to affect the returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Multifactor models
65. Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta of 1.1 on factor 2, and a
beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free
rate of return is 3%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 13.4%
C. 16.5%
D. 23.0%
10-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3% + 0.8(3%) + 1.1(5%) + 1.25(2%) = 13.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Multifactor models
66. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%, respectively. The riskfree rate of return is 4%. Stock A has an expected return of 16% and a beta on factor-1 of 1.3. Stock A has a beta on factor-2 of
A. 1.33.
B. 1.05.
C. 1.67.
D. 2.00.
16% = 4% + 6%(1.3) + 4%(x); x = 1.05.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Multifactor models
67. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk premium on the first-factor
portfolio is 4%, and the risk premium on the second-factor portfolio is 6%. If portfolio A has a beta of 0.6 on the first factor and 1.8
on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 18.2%
D. 13.0%
E. 13.2%
0.05 + 0.6 (0.04) + 1.8 (0.06) = 0.182.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
68. Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an
expected return of 17%. The risk-free rate of return is 4%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio __________ and a long position in portfolio _______.
A. A; A
B. A; B
C. B; A
D. B; B
E. A; the riskless asset
A: 22% = 2.0F + 4%; F = 9%; B: 17% = 1.5F + 4%: F = 8.67%; thus, short B and take a long position in A.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
10-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
69. Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an
expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should
take a short position in portfolio _________ and a long position in portfolio _________.
A. A; A
B. A; B
C. B; A
D. B; B
A: 12% = 5% + 0.5F; F = 14%; B: 13% = 5% + 0.4F; F = 20%; therefore, short A and take a long position in B.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
70. Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a well-diversified portfolio on
the factor is 1.25. The variance of returns on the well-diversified portfolio is approximately
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
s 2P = (1.25)2(9%) = 14.06%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
71. Consider the one-factor APT. The variance of returns on the factor portfolio is 11%. The beta of a well-diversified portfolio on
the factor is 1.45. The variance of returns on the well-diversified portfolio is approximately
A. 23.1%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
s 2P = (1.45)2(11%) = 23.13%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
72. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%. The standard deviation on
the factor portfolio is 14%. The beta of the well-diversified portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.57.
(22%)2 = (14%)2b2; b = 1.57.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Arbitrage pricing theory
10-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 10 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Difficulty: 3 Challenge
Topic: Arbitrage pricing theory
Topic: Expected return
Topic: Fama-French three-factor model
Topic: Multifactor models
# of Questions
33
39
72
34
25
13
19
47
6
52
3
2
15
10-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
10-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 11 Test Bank - Static
Student: ___________________________________________________________________________
1. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information, including historical
stock prices and current public information about the firm, but not information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
2. When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock market was __________. Now,
these random price movements are believed to be _________.
A. inefficient; the effect of a well-functioning market
B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a well-functioning market
E. irrational; even more irrational than before
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
4. A hybrid strategy is one where the investor
A. uses both fundamental and technical analysis to select stocks.
B. selects the stocks of companies that specialize in alternative fuels.
C. selects some actively-managed mutual funds on their own and uses an investment advisor to select other actively-managed funds.
D. maintains a passive core and augments the position with an actively-managed portfolio.
5. The difference between a random walk and a submartingale is the expected price change in a random walk is ______, and the
expected price change for a submartingale is ______.
A. positive; zero
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
6. Proponents of the EMH typically advocate
A. an active trading strategy.
B. investing in an index fund.
C. a passive investment strategy.
D. an active trading strategy and investing in an index fund.
E. investing in an index fund and a passive investment strategy.
11-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
7. Proponents of the EMH typically advocate
A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
C. a passive investment strategy.
D. buying individual stocks on margin, trading frequently, and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
8. If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by
examining market trading data, such as the history of past stock prices, trading volume or short interest.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
9. If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including
information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
10. If you believe in the reversal effect, you should
A. buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. buy stocks this period that performed poorly last period and go short.
11. __________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
12. _________ above which it is difficult for the market to rise.
A. A book value is a value
B. A resistance level is a value
C. A support level is a value
D. A book value and a resistance level are values
E. A book value and a support level are values
13. _________ below which it is difficult for the market to fall.
A. An intrinsic value is a value
B. A resistance level is a value
C. A support level is a value
D. An intrinsic value and a resistance level are values
E. A resistance level and a support level are values
11-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. ___________ the return on a stock beyond what would be predicted from market movements alone.
A. An irrational return is
B. An economic return is
C. An abnormal return is
D. None of the options are correct.
E. All of the options are correct.
15. The debate over whether markets are efficient will probably never be resolved because of
A. the lucky event issue.
B. the magnitude issue.
C. the selection bias issue.
D. All of the options are correct.
E. None of the options are correct.
16. A common strategy for passive management is
A. creating an index fund.
B. creating a small firm fund.
C. creating an investment club.
D. creating an index fund and creating an investment club.
E. creating a small firm fund and creating an investment club.
17. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields than firms with high P/E ratios.
18. Basu (1977, 1983) found that firms with high P/E ratios
A. earned higher average returns than firms with low P/E ratios.
B. earned the same average returns as firms with low P/E ratios.
C. earned lower average returns than firms with low P/E ratios.
D. had higher dividend yields than firms with low P/E ratios.
19. Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
20. Jaffe (1974) found that stock prices _________ after insiders intensively sold shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
11-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
21. Banz (1981) found that, on average, the risk-adjusted returns of small firms
A. were higher than the risk-adjusted returns of large firms.
B. were the same as the risk-adjusted returns of large firms.
C. were lower than the risk-adjusted returns of large firms.
D. were unrelated to the risk-adjusted returns of large firms.
E. were negative.
22. Banz (1981) found that, on average, the risk-adjusted returns of large firms
A. were higher than the risk-adjusted returns of small firms.
B. were the same as the risk-adjusted returns of small firms.
C. were lower than the risk-adjusted returns of small firms.
D. were unrelated to the risk-adjusted returns of small firms.
E. were negative.
23. Proponents of the EMH think technical analysts
A. should focus on relative strength.
B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
24. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. a positive abnormal return on the day positive earnings surprises are announced and a positive drift in the stock price on the days
following the earnings surprise announcement.
E. a positive abnormal return on the day positive earnings surprises are announced and a negative drift in the stock price on the days
following the earnings surprise announcement.
25. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. a negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the
days following the earnings surprise announcement.
E. a negative abnormal return on the day that negative earnings surprises are announced and a negative drift in the stock price on the
days following the earnings surprise announcement.
26. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
11-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
27. On November 22, the stock price of WalMart was $69.50, and the retailer stock index was 600.30. On November 25, the stock
price of WalMart was $70.25, and the retailer stock index was 605.20. Consider the ratio of WalMart to the retailer index on
November 22 and November 25. WalMart is _______ the retail industry, and technical analysts who follow relative strength would
advise _______ the stock.
A. outperforming; buying
B. outperforming; selling
C. underperforming; buying
D. underperforming; selling
E. equally performing; neither buying nor selling
28. Work by Amihud and Mendelson (1986, 1991)
A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
C. may be related to the neglected firm effect.
D. may help explain the small firm effect and may be related to the neglected firm effect.
E. All of the options are correct.
29. Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market ratios had an average annual
return of _______, while the stocks of firms within the lowest decile of book-to-market ratios had an average annual return of
________.
A. 15.6%; 13.1%
B. 17.2%; 11.1%
C. 13.2%; 16.4%
D. 11.1%; 17.2%
30. A market decline of 23% on a day when there is no significant macroeconomic event ______ consistent with the EMH because
________.
A. would be; it was a clear response to macroeconomic news
B. would be; it was not a clear response to macroeconomic news
C. would not be; it was a clear response to macroeconomic news
D. would not be; it was not a clear response to macroeconomic news
31. In an efficient market,
A. security prices react quickly to new information.
B. security prices are seldom far above or below their justified levels.
C. security analysis will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. security prices react quickly to new information, security prices are seldom far above or below their justified levels, and security
analysis will not enable investors to realize superior returns consistently.
32. The weak form of the efficient-market hypothesis asserts that
A. stock prices do not rapidly adjust to new information contained in past prices or past data.
B. future changes in stock prices cannot be predicted from past prices.
C. technicians cannot expect to outperform the market.
D. stock prices do not rapidly adjust to new information contained in past prices or past data, and future changes in stock prices cannot
be predicted from past prices.
E. future changes in stock prices cannot be predicted from past prices, and technicians cannot expect to outperform the market.
11-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
33. A support level is the price range at which a technical analyst would expect the
A. supply of a stock to increase dramatically.
B. supply of a stock to decrease substantially.
C. demand for a stock to increase substantially.
D. demand for a stock to decrease substantially.
E. price of a stock to fall.
34. A finding that _________ would provide evidence against the semistrong form of the efficient-market theory.
A. low P/E stocks tend to have positive abnormal returns
B. trend analysis is worthless in determining stock prices
C. one can consistently outperform the market by adopting the contrarian approach exemplified by the reversals phenomenon
D. low P/E stocks tend to have positive abnormal returns and trend analysis is worthless in determining stock prices
E. low P/E stocks tend to have positive abnormal returns and one can consistently outperform the market by adopting the contrarian
approach exemplified by the reversals phenomenon
35. The weak form of the efficient-market hypothesis contradicts
A. technical analysis but supports fundamental analysis as valid.
B. fundamental analysis but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis but is silent on the possibility of successful fundamental analysis.
36. Two basic assumptions of technical analysis are that security prices adjust
A. rapidly to new information, and market prices are determined by the interaction of supply and demand.
B. rapidly to new information, and liquidity is provided by security dealers.
C. gradually to new information, and market prices are determined by the interaction of supply and demand.
D. gradually to new information, and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
37. Cumulative abnormal returns (CAR)
A. are used in event studies.
B. are better measures of security returns due to firm-specific events than are abnormal returns (AR).
C. are cumulated over the period prior to the firm-specific event.
D. are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns (AR).
E. are used in event studies and are cumulated over the period prior to the firm-specific event.
38. Studies of mutual-fund performance
A. indicate that one should not randomly select a mutual fund.
B. indicate that historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. indicate that one should not randomly select a mutual fund and indicate that historical performance is not necessarily indicative of
future performance.
E. indicate that historical performance is not necessarily indicative of future performance and indicate that the professional
management of the fund insures above market returns.
11-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
39. The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by
chance should be
A. between 50% and 70%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
40. In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
41. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus
harvest. In an efficient market, one would expect the price of Florida Orange's stock to
A. drop immediately.
B. unable to determine.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.
42. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%.
You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that
A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
43. Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth
quarter. Nicholas had an abnormal return of 1.2% yesterday. This suggests that
A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
44. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.
B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a distinct pattern.
11-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
45. If stock prices follow a random walk,
A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.
46. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.
B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.
47. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.
48. Which of the following are used by fundamental analysts to determine proper stock prices? I) Trendlines
II) Earnings
III) Dividend prospects
IV) Expectations of future interest rates
V) Resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
49. Which of the following are used by technical analysts to determine proper stock prices? I) Trendlines
II) Earnings
III) Dividend prospects
IV) Expectations of future interest rates
V) Resistance levels
A. I and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
50. According to proponents of the efficient-market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is
probably to
A. perform fundamental analysis.
B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual funds.
11-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
51. Which of the following are investment superstars who have consistently shown superior performance? I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
52. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free rate is currently 5%. You observe that
Google had an annualized return yesterday of 14%. Assuming that markets are efficient, this suggests that
A. bad news about Google was announced yesterday.
B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
53. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You
observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that
A. bad news about Music Doctors was announced yesterday.
B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
54. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate is currently 3%. You observe that
QQAG had an annualized return yesterday of 20%. Assuming that markets are efficient, this suggests that
A. bad news about QQAG was announced yesterday.
B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
55. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's fourth quarter. You observe
that QQAG had an abnormal return of 1.7% yesterday. This suggests that
A. the market is not efficient.
B. QQAG stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
56. LJP Corporation just announced yesterday that it would undertake an international joint venture. You observe that LJP had an
abnormal return of 3% yesterday. This suggests that
A. the market is not efficient.
B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
E. earnings are expected to decrease next quarter.
11-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
57. Music Doctors just announced yesterday that its first quarter sales were 35% higher than last year's first quarter. You observe that
Music Doctors had an abnormal return of 2% yesterday. This suggests that
A. the market is not efficient.
B. Music Doctors stock will probably rise in value tomorrow.
C. investors expected the sales increase to be larger than what was actually announced.
D. investors expected the sales increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
58. The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from
King. You observe that King had an abnormal return of 0% yesterday. This suggests that
A. the market is not efficient.
B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
59. Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the
trading rule to herself. This is most closely associated with
A. regret avoidance.
B. selection bias.
C. framing.
D. insider trading.
60. At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads).
This is most closely associated with
A. regret avoidance.
B. selection bias.
C. overconfidence.
D. the lucky event issue.
61. Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that information, would be
A. extremely profitable for long-term traders.
B. extremely profitable for short-term traders.
C. marginally profitable for long-term traders.
D. marginally profitable for short-term traders.
E. not sufficiently profitable to cover trading costs.
62. If you believe in the reversal effect, you should
A. sell bonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. sell stocks this period that performed well last period and go long.
11-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
63. Patell and Woflson (1984) report that most of the stock-price response to corporate dividend or earnings announcements occurs
within ____________ of the announcement.
A. 10 minutes
B. 45 minutes
C. 2 hours
D. 4 hours
E. 2 trading days
64. Del Guerico and Reuter (2014) report that the average underperformance of actively-managed mutual funds is driven largely by
A. sector mutual funds.
B. index funds.
C. direct-sold funds.
D. broker-sold funds.
E. bank-sold mutual funds.
11-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 11 Test - Bank Static Key
Multiple Choice Questions
1. If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information, including historical
stock prices and current public information about the firm, but not information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
The semistrong form of the EMH maintains that stock prices immediately reflect all historical and current public information, but not
inside information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - foundations and types
2. When Maurice Kendall examined the patterns of stock returns in 1953, he concluded that the stock market was __________. Now,
these random price movements are believed to be _________.
A. inefficient; the effect of a well-functioning market
B. efficient; the effect of an inefficient market
C. inefficient; the effect of an inefficient market
D. efficient; the effect of a well-functioning market
E. irrational; even more irrational than before
Random price changes were originally thought to be driven by irrationality. Now, financial economists believe random price changes
occur because markets are informationally efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Market efficiency - studies and challenges
3. The stock market follows a
A. nonrandom walk.
B. submartingale.
C. predictable pattern that can be exploited.
D. nonrandom walk and predictable pattern that can be exploited.
E. submartingale and predictable pattern that can be exploited.
The stock market follows a submartingale.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Efficient market hypothesis
11-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
4. A hybrid strategy is one where the investor
A. uses both fundamental and technical analysis to select stocks.
B. selects the stocks of companies that specialize in alternative fuels.
C. selects some actively-managed mutual funds on their own and uses an investment advisor to select other actively-managed funds.
D. maintains a passive core and augments the position with an actively-managed portfolio.
A hybrid strategy is one where the investor maintains a passive core and augments the position with an actively managed portfolio.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Portfolio management
5. The difference between a random walk and a submartingale is the expected price change in a random walk is ______, and the
expected price change for a submartingale is ______.
A. positive; zero
B. positive; positive
C. positive; negative
D. zero; positive
E. zero; zero
A random walk has an expected price change of zero, and a submartingale has a positive expected price change.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Efficient market hypothesis
6. Proponents of the EMH typically advocate
A. an active trading strategy.
B. investing in an index fund.
C. a passive investment strategy.
D. an active trading strategy and investing in an index fund.
E. investing in an index fund and a passive investment strategy.
Believers of market efficiency advocate passive investment strategies, and an investment in an index fund is one of the most practical
passive investment strategies, especially for small investors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Efficient market hypothesis
7. Proponents of the EMH typically advocate
A. buying individual stocks on margin and trading frequently.
B. investing in hedge funds.
C. a passive investment strategy.
D. buying individual stocks on margin, trading frequently, and investing in hedge funds.
E. investing in hedge funds and a passive investment strategy.
Believers of market efficiency advocate passive investment strategies, and an investment in an index fund is one of the most practical
passive investment strategies, especially for small investors.
11-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Efficient market hypothesis
8. If you believe in the _______ form of the EMH, you believe that stock prices only reflect all information that can be derived by
examining market trading data, such as the history of past stock prices, trading volume or short interest.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
The information described above is market data, which is the data set for the weak form of market efficiency. The semistrong form
includes the above plus all other public information. The strong form includes all public and private information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - foundations and types
9. If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including
information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. All of the options are correct.
E. None of the options are correct.
The strong form includes all public and private information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - foundations and types
10. If you believe in the reversal effect, you should
A. buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. buy stocks this period that performed poorly last period and go short.
The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent period, and vice versa.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - studies and challenges
11-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
11. __________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts
Technicians attempt to predict future stock prices based on historical stock prices.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Technical analysis
12. _________ above which it is difficult for the market to rise.
A. A book value is a value
B. A resistance level is a value
C. A support level is a value
D. A book value and a resistance level are values
E. A book value and a support level are values
When stock prices have remained stable for a long period, these prices are termed resistance levels; technicians believe it is difficult
for the stock prices to penetrate these resistance levels.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Technical analysis
13. _________ below which it is difficult for the market to fall.
A. An intrinsic value is a value
B. A resistance level is a value
C. A support level is a value
D. An intrinsic value and a resistance level are values
E. A resistance level and a support level are values
When stock prices have remained stable for a long period, these prices are termed support levels; technicians believe it is difficult for
the stock prices to penetrate these support levels.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Technical analysis
11-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
14. ___________ the return on a stock beyond what would be predicted from market movements alone.
A. An irrational return is
B. An economic return is
C. An abnormal return is
D. None of the options are correct.
E. All of the options are correct.
An economic return is the expected return based on the perceived level of risk and market factors. When returns exceed these levels,
the returns are called abnormal returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market anomalies
15. The debate over whether markets are efficient will probably never be resolved because of
A. the lucky event issue.
B. the magnitude issue.
C. the selection bias issue.
D. All of the options are correct.
E. None of the options are correct.
All of the options make rigid testing of market efficiency difficult or impossible.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - studies and challenges
16. A common strategy for passive management is
A. creating an index fund.
B. creating a small firm fund.
C. creating an investment club.
D. creating an index fund and creating an investment club.
E. creating a small firm fund and creating an investment club.
The index fund is, by definition, passively managed. The other investment alternatives may or may not be managed passively.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Portfolio management
11-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
17. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields than firms with high P/E ratios.
Firms with high P/E ratios already have an inflated price relative to earnings and thus tend to have lower returns than low P/E ratio
stocks. However, the P/E ratio may capture risk not fully impounded in market betas so this may represent an appropriate risk
adjustment rather than a market anomaly.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
18. Basu (1977, 1983) found that firms with high P/E ratios
A. earned higher average returns than firms with low P/E ratios.
B. earned the same average returns as firms with low P/E ratios.
C. earned lower average returns than firms with low P/E ratios.
D. had higher dividend yields than firms with low P/E ratios.
Firms with high P/E ratios already have an inflated price relative to earnings and thus tend to have lower returns than low P/E ratio
stocks. However, the P/E ratio may capture risk not fully impounded in market betas, so this may represent an appropriate risk
adjustment rather than a market anomaly.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
19. Jaffe (1974) found that stock prices _________ after insiders intensively bought shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
Insider trading may signal private information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
11-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
20. Jaffe (1974) found that stock prices _________ after insiders intensively sold shares.
A. decreased
B. did not change
C. increased
D. became extremely volatile
E. became much less volatile
Insider trading may signal private information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
21. Banz (1981) found that, on average, the risk-adjusted returns of small firms
A. were higher than the risk-adjusted returns of large firms.
B. were the same as the risk-adjusted returns of large firms.
C. were lower than the risk-adjusted returns of large firms.
D. were unrelated to the risk-adjusted returns of large firms.
E. were negative.
Banz found the risk-adjusted returns of small firms were higher than the risk-adjusted returns of large firms, although subsequent
studies have attempted to explain the small firm effect as the January effect, the neglected firm effect, etc.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
22. Banz (1981) found that, on average, the risk-adjusted returns of large firms
A. were higher than the risk-adjusted returns of small firms.
B. were the same as the risk-adjusted returns of small firms.
C. were lower than the risk-adjusted returns of small firms.
D. were unrelated to the risk-adjusted returns of small firms.
E. were negative.
Banz found the risk-adjusted returns of large firms were lower than the risk-adjusted returns of small firms, although subsequent
studies have attempted to explain the small firm effect as the January effect, the neglected firm effect, etc.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
11-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
23. Proponents of the EMH think technical analysts
A. should focus on relative strength.
B. should focus on resistance levels.
C. should focus on support levels.
D. should focus on financial statements.
E. are wasting their time.
Technical analysts attempt to predict future stock prices from historic stock prices; proponents of EMH believe that stock price
changes are random variables.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
24. Studies of positive earnings surprises have shown that there is
A. a positive abnormal return on the day positive earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. a positive abnormal return on the day positive earnings surprises are announced and a positive drift in the stock price on the days
following the earnings surprise announcement.
E. a positive abnormal return on the day positive earnings surprises are announced and a negative drift in the stock price on the days
following the earnings surprise announcement.
The market appears to adjust to earnings information gradually, resulting in a sustained period of abnormal returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
25. Studies of negative earnings surprises have shown that there is
A. a negative abnormal return on the day that negative earnings surprises are announced.
B. a positive drift in the stock price on the days following the earnings surprise announcement.
C. a negative drift in the stock price on the days following the earnings surprise announcement.
D. a negative abnormal return on the day that negative earnings surprises are announced and a positive drift in the stock price on the
days following the earnings surprise announcement.
E. a negative abnormal return on the day that negative earnings surprises are announced and a negative drift in the stock price on the
days following the earnings surprise announcement.
The market appears to adjust to earnings information gradually, resulting in a sustained period of abnormal returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
11-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
26. Studies of stock price reactions to news are called
A. reaction studies.
B. event studies.
C. drift studies.
D. reaction studies and event studies.
E. event studies and drift studies.
Studies of stock price reactions to news are called event studies.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
27. On November 22, the stock price of WalMart was $69.50, and the retailer stock index was 600.30. On November 25, the stock
price of WalMart was $70.25, and the retailer stock index was 605.20. Consider the ratio of WalMart to the retailer index on
November 22 and November 25. WalMart is _______ the retail industry, and technical analysts who follow relative strength would
advise _______ the stock.
A. outperforming; buying
B. outperforming; selling
C. underperforming; buying
D. underperforming; selling
E. equally performing; neither buying nor selling
11/22: $69.50/600.30 = 0.1158; 11/25: $70.25/605.20 = 0.1161; Thus, WalMart's relative strength is improving, and technicians using
this technique would recommend buying.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
28. Work by Amihud and Mendelson (1986, 1991)
A. argues that investors will demand a rate of return premium to invest in less liquid stocks.
B. may help explain the small firm effect.
C. may be related to the neglected firm effect.
D. may help explain the small firm effect and may be related to the neglected firm effect.
E. All of the options are correct.
Lack of liquidity may affect the returns of small and neglected firms; however the theory does not explain why the abnormal returns
are concentrated in January.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
11-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
29. Fama and French (1992) found that the stocks of firms within the highest decile of book-to-market ratios had an average annual
return of _______, while the stocks of firms within the lowest decile of book-to-market ratios had an average annual return of
________.
A. 15.6%; 13.1%
B. 17.2%; 11.1%
C. 13.2%; 16.4%
D. 11.1%; 17.2%
This finding suggests either that low book-to-market ratio firms are relatively overpriced or that the book-to-market ratio is serving as
a proxy for a risk factor that affects expected equilibrium returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
30. A market decline of 23% on a day when there is no significant macroeconomic event ______ consistent with the EMH because
________.
A. would be; it was a clear response to macroeconomic news
B. would be; it was not a clear response to macroeconomic news
C. would not be; it was a clear response to macroeconomic news
D. would not be; it was not a clear response to macroeconomic news
This happened on October 19, 1987. Although this specific event is not mentioned in this edition of the book, it is an example of
something that would be considered a violation of the EMH.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
31. In an efficient market,
A. security prices react quickly to new information.
B. security prices are seldom far above or below their justified levels.
C. security analysis will not enable investors to realize superior returns consistently.
D. one cannot make money.
E. security prices react quickly to new information, security prices are seldom far above or below their justified levels, and security
analysis will not enable investors to realize superior returns consistently.
Security prices react quickly to new information, security prices are seldom far above or below their justified levels, and security
analysis will not enable investors to realize superior returns consistently; however, even in an efficient market one should be able to
earn the appropriate risk-adjusted rate of return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Market efficiency - implications
11-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
32. The weak form of the efficient-market hypothesis asserts that
A. stock prices do not rapidly adjust to new information contained in past prices or past data.
B. future changes in stock prices cannot be predicted from past prices.
C. technicians cannot expect to outperform the market.
D. stock prices do not rapidly adjust to new information contained in past prices or past data, and future changes in stock prices cannot
be predicted from past prices.
E. future changes in stock prices cannot be predicted from past prices, and technicians cannot expect to outperform the market.
The weak form of the efficient market hypothesis asserts that future changes in stock prices cannot be predicted from past prices;
therefore, technicians cannot expect to outperform the market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Market efficiency - foundations and types
33. A support level is the price range at which a technical analyst would expect the
A. supply of a stock to increase dramatically.
B. supply of a stock to decrease substantially.
C. demand for a stock to increase substantially.
D. demand for a stock to decrease substantially.
E. price of a stock to fall.
A support level is considered to be a level below that the price of the stock is unlikely to fall and is believed to be determined by
market psychology.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Technical analysis
34. A finding that _________ would provide evidence against the semistrong form of the efficient-market theory.
A. low P/E stocks tend to have positive abnormal returns
B. trend analysis is worthless in determining stock prices
C. one can consistently outperform the market by adopting the contrarian approach exemplified by the reversals phenomenon
D. low P/E stocks tend to have positive abnormal returns and trend analysis is worthless in determining stock prices
E. low P/E stocks tend to have positive abnormal returns and one can consistently outperform the market by adopting the contrarian
approach exemplified by the reversals phenomenon
Both low P/E stocks tend to have positive abnormal returns and one can consistently outperform the market by adopting the contrarian
approach exemplified by the reversals phenomenon are inconsistent with the semistrong form of the EMH.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - foundations and types
11-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
35. The weak form of the efficient-market hypothesis contradicts
A. technical analysis but supports fundamental analysis as valid.
B. fundamental analysis but supports technical analysis as valid.
C. both fundamental analysis and technical analysis.
D. technical analysis but is silent on the possibility of successful fundamental analysis.
The weak form of the efficient market hypothesis contradicts technical analysis, but is silent on the possibility of successful
fundamental analysis.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - foundations and types
36. Two basic assumptions of technical analysis are that security prices adjust
A. rapidly to new information, and market prices are determined by the interaction of supply and demand.
B. rapidly to new information, and liquidity is provided by security dealers.
C. gradually to new information, and market prices are determined by the interaction of supply and demand.
D. gradually to new information, and liquidity is provided by security dealers.
E. rapidly to information and to the actions of insiders.
Technicians follow market data such as price changes and volume of trading (as indicator of supply and demand) believing that they
can identify price trends as security prices adjust gradually.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
37. Cumulative abnormal returns (CAR)
A. are used in event studies.
B. are better measures of security returns due to firm-specific events than are abnormal returns (AR).
C. are cumulated over the period prior to the firm-specific event.
D. are used in event studies and are better measures of security returns due to firm-specific events than are abnormal returns (AR).
E. are used in event studies and are cumulated over the period prior to the firm-specific event.
As leakage of information occurs, the accumulated abnormal returns that are abnormal returns summed over the period of interest
(around the event date) are better measures of the effect of firm-specific events.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market anomalies
11-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
38. Studies of mutual-fund performance
A. indicate that one should not randomly select a mutual fund.
B. indicate that historical performance is not necessarily indicative of future performance.
C. indicate that the professional management of the fund insures above market returns.
D. indicate that one should not randomly select a mutual fund and indicate that historical performance is not necessarily indicative of
future performance.
E. indicate that historical performance is not necessarily indicative of future performance and indicate that the professional
management of the fund insures above market returns.
Studies show that, in general, funds do not outperform the market and that historical performance is not necessarily an indicator of
future performance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Portfolio performance evaluation
39. The likelihood of an investment newsletter's successfully predicting the direction of the market for three consecutive years by
chance should be
A. between 50% and 70%.
B. between 25% and 50%.
C. between 10% and 25%.
D. less than 10%.
E. greater than 70%.
The probability of successful prediction for three consecutive years is 12.5%.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Performance of managers and analysts
40. In an efficient market the correlation coefficient between stock returns for two nonoverlapping time periods should be
A. positive and large.
B. positive and small.
C. zero.
D. negative and small.
E. negative and large.
In an efficient market there should be no serial correlation between returns from nonoverlapping periods.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
11-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
41. The weather report says that a devastating and unexpected freeze is expected to hit Florida tonight during the peak of the citrus
harvest. In an efficient market, one would expect the price of Florida Orange's stock to
A. drop immediately.
B. unable to determine.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.
In an efficient market the price of the stock should drop immediately when the bad news is announced. If later news changes the
perceived impact to Florida Orange, the price may once again adjust quickly to the new information. A gradual change is a violation
of the EMH.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
42. Matthews Corporation has a beta of 1.2. The annualized market return yesterday was 13%, and the risk-free rate is currently 5%.
You observe that Matthews had an annualized return yesterday of 17%. Assuming that markets are efficient, this suggests that
A. bad news about Matthews was announced yesterday.
B. good news about Matthews was announced yesterday.
C. no news about Matthews was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
AR = 17% − (5% + 1.2 (8%)) = +2.4%. A positive abnormal return suggests that there was firm-specific good news.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
43. Nicholas Manufacturing just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth
quarter. Nicholas had an abnormal return of 1.2% yesterday. This suggests that
A. the market is not efficient.
B. Nicholas' stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market
response indicates that the earnings surprise was negative, that is, the increase was less than anticipated.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
11-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
44. When Maurice Kendall first examined stock price patterns in 1953, he found that
A. certain patterns tended to repeat within the business cycle.
B. there were no predictable patterns in stock prices.
C. stocks whose prices had increased consistently for one week tended to have a net decrease the following week.
D. stocks whose prices had increased consistently for one week tended to have a net increase the following week.
E. the direction of change in stock prices was unpredictable, but the amount of change followed a distinct pattern.
The first studies in this area were made possible by the development of computer technology. Kendall's study was the first to indicate
that markets were efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Market efficiency - studies and challenges
45. If stock prices follow a random walk,
A. it implies that investors are irrational.
B. it means that the market cannot be efficient.
C. price levels are not random.
D. price changes are random.
E. price movements are predictable.
A random walk means that the changes in prices are random and independent.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Efficient market hypothesis
46. The main difference between the three forms of market efficiency is that
A. the definition of efficiency differs.
B. the definition of excess return differs.
C. the definition of prices differs.
D. the definition of information differs.
E. they were discovered by different people.
The main difference is that weak form encompasses only historical data, semistrong form encompasses historical data and current
public information, and strong form encompasses historical data, current public information, and inside information. All of the other
definitions remain the same.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - foundations and types
11-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
47. Chartists practice
A. technical analysis.
B. fundamental analysis.
C. regression analysis.
D. insider analysis.
E. psychoanalysis.
Chartist is another name for a technical analyst.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Technical analysis
48. Which of the following are used by fundamental analysts to determine proper stock prices? I) Trendlines
II) Earnings
III) Dividend prospects
IV) Expectations of future interest rates
V) Resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
Fundamental analysts look at factors such as earnings, dividend prospects, expectation of future interest rates, and risk of the firm. The
information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and
resistance levels.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Fundamental analysis
49. Which of the following are used by technical analysts to determine proper stock prices? I) Trendlines
II) Earnings
III) Dividend prospects
IV) Expectations of future interest rates
V) Resistance levels
A. I and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.
Fundamental analysts look at factors such as earnings, dividend prospects, expectation of future interest rates, and risk of the firm. The
information is used to determine the present value of future cash flows to stockholders. Technical analysts use trendlines and
resistance levels.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
11-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
50. According to proponents of the efficient-market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is
probably to
A. perform fundamental analysis.
B. exploit market anomalies.
C. invest in Treasury securities.
D. invest in derivative securities.
E. invest in mutual funds.
Individual investors tend to have relatively small portfolios and are usually unable to realize economies of size. The best strategy is to
pool funds with other small investors and allow professional managers to invest the funds.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
51. Which of the following are investment superstars who have consistently shown superior performance? I) Warren Buffet
II) Phoebe Buffet
III) Peter Lynch
IV) Merrill Lynch
V) Jimmy Buffet
A. I, III, and IV
B. II, III, and IV
C. I and III
D. III and IV
E. I, III, IV, and V
Warren Buffet manages Berkshire Hathaway and Peter Lynch managed Fidelity's Magellan Fund. Phoebe Buffet is a character on
NBC's "Friends" and Jimmy Buffet is "Wasting Away in Margaritaville." Merrill Lynch isn't a person.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Performance of managers and analysts
52. Google has a beta of 1.0. The annualized market return yesterday was 11%, and the risk-free rate is currently 5%. You observe that
Google had an annualized return yesterday of 14%. Assuming that markets are efficient, this suggests that
A. bad news about Google was announced yesterday.
B. good news about Google was announced yesterday.
C. no news about Google was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
AR = 14% − (5% + 1.0 (6%)) = +3.0%. A positive abnormal return suggests that there was firm-specific good news.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
11-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
53. Music Doctors has a beta of 2.25. The annualized market return yesterday was 12%, and the risk-free rate is currently 4%. You
observe that Music Doctors had an annualized return yesterday of 15%. Assuming that markets are efficient, this suggests that
A. bad news about Music Doctors was announced yesterday.
B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
AR = 15% − (4% + 2.25 (8%)) = −7.0%. A negative abnormal return suggests that there was firm-specific bad news.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
54. QQAG has a beta of 1.7. The annualized market return yesterday was 13%, and the risk-free rate is currently 3%. You observe that
QQAG had an annualized return yesterday of 20%. Assuming that markets are efficient, this suggests that
A. bad news about QQAG was announced yesterday.
B. good news about QQAG was announced yesterday.
C. no significant news about QQAG was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.
AR = 20% − (3% + 1.7 (10%)) = 0.0%. A positive abnormal return suggests that there was firm-specific good news and a negative
abnormal return suggests that there was firm-specific bad news.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
55. QQAG just announced yesterday that its fourth quarter earnings will be 35% higher than last year's fourth quarter. You observe
that QQAG had an abnormal return of 1.7% yesterday. This suggests that
A. the market is not efficient.
B. QQAG stock will probably rise in value tomorrow.
C. investors expected the earnings increase to be larger than what was actually announced.
D. investors expected the earnings increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
Anticipated earnings changes are impounded into a security's price as soon as expectations are formed. Therefore a negative market
response indicates that the earnings surprise was negative; that is, the increase was less than anticipated.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
11-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
56. LJP Corporation just announced yesterday that it would undertake an international joint venture. You observe that LJP had an
abnormal return of 3% yesterday. This suggests that
A. the market is not efficient.
B. LJP stock will probably rise in value again tomorrow.
C. investors view the international joint venture as bad news.
D. investors view the international joint venture as good news.
E. earnings are expected to decrease next quarter.
The positive abnormal return suggests that investors view the international joint venture as good news.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
57. Music Doctors just announced yesterday that its first quarter sales were 35% higher than last year's first quarter. You observe that
Music Doctors had an abnormal return of 2% yesterday. This suggests that
A. the market is not efficient.
B. Music Doctors stock will probably rise in value tomorrow.
C. investors expected the sales increase to be larger than what was actually announced.
D. investors expected the sales increase to be smaller than what was actually announced.
E. earnings are expected to decrease next quarter.
The negative abnormal return suggests that investors expected the sales increase to be larger than what was actually announced.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
58. The Food and Drug Administration (FDA) just announced yesterday that they would approve a new cancer-fighting drug from
King. You observe that King had an abnormal return of 0% yesterday. This suggests that
A. the market is not efficient.
B. King stock will probably rise in value tomorrow.
C. King stock will probably fall in value tomorrow.
D. the approval was already anticipated by the market.
The approval was already anticipated by the market.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - implications
11-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
59. Your professor finds a stock-trading rule that generates excess risk-adjusted returns. Instead of publishing the results, she keeps the
trading rule to herself. This is most closely associated with
A. regret avoidance.
B. selection bias.
C. framing.
D. insider trading.
This is an example of selection bias.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
60. At freshman orientation, 1,500 students are asked to flip a coin 20 times. One student is crowned the winner (tossed 20 heads).
This is most closely associated with
A. regret avoidance.
B. selection bias.
C. overconfidence.
D. the lucky event issue.
This is an example of the lucky event issue.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
61. Sehun (1986) finds that the practice of monitoring insider trade disclosures, and trading on that information, would be
A. extremely profitable for long-term traders.
B. extremely profitable for short-term traders.
C. marginally profitable for long-term traders.
D. marginally profitable for short-term traders.
E. not sufficiently profitable to cover trading costs.
The practice of monitoring insider trade disclosures, and trading on that information, would be not sufficiently profitable to cover
trading costs.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
62. If you believe in the reversal effect, you should
A. sell bonds in this period if you held stocks in the last period.
B. sell stocks in this period if you held bonds in the last period.
C. sell stocks this period that performed well last period.
D. go long.
E. sell stocks this period that performed well last period and go long.
The reversal effect states that stocks that do well in one period tend to perform poorly in the subsequent period, and vice versa.
11-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Market efficiency - studies and challenges
63. Patell and Woflson (1984) report that most of the stock-price response to corporate dividend or earnings announcements occurs
within ____________ of the announcement.
A. 10 minutes
B. 45 minutes
C. 2 hours
D. 4 hours
E. 2 trading days
The correct answer is 10 minutes.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
64. Del Guerico and Reuter (2014) report that the average underperformance of actively-managed mutual funds is driven largely by
A. sector mutual funds.
B. index funds.
C. direct-sold funds.
D. broker-sold funds.
E. bank-sold mutual funds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market efficiency - studies and challenges
11-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 11 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
Topic: Fundamental analysis
Topic: Market anomalies
Topic: Market efficiency -- foundations and types
Topic: Market efficiency -- implications
Topic: Market efficiency -- studies and challenges
Topic: Performance of managers and analysts
Topic: Portfolio management
Topic: Portfolio performance evaluation
Topic: Technical analysis
# of Questions
16
48
64
16
27
21
24
40
9
1
2
7
11
21
2
2
1
8
11-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 12 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. Conventional theories presume that investors ____________, and behavioral finance presumes that they ____________.
A. are irrational; are irrational
B. are rational; may not be rational
C. are rational; are rational
D. may not be rational; may not be rational
E. may not be rational; are rational
2. The premise of behavioral finance is that
A. conventional financial theory ignores how real people make decisions and that people make a difference.
B. conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility
maximizing investors.
C. conventional financial theory should ignore how the average person makes decisions because the market is driven by investors who
are much more sophisticated than the average person.
D. conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility
maximizing investors and should ignore how the average person makes decisions because the market is driven by investors who are
much more sophisticated than the average person.
E. None of the options are correct.
3. Some economists believe that the anomalies literature is consistent with investors'
A. ability to always process information correctly, and therefore, they infer correct probability distributions about future rates of
return; and given a probability distribution of returns, they always make consistent and optimal decisions.
B. inability to always process information correctly, and therefore, they infer incorrect probability distributions about future rates of
return; and given a probability distribution of returns, they always make consistent and optimal decisions.
C. ability to always process information correctly, and therefore, they infer correct probability distributions about future rates of
return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
D. inability to always process information correctly, and therefore, they infer incorrect probability distributions about future rates of
return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
4. Information processing errors consist of
I) forecasting errors.
II) overconfidence.
III) conservatism.
IV) framing.
A. I and II
B. I and III
C. III and IV
D. IV only
E. I, II, and III
5. Forecasting errors are potentially important because
A. research suggests that people underweight recent information.
B. research suggests that people overweight recent information.
C. research suggests that people correctly weight recent information.
D. research suggests that people either underweight recent information or overweight recent information depending on whether the
information was good or bad.
E. None of the options are correct.
12-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
6. DeBondt and Thaler believe that high P/E result from investors'
A. earnings expectations that are too extreme.
B. earnings expectations that are not extreme enough.
C. stock price expectations that are too extreme.
D. stock price expectations that are not extreme enough.
7. If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors.
A. framing
B. selection bias
C. overconfidence
D. conservatism
E. forecasting
8. Single men trade far more often than women. This is due to greater ________ among men.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
9. ____________ may be responsible for the prevalence of active versus passive investments management.
A. Forecasting errors
B. Overconfidence
C. Mental accounting
D. Conservatism
E. Regret avoidance
10. Barber and Odean (2000) ranked portfolios by turnover and report that the difference in return between the highest and lowest
turnover portfolios is 7% per year. They attribute this to
A. overconfidence.
B. framing.
C. regret avoidance.
D. sample neglect.
11. ________ bias means that investors are too slow in updating their beliefs in response to evidence.
A. Framing
B. Regret avoidance
C. Overconfidence
D. Conservatism
E. None of the options are correct.
12. Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was
unconventional. The name for this phenomenon is
A. regret avoidance.
B. framing.
C. mental accounting.
D. overconfidence.
E. obnoxicity.
12-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
13. An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains,
but may accept the same investment if it is posed in terms of risk surrounding potential losses.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
14. Statman (1977) argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends
and with a tendency to hold losing positions too long.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
15. An example of ________ is that it is not as painful to have purchased a blue chip stock that decreases in value as it is to lose
money on an unknown start up firm.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
16. Arbitrageurs may be unable to exploit behavioral biases due to
I) fundamental risk.
II) implementation costs.
III) model risk.
IV) conservatism.
V) regret avoidance.
A. I and II only
B. I, II, and III
C. I, II, III, and V
D. II, III, and IV
E. IV and V
17. ____________ are good examples of the limits to arbitrage because they show that the law of one price is violated.
I) Siamese twin companies
II) Unit trusts
III) Closed end funds
IV) Open end funds
V) Equity carve outs
A. I and II
B. I, II, and III
C. I, III, and V
D. IV and V
E. V
12-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
18. A trin ratio of less than 1.0 is considered as a
A. bearish signal.
B. bullish signal.
C. bearish signal by some technical analysts and a bullish signal by other technical analysts.
D. bullish signal by some fundamentalists.
E. bearish signal by some technical analysts, a bullish signal by other technical analysts, and a bullish signal by some fundamentalists.
19. Suppose on August 27, there were 1,455 stocks that advanced on the NYSE and 1,553 that declined. The volume in advancing
issues was 852,581, and the volume in declining issues was 1,058,312. The trin ratio for that day was ________, and technical
analysts were likely to be ________.
A. 0.87; bullish
B. 0.87; bearish
C. 1.15; bullish
D. 1.15; bearish
20. In regard to moving averages, it is considered to be a ____________ signal when market price breaks through the moving average
from ____________.
A. bearish; below
B. bullish; below
C. bullish; above
D. None of the options are correct.
21. ____________ is a measure of the extent to which a movement in the market index is reflected in the price movements of all
stocks in the market.
A. Put call ratio
B. Trin ratio
C. Breadth
D. Confidence index
E. All of the options are correct.
22. The confidence index is computed from ____________, and higher values are considered ____________ signals.
A. bond yields; bearish
B. odd lot trades; bearish
C. odd lot trades; bullish
D. put/call ratios; bullish
E. bond yields; bullish
23. The put/call ratio is computed as ____________, and higher values are considered ____________ signals.
A. the number of outstanding put options divided by outstanding call options; bullish or bearish
B. the number of outstanding put options divided by outstanding call options; bullish
C. the number of outstanding put options divided by outstanding call options; bearish
D. the number of outstanding call options divided by outstanding put options; bullish
E. the number of outstanding call options divided by outstanding put options; bearish
12-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
24. The efficient market hypothesis
A. implies that security prices properly reflect information available to investors.
B. has little empirical validity.
C. implies that active traders will find it difficult to outperform a buy and hold strategy.
D. has little empirical validity and implies that active traders will find it difficult to outperform a buy and hold strategy.
E. implies that security prices properly reflect information available to investors and that active traders will find it difficult to
outperform a buy and hold strategy.
25. Tests of market efficiency have focused on
A. the mean variance efficiency of the selected market proxy.
B. strategies that would have provided superior risk adjusted returns.
C. results of actual investments of professional managers.
D. strategies that would have provided superior risk adjusted returns and results of actual investments of professional managers.
E. the mean variance efficiency of the selected market proxy and strategies that would have provided superior risk adjusted returns.
26. The anomalies literature
A. provides a conclusive rejection of market efficiency.
B. provides conclusive support of market efficiency.
C. suggests that several strategies would have provided superior returns.
D. provides a conclusive rejection of market efficiency and suggests that several strategies would have provided superior returns.
E. None of the options are correct.
27. Behavioral finance argues that
A. even if security prices are wrong, it may be difficult to exploit them.
B. the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency.
C. investors are rational.
D. even if security prices are wrong, it may be difficult to exploit them and the failure to uncover successful trading rules or traders
cannot be taken as proof of market efficiency.
E. All of the options are correct.
28. Markets would be inefficient if irrational investors __________ and actions of arbitragers were __________.
A. existed; unlimited
B. did not exist; unlimited
C. existed; limited
D. did not exist; limited
29. __________ can lead investors to misestimate the true probabilities of possible events or associated rates of return.
A. Information processing errors
B. Framing errors
C. Mental accounting errors
D. Regret avoidance
12-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
30. Kahneman and Tversky (1973) report that __________ and __________.
A. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the
uncertainty of their information
B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the
uncertainty of their information
C. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough
given the uncertainty of their information
D. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough
given the uncertainty of their information
31. Errors in information processing can lead investors to misestimate
A. true probabilities of possible events and associated rates of return.
B. occurrence of possible events.
C. only possible rates of return.
D. the effect of accounting manipulation.
E. fraud.
32. DeBondt and Thaler (1990) argue that the P/E effect can be explained by
A. forecasting errors.
B. earnings expectations that are too extreme.
C. earnings expectations that are not extreme enough.
D. regret avoidance.
E. forecasting errors and earnings expectations that are too extreme.
33. Barber and Odean (2001) report that men trade __________ frequently than women and the frequent trading leads to __________
returns.
A. less; superior
B. less; inferior
C. more; superior
D. more; inferior
34. Conservatism implies that investors are too __________ in updating their beliefs in response to new evidence and that they
initially __________ to news.
A. quick; overreact
B. quick; under react
C. slow; overreact
D. slow; under react
35. If information processing was perfect, many studies conclude that individuals would tend to make __________ decisions using
that information due to __________.
A. less than fully rational; behavioral biases
B. fully rational; behavioral biases
C. less than fully rational; fundamental risk
D. fully rational; fundamental risk
E. fully rational; utility maximization
12-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
36. The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory.
Conventional theory assumes that utility functions are __________, whereas prospect theory assumes that utility functions are
__________.
A. concave and defined in terms of wealth; s shaped (convex to losses and concave to gains) and defined in terms of losses relative to
current wealth
B. convex and defined in terms of losses relative to current wealth; s shaped (convex to losses and concave to gains) and defined in
terms of losses relative to current wealth
C. s shaped (convex to losses and concave to gains) and defined in terms of losses relative to current wealth; concave and defined in
terms of wealth
D. s shaped (convex to losses and concave to gains) and defined in terms of wealth; concave and defined in terms of losses relative to
current wealth
E. convex and defined in terms of wealth; concave and defined in terms of gains relative to current wealth
37. The law of one price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However,
empirical evidence suggests that __________ are often mispriced.
A. Siamese twin companies
B. equity carve outs
C. closed end funds
D. Siamese twin companies and closed end funds
E. All of the options are correct.
38. Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when
making forecasts. This is referred to as ____________.
A. too little; hyper rationality
B. too little; conservatism
C. too much; framing
D. too much; memory bias
39. Kahneman and Tversky (1973) reported that __________ give too much weight to recent experience compared to prior beliefs
when making forecasts.
A. young men
B. young women
C. people
D. older men
E. older women
40. Barber and Odean (2001) report that men trade __________ frequently than women.
A. less
B. less in down markets
C. more in up markets
D. more
41. Barber and Odean (2001) report that women trade __________ frequently than men.
A. less
B. less in down markets
C. more in up markets
D. more
12-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
42. Barber and Odean (2001) report that men __________ women.
A. earn higher returns than
B. earn lower returns than
C. earn about the same returns as
D. generate lower trading costs than
43. Barber and Odean (2001) report that women __________ men.
A. earn higher returns than
B. earn lower returns than
C. earn about the same returns as
D. generate higher trading costs than
44. __________ effects can help explain momentum in stock prices.
A. Conservatism
B. Regret avoidance
C. Prospect theory
D. Mental accounting
E. Model risk
45. Studies of Siamese twin companies find __________, which __________ the EMH.
A. correct relative pricing; supports
B. correct relative pricing; does not support
C. incorrect relative pricing; supports
D. incorrect relative pricing; does not support
46. Studies of equity carve outs find __________, which __________ the EMH.
A. strong support for the law of one price; supports
B. strong support for the law of one price; violates
C. evidence against the law of one price; violates
D. evidence against the law of one price; supports
47. Studies of closed end funds find __________, which __________ the EMH.
A. prices at a premium to NAV; is consistent with
B. prices at a premium to NAV; is inconsistent with
C. prices at a discount to NAV; is consistent with
D. prices at a discount to NAV; is inconsistent with
E. prices at premiums and discounts to NAV; is inconsistent with
48. ____________ measures the extent to which a security has outperformed or underperformed either the market as a whole or its
particular industry.
A. Put call ratio
B. Trin ratio
C. Breadth
D. Relative strength
E. All of the options are correct.
12-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 12 Test Bank - Static Key
Multiple Choice Questions
1. Conventional theories presume that investors ____________, and behavioral finance presumes that they ____________.
A. are irrational; are irrational
B. are rational; may not be rational
C. are rational; are rational
D. may not be rational; may not be rational
E. may not be rational; are rational
Conventional theories presume that investors are rational, and behavioral finance presumes that they may not be rational.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral finance
2. The premise of behavioral finance is that
A. conventional financial theory ignores how real people make decisions and that people make a difference.
B. conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility
maximizing investors.
C. conventional financial theory should ignore how the average person makes decisions because the market is driven by investors who
are much more sophisticated than the average person.
D. conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility
maximizing investors and should ignore how the average person makes decisions because the market is driven by investors who are
much more sophisticated than the average person.
E. None of the options are correct.
The premise of behavioral finance is that conventional financial theory ignores how real people make decisions and that people make
a difference.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral finance
3. Some economists believe that the anomalies literature is consistent with investors'
A. ability to always process information correctly, and therefore, they infer correct probability distributions about future rates of
return; and given a probability distribution of returns, they always make consistent and optimal decisions.
B. inability to always process information correctly, and therefore, they infer incorrect probability distributions about future rates of
return; and given a probability distribution of returns, they always make consistent and optimal decisions.
C. ability to always process information correctly, and therefore, they infer correct probability distributions about future rates of
return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
D. inability to always process information correctly, and therefore, they infer incorrect probability distributions about future rates of
return; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
Some economists believe that the anomalies literature is consistent with investors' inability to always process information correctly
and therefore they infer incorrect probability distributions about future rates of return; and given a probability distribution of returns,
they often make inconsistent or suboptimal decisions.
12-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral finance
4. Information processing errors consist of
I) forecasting errors.
II) overconfidence.
III) conservatism.
IV) framing.
A. I and II
B. I and III
C. III and IV
D. IV only
E. I, II, and III
Information processing errors consist of forecasting errors, overconfidence, and conservatism.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
5. Forecasting errors are potentially important because
A. research suggests that people underweight recent information.
B. research suggests that people overweight recent information.
C. research suggests that people correctly weight recent information.
D. research suggests that people either underweight recent information or overweight recent information depending on whether the
information was good or bad.
E. None of the options are correct.
Forecasting errors are potentially important because research suggests that people overweight recent information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
6. DeBondt and Thaler believe that high P/E result from investors'
A. earnings expectations that are too extreme.
B. earnings expectations that are not extreme enough.
C. stock price expectations that are too extreme.
D. stock price expectations that are not extreme enough.
DeBondt and Thaler believe that high P/E result from investors' earnings expectations that are too extreme.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral finance
12-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7. If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors.
A. framing
B. selection bias
C. overconfidence
D. conservatism
E. forecasting
If a person gives too much weight to recent information compared to prior beliefs, they would make forecasting errors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
8. Single men trade far more often than women. This is due to greater ________ among men.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
Single men trade far more often than women. This is due to greater overconfidence among men.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
9. ____________ may be responsible for the prevalence of active versus passive investments management.
A. Forecasting errors
B. Overconfidence
C. Mental accounting
D. Conservatism
E. Regret avoidance
Overconfidence may be responsible for the prevalence of active versus passive investments management.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
10. Barber and Odean (2000) ranked portfolios by turnover and report that the difference in return between the highest and lowest
turnover portfolios is 7% per year. They attribute this to
A. overconfidence.
B. framing.
C. regret avoidance.
D. sample neglect.
They attribute this to overconfidence.
12-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
11. ________ bias means that investors are too slow in updating their beliefs in response to evidence.
A. Framing
B. Regret avoidance
C. Overconfidence
D. Conservatism
E. None of the options are correct.
Conservatism bias means that investors are too slow in updating their beliefs in response to evidence.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
12. Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was
unconventional. The name for this phenomenon is
A. regret avoidance.
B. framing.
C. mental accounting.
D. overconfidence.
E. obnoxicity.
An investments example given in the text is buying the stock of a start up firm that shows subsequent poor performance, versus
buying blue chip stocks that perform poorly. Investors tend to have more regret if they chose the less conventional start up stock.
DeBondt and Thaler say that such regret theory is consistent with the size effect and the book to market effect.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
13. An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains,
but may accept the same investment if it is posed in terms of risk surrounding potential losses.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
An example of framing is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may
accept the same investment if it is posed in terms of risk surrounding potential losses.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
12-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
14. Statman (1977) argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends
and with a tendency to hold losing positions too long.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
Statman (1977) argues that mental accounting is consistent with some investors' irrational preference for stocks with high cash
dividends and with a tendency to hold losing positions too long.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
15. An example of ________ is that it is not as painful to have purchased a blue chip stock that decreases in value as it is to lose
money on an unknown start up firm.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
An example of regret avoidance is that it is not as painful to have purchased a blue chip stock that decreases in value, as it is to lose
money on an unknown start up firm.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
16. Arbitrageurs may be unable to exploit behavioral biases due to
I) fundamental risk.
II) implementation costs.
III) model risk.
IV) conservatism.
V) regret avoidance.
A. I and II only
B. I, II, and III
C. I, II, III, and V
D. II, III, and IV
E. IV and V
Arbitrageurs may be unable to exploit behavioral biases due to fundamental risk, implementation costs, and model risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
12-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
17. ____________ are good examples of the limits to arbitrage because they show that the law of one price is violated.
I) Siamese twin companies
II) Unit trusts
III) Closed end funds
IV) Open end funds
V) Equity carve outs
A. I and II
B. I, II, and III
C. I, III, and V
D. IV and V
E. V
Siamese twin companies, closed end funds, and equity carve outs are good examples of the limits to arbitrage because they show that
the law of one price is violated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
18. A trin ratio of less than 1.0 is considered as a
A. bearish signal.
B. bullish signal.
C. bearish signal by some technical analysts and a bullish signal by other technical analysts.
D. bullish signal by some fundamentalists.
E. bearish signal by some technical analysts, a bullish signal by other technical analysts, and a bullish signal by some fundamentalists.
A trin ratio of less than 1.0 is considered bullish because the declining stocks have lower average volume than the advancing stocks,
indicating net buying pressure.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Technical analysis
19. Suppose on August 27, there were 1,455 stocks that advanced on the NYSE and 1,553 that declined. The volume in advancing
issues was 852,581, and the volume in declining issues was 1,058,312. The trin ratio for that day was ________, and technical
analysts were likely to be ________.
A. 0.87; bullish
B. 0.87; bearish
C. 1.15; bullish
D. 1.15; bearish
(1,058,312/1553)/(852,581/1455) = 1.16. A trin ratio more than 1 is considered bearish because declining stocks have a higher volume
than advancing stocks, indicating selling pressure.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Technical analysis
12-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
20. In regard to moving averages, it is considered to be a ____________ signal when market price breaks through the moving average
from ____________.
A. bearish; below
B. bullish; below
C. bullish; above
D. None of the options are correct.
In regard to moving averages, it is considered to be a bullish signal when market price breaks through the moving average from below.
In addition, it is considered to be a bearish signal when market price breaks through the moving average from above.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
21. ____________ is a measure of the extent to which a movement in the market index is reflected in the price movements of all
stocks in the market.
A. Put call ratio
B. Trin ratio
C. Breadth
D. Confidence index
E. All of the options are correct.
Breadth is a measure of the extent to which a movement in the market index is reflected in the price movements of all stocks in the
market.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Technical analysis
22. The confidence index is computed from ____________, and higher values are considered ____________ signals.
A. bond yields; bearish
B. odd lot trades; bearish
C. odd lot trades; bullish
D. put/call ratios; bullish
E. bond yields; bullish
The confidence index is computed from bond yields, and higher values are considered bullish signals.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
12-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
23. The put/call ratio is computed as ____________, and higher values are considered ____________ signals.
A. the number of outstanding put options divided by outstanding call options; bullish or bearish
B. the number of outstanding put options divided by outstanding call options; bullish
C. the number of outstanding put options divided by outstanding call options; bearish
D. the number of outstanding call options divided by outstanding put options; bullish
E. the number of outstanding call options divided by outstanding put options; bearish
The put/call ratio is computed as the number of outstanding put options divided by outstanding call options, and higher values are
considered bullish or bearish signals.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Technical analysis
24. The efficient market hypothesis
A. implies that security prices properly reflect information available to investors.
B. has little empirical validity.
C. implies that active traders will find it difficult to outperform a buy and hold strategy.
D. has little empirical validity and implies that active traders will find it difficult to outperform a buy and hold strategy.
E. implies that security prices properly reflect information available to investors and that active traders will find it difficult to
outperform a buy and hold strategy.
The efficient market hypothesis implies that security prices properly reflect information available to investors and active traders will
find it difficult to outperform a buy and hold strategy.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Efficient market hypothesis
25. Tests of market efficiency have focused on
A. the mean variance efficiency of the selected market proxy.
B. strategies that would have provided superior risk adjusted returns.
C. results of actual investments of professional managers.
D. strategies that would have provided superior risk adjusted returns and results of actual investments of professional managers.
E. the mean variance efficiency of the selected market proxy and strategies that would have provided superior risk adjusted returns.
Tests of market efficiency have focused on strategies that would have provided superior risk adjusted returns and results of actual
investments of professional managers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Market efficiency studies and challenges
12-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
26. The anomalies literature
A. provides a conclusive rejection of market efficiency.
B. provides conclusive support of market efficiency.
C. suggests that several strategies would have provided superior returns.
D. provides a conclusive rejection of market efficiency and suggests that several strategies would have provided superior returns.
E. None of the options are correct.
The anomalies literature suggests that several strategies would have provided superior returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Market anomalies
27. Behavioral finance argues that
A. even if security prices are wrong, it may be difficult to exploit them.
B. the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency.
C. investors are rational.
D. even if security prices are wrong, it may be difficult to exploit them and the failure to uncover successful trading rules or traders
cannot be taken as proof of market efficiency.
E. All of the options are correct.
Behavioral finance argues that even if security prices are wrong it may be difficult to exploit them and the failure to uncover
successful trading rules or traders cannot be taken as proof of market efficiency.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral finance
28. Markets would be inefficient if irrational investors __________ and actions of arbitragers were __________.
A. existed; unlimited
B. did not exist; unlimited
C. existed; limited
D. did not exist; limited
Markets would be inefficient if irrational investors existed and actions if arbitragers were limited.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
29. __________ can lead investors to misestimate the true probabilities of possible events or associated rates of return.
A. Information processing errors
B. Framing errors
C. Mental accounting errors
D. Regret avoidance
Information processing errors can lead investors to misestimate the true probabilities of possible events or associated rates of return.
12-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
30. Kahneman and Tversky (1973) report that __________ and __________.
A. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the
uncertainty of their information
B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the
uncertainty of their information
C. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough
given the uncertainty of their information
D. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough
given the uncertainty of their information
Kahneman and Tversky (1973) report that people give too much weight to recent experience compared to prior beliefs and tend to
make forecasts that are too extreme given the uncertainty of their information.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Behavioral characteristics
31. Errors in information processing can lead investors to misestimate
A. true probabilities of possible events and associated rates of return.
B. occurrence of possible events.
C. only possible rates of return.
D. the effect of accounting manipulation.
E. fraud.
Errors in information processing can lead investors to misestimate true probabilities of possible events and associated rates of return.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
32. DeBondt and Thaler (1990) argue that the P/E effect can be explained by
A. forecasting errors.
B. earnings expectations that are too extreme.
C. earnings expectations that are not extreme enough.
D. regret avoidance.
E. forecasting errors and earnings expectations that are too extreme.
DeBondt and Thaler (1990) argue that the P/E effect can be explained by forecasting errors and earnings expectations that are too
extreme.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral finance
12-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
33. Barber and Odean (2001) report that men trade __________ frequently than women and the frequent trading leads to __________
returns.
A. less; superior
B. less; inferior
C. more; superior
D. more; inferior
Barber and Odean (2001) report that men trade more frequently than women and the frequent trading leads to inferior returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
34. Conservatism implies that investors are too __________ in updating their beliefs in response to new evidence and that they
initially __________ to news.
A. quick; overreact
B. quick; under react
C. slow; overreact
D. slow; under react
Conservatism implies that investors are too slow in updating their beliefs in response to new evidence and that they initially underreact
to news.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
35. If information processing was perfect, many studies conclude that individuals would tend to make __________ decisions using
that information due to __________.
A. less than fully rational; behavioral biases
B. fully rational; behavioral biases
C. less than fully rational; fundamental risk
D. fully rational; fundamental risk
E. fully rational; utility maximization
If information processing was perfect, many studies conclude that individuals would tend to make less than fully rational decisions
using that information due to behavioral biases.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
12-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
36. The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory.
Conventional theory assumes that utility functions are __________, whereas prospect theory assumes that utility functions are
__________.
A. concave and defined in terms of wealth; s shaped (convex to losses and concave to gains) and defined in terms of losses relative to
current wealth
B. convex and defined in terms of losses relative to current wealth; s shaped (convex to losses and concave to gains) and defined in
terms of losses relative to current wealth
C. s shaped (convex to losses and concave to gains) and defined in terms of losses relative to current wealth; concave and defined in
terms of wealth
D. s shaped (convex to losses and concave to gains) and defined in terms of wealth; concave and defined in terms of losses relative to
current wealth
E. convex and defined in terms of wealth; concave and defined in terms of gains relative to current wealth
The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory.
Conventional theory assumes that utility functions are concave and defined in terms of wealth whereas prospect theory assumes that
utility functions are s shaped (convex to losses and concave to gains) and defined in terms of losses relative to current wealth.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Behavioral theories
37. The law of one price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However,
empirical evidence suggests that __________ are often mispriced.
A. Siamese twin companies
B. equity carve outs
C. closed end funds
D. Siamese twin companies and closed end funds
E. All of the options are correct.
The law of one price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However, empirical
evidence suggests that Siamese twin companies, equity carve outs, and closed end funds are often mispriced.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Arbitrage and its limits
38. Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when
making forecasts. This is referred to as ____________.
A. too little; hyper rationality
B. too little; conservatism
C. too much; framing
D. too much; memory bias
Kahneman and Tversky (1973) reported that people give too much weight to recent experience compared to prior beliefs when making
forecasts. This is referred to as memory bias.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
12-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
39. Kahneman and Tversky (1973) reported that __________ give too much weight to recent experience compared to prior beliefs
when making forecasts.
A. young men
B. young women
C. people
D. older men
E. older women
Kahneman and Tversky (1973) reported that people give too much weight to recent experience compared to prior beliefs when making
forecasts.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
40. Barber and Odean (2001) report that men trade __________ frequently than women.
A. less
B. less in down markets
C. more in up markets
D. more
Barber and Odean (2001) report that men trade more frequently than women.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral characteristics
41. Barber and Odean (2001) report that women trade __________ frequently than men.
A. less
B. less in down markets
C. more in up markets
D. more
Barber and Odean (2001) report that men trade more frequently than women.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral characteristics
42. Barber and Odean (2001) report that men __________ women.
A. earn higher returns than
B. earn lower returns than
C. earn about the same returns as
D. generate lower trading costs than
Barber and Odean (2001) report that men trade more frequently than women and have lower returns.
12-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral characteristics
43. Barber and Odean (2001) report that women __________ men.
A. earn higher returns than
B. earn lower returns than
C. earn about the same returns as
D. generate higher trading costs than
Barber and Odean (2001) report that men trade more frequently than women and have lower returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Behavioral characteristics
44. __________ effects can help explain momentum in stock prices.
A. Conservatism
B. Regret avoidance
C. Prospect theory
D. Mental accounting
E. Model risk
Mental accounting effects can help explain momentum in stock prices.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Behavioral characteristics
45. Studies of Siamese twin companies find __________, which __________ the EMH.
A. correct relative pricing; supports
B. correct relative pricing; does not support
C. incorrect relative pricing; supports
D. incorrect relative pricing; does not support
Studies of Siamese twin companies find incorrect relative pricing, which does not support the EMH.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
12-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
46. Studies of equity carve outs find __________, which __________ the EMH.
A. strong support for the law of one price; supports
B. strong support for the law of one price; violates
C. evidence against the law of one price; violates
D. evidence against the law of one price; supports
Studies of equity carve outs find evidence against the law of one price, which violates the EMH.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
47. Studies of closed end funds find __________, which __________ the EMH.
A. prices at a premium to NAV; is consistent with
B. prices at a premium to NAV; is inconsistent with
C. prices at a discount to NAV; is consistent with
D. prices at a discount to NAV; is inconsistent with
E. prices at premiums and discounts to NAV; is inconsistent with
Studies of closed end funds find prices at premiums and discounts to NAV, which is inconsistent with the EMH.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
48. ____________ measures the extent to which a security has outperformed or underperformed either the market as a whole or its
particular industry.
A. Put call ratio
B. Trin ratio
C. Breadth
D. Relative strength
E. All of the options are correct.
Relative strength measures the extent to which a security has outperformed or underperformed either the market as a whole or its
particular industry. Relative strength is computed by calculating the ratio of the price of the security to a price index for the industry.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Technical analysis
12-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 12 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
1
AACSB: Reflective Thinking
47
Accessibility: Keyboard Navigation
48
Blooms: Apply
1
Blooms: Remember
21
Blooms: Understand
26
Difficulty: 1 Basic
7
Difficulty: 2 Intermediate
38
Difficulty: 3 Challenge
3
Topic: Arbitrage and its limits
7
Topic: Behavioral characteristics
24
Topic: Behavioral finance
6
Topic: Behavioral theories
1
Topic: Efficient market hypothesis
1
Topic: Market anomalies
1
Topic: Market efficiency -- studies and challenges
1
Topic: Technical analysis
7
12-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 13 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. The expected return/beta relationship is used
A. by regulatory commissions in determining the costs of capital for regulated firms.
B. in court rulings to determine discount rates to evaluate claims of lost future incomes.
C. to advise clients as to the composition of their portfolios.
D. All of the options are correct.
E. None of the options are correct.
2. The expected return/beta relationship is not used
A. by regulatory commissions in determining the costs of capital for regulated firms.
B. in court rulings to determine discount rates to evaluate claims of lost future incomes.
C. to advise clients as to the composition of their portfolios.
D. by regulatory commissions in determining the costs of capital for regulated firms and to advise clients as to the composition of their
portfolios.
E. None of the options are correct.
3. __________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that
the CAPM can ever be tested.
A. Kim
B. Markowitz
C. Modigliani
D. Roll
E. None of the options are correct.
4. Fama and MacBeth (1973) found that the relationship between average excess returns and betas was
A. linear.
B. nonexistent.
C. as expected, based on earlier studies.
D. linear and as expected, based on earlier studies.
E. Fama and MacBeth did not examine the relationship between excess returns and beta.
5. In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor (the factors) that appeared to have significant
explanatory power in explaining security returns was (were)
A. the change in the expected rate of inflation.
B. the risk premium on corporate bonds.
C. the unexpected change in the rate of inflation.
D. industrial production.
E. the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production.
6. In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory
power in explaining security returns was
A. the change in the expected rate of inflation.
B. the risk premium on corporate bonds.
C. the unexpected change in the rate of inflation.
D. industrial production.
20-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7. In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972), it was found
that the average difference between a stock's return and the risk free rate was ________ to its nonsystematic risk.
A. positively related
B. negatively related
C. unrelated
D. related in a nonlinear fashion
E. None of the options are correct.
8. In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average
difference between a stock's return and the risk free rate was ________ to its beta.
A. positively related
B. negatively related
C. unrelated
D. inversely related
E. not proportional
9. In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average
difference between a stock's return and the risk free rate was ________ to its nonsystematic risk and ________ to its beta.
A. positively related; negatively related
B. negatively related; positively related
C. positively related; positively related
D. negatively related; negatively related
E. not related; not related
10. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was
_______ what the CAPM would predict.
A. higher than
B. equal to
C. less than
D. twice as much as
E. More information is required to answer this question.
11. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was
_______ what the CAPM would predict.
A. flatter than
B. equal to
C. steeper than
D. one half as much as
E. None of the options are correct.
12. If a professionally managed portfolio consistently outperforms the market proxy on a risk adjusted basis and the market is
efficient, it should be concluded that
A. the CAPM is invalid.
B. the proxy is inadequate.
C. either the CAPM is invalid or the proxy is inadequate.
D. the CAPM is valid and the proxy is adequate.
E. None of the options are correct.
20-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
13. Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972), one would conclude that
A. high beta stocks tend to outperform the predictions of the CAPM.
B. low beta stocks tend to outperform the predictions of the CAPM.
C. there is no relationship between beta and the predictions of the CAPM.
D. high beta stocks and low beta stocks tend to outperform the predictions of the CAPM.
E. None of the options are correct.
14. If a market proxy portfolio consistently beats all professionally managed portfolios on a risk adjusted basis, it may be concluded
that
A. the CAPM is valid.
B. the market proxy is mean/variance efficient.
C. the CAPM is invalid.
D. the CAPM is valid and the market proxy is mean/variance efficient.
E. the market proxy is mean/variance efficient and the CAPM is invalid.
15. In developing their test of a multifactor model, Chen, Roll, and Ross hypothesized that __________ might be a proxy for
systematic factors.
A. the monthly growth rate in industrial production
B. unexpected inflation
C. expected inflation
D. the monthly growth rate in industrial production and unexpected inflation
E. the monthly growth rate in industrial production, unexpected inflation, and expected inflation
16. Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship
between average return and beta are demonstrating
A. the inefficiency of the market proxy used in the tests.
B. that the relationship between average return and beta is not linear.
C. that the relationship between average return and beta is negative.
D. the need for a better way of explaining security returns.
E. None of the options are correct.
17. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk adjusted returns of high beta portfolios were
_____________ the risk adjusted returns of low beta portfolios.
A. greater than
B. equal to
C. less than
D. unrelated to
E. More information is necessary to answer this question.
18. The research by Fama and French suggesting that CAPM is invalid has generated which of the following responses?
A. Better econometrics should be used in the test procedure.
B. Estimates of asset betas need to be improved.
C. Theoretical sources and implications of research that contradicts CAPM needs to be reconsidered.
D. The single index model needs to account for nontraded assets and the cyclical behavior of asset betas.
E. All of the options are correct.
20-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
19. Consider the regression equation:
rit rft = ai + bi(rmt rft) + eit
where:
rit = return on stock i in month t
rft = the monthly risk free rate of return in month t
rmt = the return on the market portfolio proxy in month t
This regression equation is used to estimate
A. the security characteristic line.
B. benchmark error.
C. the capital market line.
D. All of the options are correct.
E. None of the options are correct.
20. Consider the regression equation:
ri rf = g0 + g1b1 + g2s2(ei) + eit
where:
ri rf = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g0, has to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. None of the options are correct.
21. Consider the regression equation:
ri rf = g0 + g1bi + g2s2(ei) + eit
where:
ri rt = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g1, to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. equal to the average monthly return on the market portfolio.
20-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
22. Consider the regression equation:
ri rf = g0 + g1bi + g2s2(ei) + eit
where:
ri rt = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g2, to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. None of the options are correct.
23. Consider the regression equation:
ri rf = g0 + g1bi + eit
where:
ri rf = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
This regression equation is used to estimate
A. the benchmark error.
B. the security market line.
C. the capital market line.
D. the benchmark error and the security market line.
E. the benchmark error, the security market line, and the capital market line.
24. Benchmark error
A. refers to the use of an incorrect market proxy in tests of the CAPM.
B. can result in inconclusive tests of the CAPM.
C. can result in incorrect evaluation measures for portfolio managers.
D. refers to the use of an incorrect market proxy in tests of the CAPM and can result in inconclusive tests of the CAPM.
E. All of the options are correct.
25. The CAPM is not testable unless
A. the exact composition of the true market portfolio is known and used in the tests.
B. all individual assets are included in the market proxy.
C. the market proxy and the true market portfolio are highly negatively correlated.
D. the exact composition of the true market portfolio is known and used in the tests, and all individual assets are included in the
market proxy.
E. all individual assets are included in the market proxy and the market proxy, and the true market portfolio are highly negatively
correlated.
26. In their multifactor model, Chen, Roll, and Ross found
A. that two market indexes, the equally weighted NYSE and the value weighted NYSE, were not significant predictors of security
returns.
B. that the value weighted NYSE index had the incorrect sign, implying a negative market risk premium.
C. expected changes in inflation predicted security returns.
D. that two market indexes, the equally weighted NYSE and the value weighted NYSE, were not significant predictors of security
returns and that the value weighted NYSE index had the incorrect sign, implying a negative market risk premium.
E. All of the options are correct.
20-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
27. Early tests of the CAPM involved
A. establishing sample data.
B. estimating the security characteristic line.
C. estimating the security market line.
D. All of the options are correct.
E. None of the options are correct.
28. According to Roll, the only testable hypothesis associated with the CAPM is
A. the number of ex post mean variance efficient portfolios.
B. the exact composition of the market portfolio.
C. whether the market portfolio is mean variance efficient.
D. the SML relationship.
E. None of the options are correct.
29. One way that Black, Jensen and Scholes overcame the problem of measurement error was to
A. group securities into portfolios.
B. use a two stage regression methodology.
C. reduce the precision of beta estimates.
D. set alpha equal to one.
E. None of the options are correct.
30. Strongest evidence in support of the CAPM has come from demonstrating that
A. the market beta is equal to 1.0.
B. nonsystematic risk has significant explanatory power in estimating security returns.
C. the average return beta relationship is highly significant.
D. the intercept in tests of the excess returns beta relationship is exactly zero.
E. professional investors do not generally outperform market indexes, demonstrating that the market is efficient.
31. Which of the following would be required for tests of the multifactor CAPM and APT?
A. Specification of risk factors
B. Identification of portfolios that hedge these fundamental risk factors
C. Tests of the explanatory power and risk premiums of the hedge portfolios
D. All of the options are correct.
E. None of the options are correct.
32. Tests of multifactor models indicate
A. the single factor model has better explanatory power in estimating security returns.
B. macroeconomic variables have no explanatory power in estimating security returns.
C. it may be possible to hedge some economic factors that affect future consumption risk with appropriate portfolios.
D. multifactor models do not work.
E. None of the options are correct.
33. Fama and French (1992) found that
A. firm size had better explanatory power than beta in describing portfolio returns.
B. beta had better explanatory power than firm size in describing portfolio returns.
C. beta had better explanatory power than book to market ratios in describing portfolio returns.
D. macroeconomic factors had better explanatory power than beta in describing portfolio returns.
E. None of the options are correct.
20-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
34. Which of the following statements is true about models that attempt to measure the empirical performance of the CAPM?
A. The conventional CAPM works better than the conditional CAPM with human capital.
B. The conventional CAPM works about the same as the conditional CAPM with human capital.
C. The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.
D. Adding firm size to the model specification dramatically improves the fit.
E. Adding firm size to the model specification worsens the fit.
35. Which of the following statements is false about models that attempt to measure the empirical performance of the CAPM?
I) The conventional CAPM works better than the conditional CAPM with human capital.
II) The conventional CAPM works about the same as the conditional CAPM with human capital.
III) The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.
A. I only
B. II only
C. III only
D. I and II
E. II and III
36. A study by Mehra and Prescott (1985) found that historical average excess returns
A. have been too small to be consistent with rational security pricing.
B. have been too large to be consistent with rational security pricing.
C. have been too small to be consistent with fractional security pricing.
D. prove CAPM is incorrect.
E. prove the market is efficient.
37. Fama and French (2002) studied the equity premium puzzle by breaking their sample into subperiods and found that
A. the equity premium was largest throughout the entire 1872 1999 period.
B. the equity premium was largest during the 1872 1949 subperiod.
C. the equity premium was largest during the 1950 1999 subperiod.
D. the differences in equity premiums for the three time periods were statistically insignificant.
E. the constant growth dividend discount model never works.
38. Which of the following is a (are) result(s) of the Fama and French (2002) study of the equity premium puzzle?
I) Average realized returns during 1950 1999 exceeded the internal rate of return (IRR) for corporate investments.
II) The statistical precision of average historical returns is far higher than the precision of estimates from the dividend discount model
(DDM).
III) The reward to variability ratio (Sharpe) derived from the DDM is far more stable than that derived from realized returns.
IV) There is no difference between DDM estimates and actual returns with regard to IRR, statistical precision, or the Sharpe measure.
A. I, II, and III
B. I and III
C. I and II
D. II and III
E. IV
39. Equity premium puzzle studies may be subject to survivorship bias because
A. the time period covered was not long enough.
B. an inappropriate index was used.
C. the indexes used did not exist for the whole period of the study.
D. both U.S. and foreign data were used.
E. only U.S. data was used.
20-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
40. Tests of the CAPM that use regression techniques are subject to inaccuracies because
A. the statistical results used are almost always incorrect.
B. the slope coefficient of the regression equation is biased downward.
C. the slope coefficient of the regression equation is biased upward.
D. the intercept of the regression equation is biased downward.
E. the intercept of the regression equation is equal to the risk free rate.
41. Which of the following must be done to test the multifactor CAPM or the APT?
I) Specify the risk factors
II) Identify portfolios that hedge the risk factors
III) Test the explanatory power of hedge portfolios
IV) Test the risk premiums of hedge portfolios
A. I and II
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
42. The Fama and French three factor model uses ___, ___, and ___ as factors.
A. industrial production; term spread; default spread
B. industrial production; inflation; default spread
C. firm size; book to market ratio; market index
D. firm size; book to market ratio; default spread
E. None of the options are correct.
43. The Fama and French three factor model does not use ___ as one of the explanatory factors.
A. industrial production
B. inflation
C. firm size
D. book to market ratio
E. industrial production or inflation
44. Jagannathan and Wang (2006) find that the CCAPM explains returns ______ the Fama French three factor model, and that the
Fama French three factor model explains returns ______ the traditional CAPM.
A. worse than; worse than
B. worse than; better than
C. better than; better than
D. better than; worse than
E. equally as well as; equally as well as
45. A major finding by Heaton and Lucas (2000) is that
A. the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected.
B. the market rate of return does explain the rate of return of individual securities.
C. the change in proprietary wealth helps explain the rate of return of individual securities.
D. the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected, but the
change in proprietary wealth helps explain the rate of return of individual securities.
E. None of the options are correct.
20-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
46. Liew and Vassalou (2000) show that returns on style portfolios (SMB and HML)
A. seem like statistical flukes.
B. seem to predict GDP growth.
C. may be proxies for business cycle risk.
D. seem to predict GDP growth and may be proxies for business cycle risk.
E. None of the options are correct.
47. Petkova and Zhang (2005) examine the relationship between beta and the market risk premium and find
A. a countercyclical beta is negative in good economies and positive in bad economies.
B. the beta of the HML portfolio is negative in good economies and positive in bad economies.
C. a cyclical beta is positive in good economies and negative in bad economies.
D. the beta of the HML portfolio is positive in good economies and negative in bad economies.
E. a countercyclical beta and the beta of the HML portfolio are negative in good economies and positive in bad economies.
48. Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997) report that
A. the value premium is a manifestation of market irrationality.
B. the value premium is a rational risk premia.
C. the value premium is a statistical artifact found only in the U.S.
D. All of the options are correct.
E. None of the options are correct.
49. The Fama French model
I) is a useful tool for benchmarking performance against a well defined set of factors.
II) premia are determined by market irrationality.
III) premia are determined by rational risk factors.
IV) is the reason that the premia is unsettled.
V) is not a useful tool for benchmarking performance against a well defined set of factors.
A. I only
B. V only
C. I and II
D. I and IV
E. II and V
50. An extension of the Fama French three factor model was introduced by
A. Black.
B. Scholes.
C. Carhart.
D. Jensen.
E. Miller.
51. An extension of the Fama French three factor model includes a fourth factor to measure
A. default spread.
B. term spread.
C. momentum.
D. industrial production.
E. inflation.
20-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
52. Liquidity embodies several characteristics, such as
A. trading costs.
B. ease of sale.
C. market depth.
D. necessary price concessions to effect a quick transaction.
E. All of the options are correct.
Chapter 13 Test Bank - Static Key
Multiple Choice Questions
1. The expected return/beta relationship is used
A. by regulatory commissions in determining the costs of capital for regulated firms.
B. in court rulings to determine discount rates to evaluate claims of lost future incomes.
C. to advise clients as to the composition of their portfolios.
D. All of the options are correct.
E. None of the options are correct.
The risk/return relationship is appropriate for all of the uses cited above.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
2. The expected return/beta relationship is not used
A. by regulatory commissions in determining the costs of capital for regulated firms.
B. in court rulings to determine discount rates to evaluate claims of lost future incomes.
C. to advise clients as to the composition of their portfolios.
D. by regulatory commissions in determining the costs of capital for regulated firms and to advise clients as to the composition of their
portfolios.
E. None of the options are correct.
The risk/return relationship is appropriate for all of the uses cited above.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
3. __________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that
the CAPM can ever be tested.
A. Kim
B. Markowitz
C. Modigliani
D. Roll
E. None of the options are correct.
These arguments were made by Richard Roll in his famous critique of the CAPM, resulting the Institutional Investor article, "Is Beta
Dead?"
20-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
4. Fama and MacBeth (1973) found that the relationship between average excess returns and betas was
A. linear.
B. nonexistent.
C. as expected, based on earlier studies.
D. linear and as expected, based on earlier studies.
E. Fama and MacBeth did not examine the relationship between excess returns and beta.
The Fama and MacBeth study validated earlier studies of the excess returns/beta relationship.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
5. In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor (the factors) that appeared to have significant
explanatory power in explaining security returns was (were)
A. the change in the expected rate of inflation.
B. the risk premium on corporate bonds.
C. the unexpected change in the rate of inflation.
D. industrial production.
E. the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production.
Of the variables tested, Chen, Roll, and Ross found that the risk premium on corporate bonds, the unexpected change in the rate of
inflation, and industrial production were significant predictors of security returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 3 Challenge
Topic: Empirical evidence multifactor CAPM and APT
6. In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory
power in explaining security returns was
A. the change in the expected rate of inflation.
B. the risk premium on corporate bonds.
C. the unexpected change in the rate of inflation.
D. industrial production.
Of the variables tested, Chen, Roll, and Ross found that the risk premium on corporate bonds, the unexpected change in the rate of
inflation, and industrial production were significant predictors of security returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Empirical evidence multifactor CAPM and APT
20-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7. In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972), it was found
that the average difference between a stock's return and the risk free rate was ________ to its nonsystematic risk.
A. positively related
B. negatively related
C. unrelated
D. related in a nonlinear fashion
E. None of the options are correct.
These results were surprising, as it was expected that systematic, not nonsystematic, risk would be positively related to stock returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
8. In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average
difference between a stock's return and the risk free rate was ________ to its beta.
A. positively related
B. negatively related
C. unrelated
D. inversely related
E. not proportional
These results are consistent with the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
9. In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average
difference between a stock's return and the risk free rate was ________ to its nonsystematic risk and ________ to its beta.
A. positively related; negatively related
B. negatively related; positively related
C. positively related; positively related
D. negatively related; negatively related
E. not related; not related
The risk premium was positively related to both factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
10. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was
_______ what the CAPM would predict.
A. higher than
B. equal to
C. less than
D. twice as much as
E. More information is required to answer this question.
These studies found that the SML was "too flat" compared to CAPM predictions by a statistically significant margin.
20-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
11. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was
_______ what the CAPM would predict.
A. flatter than
B. equal to
C. steeper than
D. one half as much as
E. None of the options are correct.
These studies found that the SML was "too flat" compared to CAPM predictions by a statistically significant margin.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
12. If a professionally managed portfolio consistently outperforms the market proxy on a risk adjusted basis and the market is
efficient, it should be concluded that
A. the CAPM is invalid.
B. the proxy is inadequate.
C. either the CAPM is invalid or the proxy is inadequate.
D. the CAPM is valid and the proxy is adequate.
E. None of the options are correct.
If a professionally managed portfolio consistently outperforms the market proxy on a risk adjusted basis and the market is efficient, it
should be concluded that either the CAPM is invalid or the proxy is inadequate; however, unfortunately, one cannot conclude which
one (or both) is the problem.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
13. Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972), one would conclude that
A. high beta stocks tend to outperform the predictions of the CAPM.
B. low beta stocks tend to outperform the predictions of the CAPM.
C. there is no relationship between beta and the predictions of the CAPM.
D. high beta stocks and low beta stocks tend to outperform the predictions of the CAPM.
E. None of the options are correct.
The results of these studies are exactly the opposite of what one would expect.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
20-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
14. If a market proxy portfolio consistently beats all professionally managed portfolios on a risk adjusted basis, it may be concluded
that
A. the CAPM is valid.
B. the market proxy is mean/variance efficient.
C. the CAPM is invalid.
D. the CAPM is valid and the market proxy is mean/variance efficient.
E. the market proxy is mean/variance efficient and the CAPM is invalid.
If such results were obtained consistently, one could be assured that the model is valid and that the market proxy is mean/variance
efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
15. In developing their test of a multifactor model, Chen, Roll, and Ross hypothesized that __________ might be a proxy for
systematic factors.
A. the monthly growth rate in industrial production
B. unexpected inflation
C. expected inflation
D. the monthly growth rate in industrial production and unexpected inflation
E. the monthly growth rate in industrial production, unexpected inflation, and expected inflation
In their model, Chen, Roll, and Ross hypothesized that the monthly growth rate in industrial production, unexpected inflation, and
expected inflation might be proxies for systematic risk. However, of the above factors, only the monthly growth rate in industrial
production and unexpected inflation appeared to have significant explanatory power.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
16. Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship
between average return and beta are demonstrating
A. the inefficiency of the market proxy used in the tests.
B. that the relationship between average return and beta is not linear.
C. that the relationship between average return and beta is negative.
D. the need for a better way of explaining security returns.
E. None of the options are correct.
These results are typical of the results of similar studies.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
20-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
17. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk adjusted returns of high beta portfolios were
_____________ the risk adjusted returns of low beta portfolios.
A. greater than
B. equal to
C. less than
D. unrelated to
E. More information is necessary to answer this question.
These results are inconsistent with what would be predicted with the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
18. The research by Fama and French suggesting that CAPM is invalid has generated which of the following responses?
A. Better econometrics should be used in the test procedure.
B. Estimates of asset betas need to be improved.
C. Theoretical sources and implications of research that contradicts CAPM needs to be reconsidered.
D. The single index model needs to account for nontraded assets and the cyclical behavior of asset betas.
E. All of the options are correct.
All four responses have been given in the literature responding to the Fama French critique.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
19. Consider the regression equation:
rit rft = ai + bi(rmt rft) + eit
where:
rit = return on stock i in month t
rft = the monthly risk free rate of return in month t
rmt = the return on the market portfolio proxy in month t
This regression equation is used to estimate
A. the security characteristic line.
B. benchmark error.
C. the capital market line.
D. All of the options are correct.
E. None of the options are correct.
The security characteristic line is a graphical depiction of the excess returns on the security as a function of the excess returns on the
market.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
20-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
20. Consider the regression equation:
ri rf = g0 + g1b1 + g2s2(ei) + eit
where:
ri rf = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g0, has to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. None of the options are correct.
In this model, the coefficient, g0, represents the excess return of the security, which would be zero if the CAPM held.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
21. Consider the regression equation:
ri rf = g0 + g1bi + g2s2(ei) + eit
where:
ri rt = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g1, to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. equal to the average monthly return on the market portfolio.
The variable measured by the coefficient, g1, in this model is the market risk premium.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
20-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
22. Consider the regression equation:
ri rf = g0 + g1bi + g2s2(ei) + eit
where:
ri rt = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g2, to be
A. 0.
B. 1.
C. equal to the risk free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the monthly risk free rate.
E. None of the options are correct.
If the CAPM is valid, the excess return on the stock is predicted by the systematic risk of the stock and the excess return on the
market, not by the nonsystematic risk of the stock.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
23. Consider the regression equation:
ri rf = g0 + g1bi + eit
where:
ri rf = the average difference between the monthly return on stock i and the monthly risk free rate
bi = the beta of stock i
This regression equation is used to estimate
A. the benchmark error.
B. the security market line.
C. the capital market line.
D. the benchmark error and the security market line.
E. the benchmark error, the security market line, and the capital market line.
The security market line is a graphical depiction of the excess returns on the security and a function of the beta of the security.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
24. Benchmark error
A. refers to the use of an incorrect market proxy in tests of the CAPM.
B. can result in inconclusive tests of the CAPM.
C. can result in incorrect evaluation measures for portfolio managers.
D. refers to the use of an incorrect market proxy in tests of the CAPM and can result in inconclusive tests of the CAPM.
E. All of the options are correct.
If an incorrect market proxy is used, all of these options can result.
20-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
25. The CAPM is not testable unless
A. the exact composition of the true market portfolio is known and used in the tests.
B. all individual assets are included in the market proxy.
C. the market proxy and the true market portfolio are highly negatively correlated.
D. the exact composition of the true market portfolio is known and used in the tests, and all individual assets are included in the
market proxy.
E. all individual assets are included in the market proxy and the market proxy, and the true market portfolio are highly negatively
correlated.
The exact composition of the true market portfolio is known and used in the tests and all individual assets are included in the market
proxy must be true for the CAPM to be tested; however, the exact composition of the true market portfolio cannot be known, thus the
CAPM probably can never be tested.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
26. In their multifactor model, Chen, Roll, and Ross found
A. that two market indexes, the equally weighted NYSE and the value weighted NYSE, were not significant predictors of security
returns.
B. that the value weighted NYSE index had the incorrect sign, implying a negative market risk premium.
C. expected changes in inflation predicted security returns.
D. that two market indexes, the equally weighted NYSE and the value weighted NYSE, were not significant predictors of security
returns and that the value weighted NYSE index had the incorrect sign, implying a negative market risk premium.
E. All of the options are correct.
Two market indexes, the equally weighted NYSE and the value weighted NYSE, a negative market risk premium, and unexpected
changes in inflation were significant predictors of security returns.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
27. Early tests of the CAPM involved
A. establishing sample data.
B. estimating the security characteristic line.
C. estimating the security market line.
D. All of the options are correct.
E. None of the options are correct.
These three basic steps, establishing sample data, estimating security characteristic lines, and estimating the security market line, were
all necessary to test the implications of the CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
20-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
28. According to Roll, the only testable hypothesis associated with the CAPM is
A. the number of ex post mean variance efficient portfolios.
B. the exact composition of the market portfolio.
C. whether the market portfolio is mean variance efficient.
D. the SML relationship.
E. None of the options are correct.
According to Roll, the only testable hypothesis about the CAPM is that the market portfolio is mean variance efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence index model and APT
29. One way that Black, Jensen and Scholes overcame the problem of measurement error was to
A. group securities into portfolios.
B. use a two stage regression methodology.
C. reduce the precision of beta estimates.
D. set alpha equal to one.
E. None of the options are correct.
Black, Jensen and Scholes, in their landmark study, found that grouping securities into well diversified portfolios significantly reduced
measurement error.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
30. Strongest evidence in support of the CAPM has come from demonstrating that
A. the market beta is equal to 1.0.
B. nonsystematic risk has significant explanatory power in estimating security returns.
C. the average return beta relationship is highly significant.
D. the intercept in tests of the excess returns beta relationship is exactly zero.
E. professional investors do not generally outperform market indexes, demonstrating that the market is efficient.
Although tests of CAPM have not found the other options to be true, the CAPM is qualitatively supported by findings that the market
portfolio is efficient.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
31. Which of the following would be required for tests of the multifactor CAPM and APT?
A. Specification of risk factors
B. Identification of portfolios that hedge these fundamental risk factors
C. Tests of the explanatory power and risk premiums of the hedge portfolios
D. All of the options are correct.
E. None of the options are correct.
Tests of multifactor models require a three stage process described by all of the options.
20-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence multifactor CAPM and APT
32. Tests of multifactor models indicate
A. the single factor model has better explanatory power in estimating security returns.
B. macroeconomic variables have no explanatory power in estimating security returns.
C. it may be possible to hedge some economic factors that affect future consumption risk with appropriate portfolios.
D. multifactor models do not work.
E. None of the options are correct.
Tests of multifactor models suggest that industrial production, the risk premium on bonds, and unanticipated inflation have significant
explanatory power for security returns, and it may be possible to hedge these risks if appropriate hedge portfolios can be constructed.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Empirical evidence multifactor CAPM and APT
33. Fama and French (1992) found that
A. firm size had better explanatory power than beta in describing portfolio returns.
B. beta had better explanatory power than firm size in describing portfolio returns.
C. beta had better explanatory power than book to market ratios in describing portfolio returns.
D. macroeconomic factors had better explanatory power than beta in describing portfolio returns.
E. None of the options are correct.
Fama and French found that firm size and book to market ratios had significant explanatory power for portfolio returns, while beta did
not.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
34. Which of the following statements is true about models that attempt to measure the empirical performance of the CAPM?
A. The conventional CAPM works better than the conditional CAPM with human capital.
B. The conventional CAPM works about the same as the conditional CAPM with human capital.
C. The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.
D. Adding firm size to the model specification dramatically improves the fit.
E. Adding firm size to the model specification worsens the fit.
The results are presented in Table 13.2.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
20-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
35. Which of the following statements is false about models that attempt to measure the empirical performance of the CAPM?
I) The conventional CAPM works better than the conditional CAPM with human capital.
II) The conventional CAPM works about the same as the conditional CAPM with human capital.
III) The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.
A. I only
B. II only
C. III only
D. I and II
E. II and III
The results are presented in Table 13.2.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
36. A study by Mehra and Prescott (1985) found that historical average excess returns
A. have been too small to be consistent with rational security pricing.
B. have been too large to be consistent with rational security pricing.
C. have been too small to be consistent with fractional security pricing.
D. prove CAPM is incorrect.
E. prove the market is efficient.
They found that the average reward investors have earned has been "too generous."
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence equity premium
37. Fama and French (2002) studied the equity premium puzzle by breaking their sample into subperiods and found that
A. the equity premium was largest throughout the entire 1872 1999 period.
B. the equity premium was largest during the 1872 1949 subperiod.
C. the equity premium was largest during the 1950 1999 subperiod.
D. the differences in equity premiums for the three time periods were statistically insignificant.
E. the constant growth dividend discount model never works.
They concluded that the equity premium puzzle has occurred mostly in modern times. This may be due to the difference between the
dividend discount model's (DDM) result of expected return in comparison to actual returns earned. The DDM yields a smaller risk
premium during the 1950 1999 period, while actual returns have been higher. This may be due to unanticipated capital gains.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence equity premium
20-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
38. Which of the following is a (are) result(s) of the Fama and French (2002) study of the equity premium puzzle?
I) Average realized returns during 1950 1999 exceeded the internal rate of return (IRR) for corporate investments.
II) The statistical precision of average historical returns is far higher than the precision of estimates from the dividend discount model
(DDM).
III) The reward to variability ratio (Sharpe) derived from the DDM is far more stable than that derived from realized returns.
IV) There is no difference between DDM estimates and actual returns with regard to IRR, statistical precision, or the Sharpe measure.
A. I, II, and III
B. I and III
C. I and II
D. II and III
E. IV
The study also predicts that future excess returns will be significantly lower than those experienced in recent decades. This has
important implications for current investors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Empirical evidence equity premium
39. Equity premium puzzle studies may be subject to survivorship bias because
A. the time period covered was not long enough.
B. an inappropriate index was used.
C. the indexes used did not exist for the whole period of the study.
D. both U.S. and foreign data were used.
E. only U.S. data was used.
Equity premium puzzle studies may be subject to survivorship bias because only U.S. data were used.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence equity premium
40. Tests of the CAPM that use regression techniques are subject to inaccuracies because
A. the statistical results used are almost always incorrect.
B. the slope coefficient of the regression equation is biased downward.
C. the slope coefficient of the regression equation is biased upward.
D. the intercept of the regression equation is biased downward.
E. the intercept of the regression equation is equal to the risk free rate.
This would be a problem even if it were possible to use the returns on the true market portfolio in these regressions. It is due to the fact
that the independent variable (the beta that is found in the first pass regression and used as the independent variable in the second pass
regression) is measured with error.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Empirical evidence multifactor CAPM and APT
20-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
41. Which of the following must be done to test the multifactor CAPM or the APT?
I) Specify the risk factors
II) Identify portfolios that hedge the risk factors
III) Test the explanatory power of hedge portfolios
IV) Test the risk premiums of hedge portfolios
A. I and II
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
All of these tasks must be completed. An example is the Chen, Roll, and Ross (1986) study, although they skipped II because they
used the factors themselves and assumed that factor portfolios existed that could proxy for the factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence multifactor CAPM and APT
42. The Fama and French three factor model uses ___, ___, and ___ as factors.
A. industrial production; term spread; default spread
B. industrial production; inflation; default spread
C. firm size; book to market ratio; market index
D. firm size; book to market ratio; default spread
E. None of the options are correct.
The Fama and French three factor model uses firm size, book to market ratio, and market index as factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence Fama French type models
43. The Fama and French three factor model does not use ___ as one of the explanatory factors.
A. industrial production
B. inflation
C. firm size
D. book to market ratio
E. industrial production or inflation
The Fama and French three factor model does not use industrial production or inflation as explanatory factors.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Empirical evidence Fama French type models
20-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
44. Jagannathan and Wang (2006) find that the CCAPM explains returns ______ the Fama French three factor model, and that the
Fama French three factor model explains returns ______ the traditional CAPM.
A. worse than; worse than
B. worse than; better than
C. better than; better than
D. better than; worse than
E. equally as well as; equally as well as
Jagannathan and Wang (2006) find that the CCAPM explains returns better than the Fama French three factor model and that the
Fama French three factor model explains returns better than the traditional CAPM.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
45. A major finding by Heaton and Lucas (2000) is that
A. the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected.
B. the market rate of return does explain the rate of return of individual securities.
C. the change in proprietary wealth helps explain the rate of return of individual securities.
D. the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected, but the
change in proprietary wealth helps explain the rate of return of individual securities.
E. None of the options are correct.
A major finding by Heaton and Lucas (2000) is that the market rate of return does not help explain the rate of return of individual
securities, and CAPM must be rejected and the change in proprietary wealth helps explain the rate of return of individual securities.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence index model and APT
46. Liew and Vassalou (2000) show that returns on style portfolios (SMB and HML)
A. seem like statistical flukes.
B. seem to predict GDP growth.
C. may be proxies for business cycle risk.
D. seem to predict GDP growth and may be proxies for business cycle risk.
E. None of the options are correct.
Liew and Vassalou (2000) show that returns on style portfolios (SMB and HML) seem to predict GDP growth and may be proxies for
business cycle risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
20-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
47. Petkova and Zhang (2005) examine the relationship between beta and the market risk premium and find
A. a countercyclical beta is negative in good economies and positive in bad economies.
B. the beta of the HML portfolio is negative in good economies and positive in bad economies.
C. a cyclical beta is positive in good economies and negative in bad economies.
D. the beta of the HML portfolio is positive in good economies and negative in bad economies.
E. a countercyclical beta and the beta of the HML portfolio are negative in good economies and positive in bad economies.
Petkova and Zhang (2005) examine the relationship between beta and the market risk premium and find a countercyclical beta and the
beta of the HML portfolio are negative in good economies and positive in bad economies.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
48. Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997) report that
A. the value premium is a manifestation of market irrationality.
B. the value premium is a rational risk premia.
C. the value premium is a statistical artifact found only in the U.S.
D. All of the options are correct.
E. None of the options are correct.
Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997) report that the value
premium is a manifestation of market irrationality.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
49. The Fama French model
I) is a useful tool for benchmarking performance against a well defined set of factors.
II) premia are determined by market irrationality.
III) premia are determined by rational risk factors.
IV) is the reason that the premia is unsettled.
V) is not a useful tool for benchmarking performance against a well defined set of factors.
A. I only
B. V only
C. I and II
D. I and IV
E. II and V
The Fama French model is a useful tool for benchmarking performance against a well defined set of factors, and the reason for the
premia is unsettled.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
20-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
50. An extension of the Fama French three factor model was introduced by
A. Black.
B. Scholes.
C. Carhart.
D. Jensen.
E. Miller.
An extension of the Fama French three factor model was introduced by Carhart.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
51. An extension of the Fama French three factor model includes a fourth factor to measure
A. default spread.
B. term spread.
C. momentum.
D. industrial production.
E. inflation.
An extension of the Fama French three factor model includes a fourth factor to measure momentum.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Empirical evidence Fama French type models
52. Liquidity embodies several characteristics, such as
A. trading costs.
B. ease of sale.
C. market depth.
D. necessary price concessions to effect a quick transaction.
E. All of the options are correct.
Liquidity embodies several characteristics such as trading costs, ease of sale, market depth, and necessary price concessions to effect a
quick transaction.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Empirical evidence liquidity and asset pricing
20-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 13 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
6
AACSB: Reflective Thinking
46
Accessibility: Keyboard Navigation
52
Blooms: Apply
4
Blooms: Remember
31
Blooms: Understand
17
Difficulty: 1 Basic
11
Difficulty: 2 Intermediate
37
Difficulty: 3 Challenge
4
Topic: Empirical evidence -- equity premium
4
Topic: Empirical evidence -- Fama-French-type models
11
Topic: Empirical evidence -- index model and APT
21
Topic: Empirical evidence -- liquidity and asset pricing
1
Topic: Empirical evidence -- multifactor CAPM and APT
15
20-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 14 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. The current yield on a bond is equal to
A. annual interest payment divided by the current market price.
B. the yield to maturity.
C. annual interest divided by the par value.
D. the internal rate of return.
E. None of the options are correct.
2. If a 7% coupon bond is trading for $975.00, it has a current yield of
A. 7.00%.
B. 6.53%.
C. 7.24%.
D. 8.53%.
E. 7.18%.
3. If a 7.25% coupon bond is trading for $982.00, it has a current yield of
A. 7.38%.
B. 6.53%.
C. 7.25%.
D. 8.53%.
E. 7.18%.
4. If a 6.75% coupon bond is trading for $1,016.00, it has a current yield of
A. 7.38%.
B. 6.64%.
C. 7.25%.
D. 8.53%.
E. 7.18%.
5. If a 7.75% coupon bond is trading for $1,019.00, it has a current yield of
A. 7.38%.
B. 6.64%.
C. 7.25%.
D. 7.61%.
E. 7.18%.
6. If a 6% coupon bond is trading for $950.00, it has a current yield of
A. 6.5%.
B. 6.3%.
C. 6.1%.
D. 6.0%.
E. 6.6%.
7. If an 8% coupon bond is trading for $1,025.00, it has a current yield of
A. 7.8%.
B. 8.7%.
C. 7.6%.
D. 7.9%.
E. 8.1%.
14-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8. If a 7.5% coupon bond is trading for $1,050.00, it has a current yield of
A. 7.0%.
B. 7.4%.
C. 7.1%.
D. 6.9%.
E. 6.7%.
9. A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 10%, and has a yield to
maturity of 12%. The current yield on this bond is
A. 10.65%.
B. 10.45%.
C. 10.95%.
D. 10.52%.
E. None of the options are correct.
10. A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 8.25%, and has a
yield to maturity of 8.64%. The current yield on this bond is
A. 8.65%.
B. 8.45%.
C. 7.95%.
D. 8.36%.
E. None of the options are correct.
11. A coupon bond pays annual interest, has a par value of $1,000, matures in 12 years, has a coupon rate of 11%, and has a yield to
maturity of 12%. The current yield on this bond is
A. 10.39%.
B. 10.43%.
C. 10.58%.
D. 11.73%.
E. None of the options are correct.
12. A coupon bond pays annual interest, has a par value of $1,000, matures in 12 years, has a coupon rate of 8.7%, and has a yield to
maturity of 7.9%. The current yield on this bond is
A. 8.39%.
B. 8.43%.
C. 8.83%.
D. 8.66%.
E. None of the options are correct.
13. Of the following five investments, ________ is (are) considered the safest.
A. commercial paper
B. corporate bonds
C. U.S. agency issues
D. Treasury bonds
E. Treasury bills
14. Of the following five investments, ________ is (are) considered the least risky.
A. Treasury bills
B. corporate bonds
C. U.S. agency issues
D. Treasury bonds
E. commercial paper
15. To earn a high rating from the bond-rating agencies, a firm should have
A. a low times-interest-earned ratio.
B. a low debt-to-equity ratio.
C. a high quick ratio.
14-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
D. a low debt-to-equity ratio and a high quick ratio.
E. a low times-interest-earned ratio and a high quick ratio.
16. A firm with a low rating from the bond-rating agencies would have
A. a low times-interest-earned ratio.
B. a low debt-to-equity ratio.
C. a low quick ratio.
D. a low debt-to-equity ratio and a low quick ratio.
E. a low times-interest-earned ratio and a low quick ratio.
17. At issue, coupon bonds typically sell
A. above par value.
B. below par value.
C. at or near par value.
D. at a value unrelated to par.
E. None of the options are correct.
18. Accrued interest
A. is quoted in the bond price in the financial press.
B. must be paid by the buyer of the bond and remitted to the seller of the bond.
C. must be paid to the broker for the inconvenience of selling bonds between maturity dates.
D. is quoted in the bond price in the financial press and must be paid by the buyer of the bond and remitted to the seller of the bond.
E.is quoted in the bond price in the financial press and must be paid to the broker for the inconvenience of selling bonds between
maturity dates.
19. The invoice price of a bond that a buyer would pay is equal to
A. the asked price plus accrued interest.
B. the asked price less accrued interest.
C. the bid price plus accrued interest.
D. the bid price less accrued interest.
E. the bid price.
20. An 8% coupon U.S. Treasury note pays interest on May 30 and November 30 and is traded for settlement on August 15. The
accrued interest on the $100,000 face value of this note is
A. $491.80.
B. $800.00.
C. $983.61.
D. $1,661.20.
E. None of the options are correct.
21. A coupon bond is reported as having an ask price of 108% of the $1,000 par value in the Wall Street Journal. If the last interest
payment was made one month ago and the coupon rate is 9%, the invoice price of the bond will be
A. $1,087.50.
B. $1,110.10.
C. $1,150.00.
D. $1,160.25.
E. None of the options are correct.
22. A coupon bond is reported as having an ask price of 113% of the $1,000 par value in the Wall Street Journal. If the last interest
payment was made two months ago and the coupon rate is 12%, the invoice price of the bond will be
A. $1,100.
B. $1,110.
C. $1,150.
D. $1,160.
E. None of the options are correct.
23. The bonds of Ford Motor Company have received a rating of "B" by Moody's. The "B" rating indicates
14-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. the bonds are insured.
B. the bonds are junk bonds.
C. the bonds are referred to as "high-yield" bonds.
D. the bonds are insured or junk bonds.
E. the bonds are "high-yield" or junk bonds.
24. The bond market
A. can be quite "thin."
B. primarily consists of a network of bond dealers in the over-the-counter market.
C. consists of many investors on any given day.
D. can be quite "thin" and primarily consists of a network of bond dealers in the over-the-counter market.
E. primarily consists of a network of bond dealers in the over-the-counter market and consists of many investors on any given day.
25. Ceteris paribus, the price and yield on a bond are
A. positively related.
B. negatively related.
C. sometimes positively and sometimes negatively related.
D. not related.
E. indefinitely related.
26. The ______ is a measure of the average rate of return an investor will earn if the investor buys the bond now and holds until
maturity.
A. current yield
B. dividend yield
C. P/E ratio
D. yield to maturity
E. discount yield
27. The _________ gives the number of shares for which each convertible bond can be exchanged.
A. conversion ratio
B. current ratio
C. P/E ratio
D. conversion premium
E. convertible floor
28. A coupon bond is a bond that
A. pays interest on a regular basis (typically every six months).
B. does not pay interest on a regular basis but pays a lump sum at maturity.
C. can always be converted into a specific number of shares of common stock in the issuing company.
D. always sells at par value.
E. None of the options are correct.
29. A ___________ bond is a bond where the bondholder has the right to cash in the bond before maturity at a specified price after a
specific date.
A. callable
B. coupon
C. put
D. Treasury
E. zero-coupon
30. Callable bonds
A. are called when interest rates decline appreciably.
B. have a call price that declines as time passes.
C. are called when interest rates increase appreciably.
D. are more likely to be called when interest rates decline and have a call price that declines as time passes.
E. have a call price that declines as time passes and are called when interest rates increase appreciably.
14-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
31. A Treasury bond due in one year has a yield of 5.7%; a Treasury bond due in 5 years has a yield of 6.2%. A bond issued by Ford
Motor Company due in 5 years has a yield of 7.5%; a bond issued by Shell Oil due in one year has a yield of 6.5%. The default risk
premiums on the bonds issued by Shell and Ford, respectively, are
A. 1.0% and 1.2%.
B. 0.7% and 1.5%.
C. 1.2% and 1.0%.
D. 0.8% and 1.3%.
E. None of the options are correct.
32. A Treasury bond due in one year has a yield of 4.6%; a Treasury bond due in five years has a yield of 5.6%. A bond issued by
Lucent Technologies due in five years has a yield of 8.9%; a bond issued by Exxon due in one year has a yield of 6.2%. The default
risk premiums on the bonds issued by Exxon and Lucent Technologies, respectively, are
A. 1.6% and 3.3%.
B. 0.5% and 0.7%.
C. 3.3% and 1.6%.
D. 0.7% and 0.5%.
E. None of the options are correct.
33. A Treasury bond due in one year has a yield of 6.2%; a Treasury bond due in five years has a yield of 6.7%. A bond issued by
Xerox due in five years has a yield of 7.9%; a bond issued by Exxon due in one year has a yield of 7.2%. The default risk premiums
on the bonds issued by Exxon and Xerox, respectively, are
A. 1.0% and 1.2%.
B. 0.5% and .7%.
C. 1.2% and 1.0%.
D. 0.7% and 0.5%.
E. None of the options are correct.
34. A Treasury bond due in one year has a yield of 4.3%; a Treasury bond due in five years has a yield of 5.06%. A bond issued by
Boeing due in five years has a yield of 7.63%; a bond issued by Caterpillar due in one year has a yield of 7.16%. The default risk
premiums on the bonds issued by Boeing and Caterpillar, respectively, are
A. 3.33% and 2.10%.
B. 2.57% and 2.86%.
C. 1.2% and 1.0%.
D. 0.76% and 0.47%.
E. None of the options are correct.
35. Floating-rate bonds are designed to ___________, while convertible bonds are designed to __________.
A. minimize the holders'interest rate risk; give the investor the ability to share in the price appreciation of the company's stock
B. maximize the holders'interest rate risk; give the investor the ability to share in the price appreciation of the company's stock
C. minimize the holders'interest rate risk; give the investor the ability to benefit from interest rate changes
D. maximize the holders'interest rate risk; give investor the ability to share in the profits of the issuing company
E. None of the options are correct.
36. A coupon bond that pays interest annually is selling at a par value of $1,000, matures in five years, and has a coupon rate of 9%.
The yield to maturity on this bond is
A. 8.0%.
B. 8.3%.
C. 9.0%.
D. 10.0%.
E. None of the options are correct.
37. A coupon bond that pays interest semi-annually is selling at a par value of $1,000, matures in seven years, and has a coupon rate
of 8.6%. The yield to maturity on this bond is
A. 8.0%.
B. 8.6%.
C. 9.0%.
D. 10.0%.
E. None of the options are correct.
14-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
38. A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%.
The intrinsic value of the bond today will be ______ if the coupon rate is 7%.
A. $712.99
B. $620.92
C. $1,123.01
D. $886.28
E. $1,000.00
39. A coupon bond that pays interest annually has a par value of $1,000, matures in seven years, and has a yield to maturity of 9.3%.
The intrinsic value of the bond today will be ______ if the coupon rate is 8.5%.
A. $712.99
B. $960.14
C. $1,123.01
D. $886.28
E. $1,000.00
40. A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%.
The intrinsic value of the bond today will be _________ if the coupon rate is 12%.
A. $922.77
B. $924.16
C. $1,075.82
D. $1,077.20
E. None of the options
41. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in five years, and has a yield to maturity of
10%. The intrinsic value of the bond today will be __________ if the coupon rate is 8%.
A. $922.78
B. $924.16
C. $1,075.80
D. $1,077.20
E. None of the options
42. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in seven years, and has a yield to maturity of
9.3%. The intrinsic value of the bond today will be ________ if the coupon rate is 9.5%.
A. $922.77
B. $1,010.12
C. $1,075.80
D. $1,077.22
E. None of the options are correct.
43. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in five years, and has a yield to maturity of
10%. The intrinsic value of the bond today will be ________ if the coupon rate is 12%.
A. $922.77
B. $924.16
C. $1,075.80
D. $1,077.22
E. None of the options are correct.
44. A coupon bond that pays interest of $100 annually has a par value of $1,000, matures in five years, and is selling today at a $72
discount from par value. The yield to maturity on this bond is
A. 6.00%.
B. 8.33%.
C. 12.00%.
D. 60.00%.
E. None of the options are correct.
45. You purchased an annual interest coupon bond one year ago that now has six years remaining until maturity. The coupon rate of
interest was 10%, and par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. The amount you
paid for this bond one year ago was
14-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $1,057.50.
B. $1,075.50.
C. $1,088.50.
D. $1.092.46.
E. $1,104.13.
46. You purchased an annual interest coupon bond one year ago that had six years remaining to maturity at that time. The coupon
interest rate was 10%, and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on
holding the bond for that year would have been
A. 7.00%.
B. 7.82%.
C. 8.00%.
D. 11.95%.
E. None of the options are correct.
47. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually.
Bond A will mature in five years, while bond B will mature in six years. If the yields to maturity on the two bonds change from
12% to 10%,
A. both bonds will increase in value, but bond A will increase more than bond B.
B. both bonds will increase in value, but bond B will increase more than bond A.
C. both bonds will decrease in value, but bond A will decrease more than bond B.
D. both bonds will decrease in value, but bond B will decrease more than bond A.
E. None of the options are correct.
48. A zero-coupon bond has a yield to maturity of 9% and a par value of $1,000. If the bond matures in eight years, the bond should
sell for a price of _______ today.
A. $422.41
B. $501.87
C. $513.16
D. $483.49
E. None of the options are correct.
49. You have just purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 11% at the time you
sell.
A. 10.00%
B. 20.42%
C. 13.8%
D. 1.4%
E. None of the options are correct.
50. A Treasury bill with a par value of $100,000 due one month from now is selling today for $99,010. The effective annual yield is
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
51. A Treasury bill with a par value of $100,000 due two months from now is selling today for $98,039 with an effective annual
yield of
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
52. A Treasury bill with a par value of $100,000 due three months from now is selling today for $97,087 with an effective annual
yield of
14-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
53. A coupon bond pays interest semi-annually, matures in five years, has a par value of $1,000, a coupon rate of 12%, and an
effective annual yield to maturity of 10.25%. The price the bond should sell for today is
A. $922.77.
B. $924.16.
C. $1,075.80.
D. $1,077.20.
E. None of the options are correct.
54. A convertible bond has a par value of $1,000 and a current market price of $850. The current price of the issuing firm's stock is
$29, and the conversion ratio is 30 shares. The bond's market conversion value is
A. $729.
B. $810.
C. $870.
D. $1,000.
E. None of the options are correct.
55. A convertible bond has a par value of $1,000 and a current market value of $850. The current price of the issuing firm's stock is
$27, and the conversion ratio is 30 shares. The bond's conversion premium is
A. $40.
B. $150.
C. $190.
D. $200.
E. None of the options are correct.
56. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond A is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
57. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond B is
A. 10%.
14-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
58. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond C is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
59. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond D is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
60. A 10% coupon bond with annual payments and 10 years to maturity is callable in three years at a call price of $1,100. If the
bond is selling today for $975, the yield to call is
A. 10.26%.
B. 10.00%.
C. 9.25%.
D. 13.98%.
E. None of the options are correct.
61. A 12% coupon bond with semi-annual payments is callable in five years. The call price is $1,120. If the bond is selling today for
$1,110, what is the yield to call?
A. 12.03%
B. 10.86%
C. 10.95%
D. 9.14%
E. None of the options are correct.
62. A 10% coupon bond maturing in 10 years that requires annual payments is expected to make all coupon payments but to pay
only 50% of par value at maturity. What is the expected yield on this bond if the bond is purchased for $975?
A. 10.00%
B. 6.68%
C. 11.00%
14-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
D. 8.68%
E. None of the options are correct.
63. You purchased an annual-interest coupon bond one year ago with six years remaining to maturity at the time of purchase. The
coupon interest rate is 10%, and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%, your annual total rate of
return on holding the bond for that year would have been
A. 7.00%.
B. 8.00%.
C. 9.95%.
D. 11.95%.
E. None of the options are correct.
64. The ________ is used to calculate the present value of a bond.
A. nominal yield
B. current yield
C. yield to maturity
D. yield to call
E. None of the options are correct.
65. The yield to maturity on a bond is
A. below the coupon rate when the bond sells at a discount and equal to the coupon rate when the bond sells at a premium.
B. the discount rate that will set the present value of the payments equal to the bond price.
C. based on the assumption that any payments received are reinvested at the coupon rate.
D. None of the options are correct.
66. A bond will sell at a discount when
A. the coupon rate is greater than the current yield, and the current yield is greater than yield to maturity.
B. the coupon rate is greater than yield to maturity.
C. the coupon rate is less than the current yield, and the current yield is greater than the yield to maturity.
D. the coupon rate is less than the current yield, and the current yield is less than yield to maturity.
E. None of the options are true.
67. Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If interest rates remain constant, one year
from now, the price of this bond will be
A. higher.
B. lower.
C. the same.
D. $1,000.
E. Cannot be determined.
68. A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current
price of $850, and a yield to maturity of 12%. Intuitively and without using calculations, if interest payments are reinvested at 10%,
the realized compound yield on this bond must be
A. 10.00%.
B. 10.9%.
C. 12.0%.
D. 12.4%.
E. None of the options are correct.
69. A bond with a 12% coupon, 10 years to maturity, and selling at $88.00 has a yield to maturity of
A. over 14%.
B. between 13% and 14%.
C. between 12% and 13%.
D. between 10% and 12%.
E. less than 12%.
70. Using semi-annual compounding, a 15-year zero-coupon bond that has a par value of $1,000 and a required return of 8% would
be priced at approximately
14-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $308.
B. $315.
C. $464.
D. $555.
E. None of the options are correct.
71. The yield to maturity of a 20-year zero-coupon bond that is selling for $372.50 with a value at maturity of $1,000 is
A. 5.1%.
B. 8.8%.
C. 10.8%.
D. 13.4%.
E. None of the options are correct.
72. Which one of the following statements about convertibles is true?
A. The longer the call protection on a convertible, the less the security is worth.
B. The more volatile the underlying stock, the greater the value of the conversion feature.
C. The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the convertible is
worth.
D. The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock.
E. Convertibles are not callable.
73. Which one of the following statements about convertibles are false?
I) The longer the call protection on a convertible, the less the security is worth.
II) The more volatile the underlying stock, the greater the value of the conversion feature.
III)
The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the
convertible is worth.
IV) The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock.
A. I only
B. II only
C. I and III
D. IV only
E. I, III, and IV
74. Consider a $1,000-par-value 20-year zero-coupon bond issued at a yield to maturity of 10%. If you buy that bond when it is
issued and continue to hold the bond as yields decline to 9%, the imputed interest income for the first year of that bond is
A. zero.
B. $14.87.
C. $45.85.
D. $7.44.
E. None of the options are correct.
75. The bond indenture includes
A. the coupon rate of the bond.
B. the par value of the bond.
C. the maturity date of the bond.
D. All of the options are correct.
E. None of the options are correct.
76. Most corporate bonds are traded
A. on a formal exchange operated by the New York Stock Exchange.
B. by the issuing corporation.
C. over the counter by bond dealers linked by a computer quotation system.
D. on a formal exchange operated by the American Stock Exchange.
E. on a formal exchange operated by the Philadelphia Stock Exchange.
77. The process of retiring high-coupon debt and issuing new bonds at a lower coupon to reduce interest payments is called
14-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. deferral.
B. reissue.
C. repurchase.
D. refunding.
E. None of the options are correct.
78. Convertible bonds
A. give their holders the ability to share in price appreciation of the underlying stock.
B. offer lower coupon rates than similar nonconvertible bonds.
C. offer higher coupon rates than similar nonconvertible bonds.
D give their holders the ability to share in price appreciation of the underlying stock and offer lower coupon rates . than similar
nonconvertible bonds.
E.give their holders the ability to share in price appreciation of the underlying stock and offer higher coupon rates than similar
nonconvertible bonds.
79. TIPS are
A. securities formed from the coupon payments only of government bonds.
B. securities formed from the principal payments only of government bonds.
C. government bonds with par value linked to the general level of prices.
D. government bonds with coupon rates linked to the general level of prices.
E. zero-coupon government bonds.
80. Altman’s Z scores are assigned based on a firm's financial characteristics and are used to predict
A. required coupon rates for new bond issues.
B. bankruptcy risk.
C. the likelihood of a firm becoming a takeover target.
D. the probability of a bond issue being called.
E. None of the options are correct.
81. When a bond indenture includes a sinking fund provision,
A. firms must establish a cash fund for future bond redemption.
B. bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed.
C. bondholders may lose because their bonds can be repurchased by the corporation at below-market prices.
D. firms must establish a cash fund for future bond redemption, and bondholders always benefit because principal . repayment on
the scheduled maturity date is guaranteed.
E. None of the options are true.
82. Subordination clauses in bond indentures
A. may restrict the amount of additional borrowing the firm can undertake.
B. are always bad for investors.
C. provide higher priority to senior creditors in the event of bankruptcy.
D. may restrict the amount of additional borrowing the firm can undertake and provide higher priority to senior creditors in the
event of bankruptcy.
E. All of the options are true.
83. Collateralized bonds
A. rely on the general earning power of the firm for the bond's safety.
B. are backed by specific assets of the issuing firm.
C. are considered the safest variety of bonds.
D. are backed by specific assets of the issuing firm and are generally considered the safest variety of bonds.
E. All of the options are true.
84. Debt securities are often called fixed-income securities because
A. the government fixes the maximum rate that can be paid on bonds.
B. they are held predominantly by older people who are living on fixed incomes.
14-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. they pay a fixed amount at maturity.
D. they promise either a fixed stream of income or a stream of income determined by a specific formula. E.they were the first type
of investment offered to the public which allowed them to "fix" their income at a higher level by investing in bonds.
85. A zero-coupon bond is one that
A. effectively has a zero-percent coupon rate.
B. pays interest to the investor based on the general level of interest rates rather than at a specified coupon rate.
C. pays interest to the investor without requiring the actual coupon to be mailed to the corporation.
D. is issued by state governments because they don't have to pay interest.
E. is analyzed primarily by focusing ("zeroing in") on the coupon rate.
86. Swingin'Soiree, Inc. is a firm that has its main office on the Right Bank in Paris. The firm just issued bonds with a final payment
amount that depends on whether the Seine River floods. This type of bond is known as
A. a contingency bond.
B. a catastrophe bond.
C. an emergency bond.
D. an incident bond.
E. an eventuality bond.
87. One year ago, you purchased a newly-issued TIPS bond that has a 6% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 4.2%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $60.00, $1,000
B. $42.00, $1,042
C. $60.00, $1,042
D. $62.52, $1,042
E. $102.00, $1,000
88. Bond analysts might be more interested in a bond's yield to call if
A. the bond's yield to maturity is insufficient.
B. the firm has called some of its bonds in the past.
C. the investor only plans to hold the bond until its first call date.
D. interest rates are expected to rise.
E. interest rates are expected to fall.
89. What is the relationship between the price of a straight bond and the price of a callable bond?
A. The straight bond's price will be higher than the callable bond's price for low interest rates.
B. The straight bond's price will be lower than the callable bond's price for low interest rates.
C. The straight bond's price will change as interest rates change, but the callable bond's price will stay the same.
D. The straight bond and the callable bond will have the same price.
E. There is no consistent relationship between the two types of bonds.
90. Three years ago, you purchased a bond for $974.69. The bond had three years to maturity, a coupon rate of 8%, paid annually,
and a face value of $1,000. Each year, you reinvested all coupon interest at the prevailing reinvestment rate shown in the table
below. Today is the bond's maturity date. What is your realized compound yield on the bond?
A. 6.43%
B. 7.96%
C. 8.23%
D. 8.97%
E. 9.13%
14-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
91. Which of the following is not a type of international bond?
A. Samurai bonds
B. Yankee bonds
C. Bulldog bonds
D. Elton bonds
E. All of the options are international bonds.
92. A coupon bond that pays interest annually has a par value of $1,000, matures in six years, and has a yield to maturity of 11%.
The intrinsic value of the bond today will be ______ if the coupon rate is 7.5%.
A. $712.99
B. $851.93
C. $1,123.01
D. $886.28
E. $1,000.00
93. A coupon bond that pays interest annually has a par value of $1,000, matures in eight years, and has a yield to maturity of 9%.
The intrinsic value of the bond today will be ______ if the coupon rate is 6%.
A. $833.96
B. $620.92
C. $1,123.01
D. $886.28
E. $1,000.00
94. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in six years, and has a yield to maturity of
9%. The intrinsic value of the bond today will be __________ if the coupon rate is 9%.
A. $922.78
B. $924.16
C. $1,075.80
D. $1,000.00
E. None of the options are correct.
95. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in seven years, and has a yield to maturity of
11%. The intrinsic value of the bond today will be __________ if the coupon rate is 8.8%.
A. $922.78
B. $894.51
C. $1,075.80
D. $1,077.20
E. None of the options are correct.
96. A coupon bond that pays interest of $90 annually has a par value of $1,000, matures in nine years, and is selling today at a $66
discount from par value. The yield to maturity on this bond is
A. 9.00%.
B. 10.15%.
C. 11.25%.
D. 12.32%.
E. None of the options are correct.
97. A coupon bond that pays interest of $40 semi-annually has a par value of $1,000, matures in four years, and is selling today at a
$36 discount from par value. The yield to maturity on this bond is
A. 8.69%.
B. 9.09%.
C. 10.43%.
D. 9.76%.
E. None of the options are correct.
14-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
98. You purchased an annual interest coupon bond one year ago that now has 18 years remaining until maturity. The coupon rate of
interest was 11%, and par value was $1,000. At the time you purchased the bond, the yield to maturity was 10%. The amount you
paid for this bond one year ago was
A. $1,057.50.
B. $1,075.50.
C. $1,083.65.
D. $1.092.46.
E. $1,104.13.
99. You purchased an annual interest coupon bond one year ago that had nine years remaining to maturity at that time. The coupon
interest rate was 10%, and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on
holding the bond for that year would have been
A. 8.00%.
B. 7.82%.
C. 7.00%.
D. 11.95%.
E. None of the options are correct.
100. Consider two bonds, F and G. Both bonds presently are selling at their par value of $1,000. Each pays interest of $90 annually.
Bond F will mature in 15 years while bond G will mature in 26 years. If the yields to maturity on the two bonds change from 9% to
10%,
A. both bonds will increase in value, but bond F will increase more than bond G.
B. both bonds will increase in value, but bond G will increase more than bond F.
C. both bonds will decrease in value, but bond F will decrease more than bond G.
D. both bonds will decrease in value, but bond G will decrease more than bond F.
E. None of the options are correct.
101. A zero-coupon bond has a yield to maturity of 12% and a par value of $1,000. If the bond matures in 18 years, the bond should
sell for a price of _______ today.
A. $422.41
B. $501.87
C. $513.16
D. $130.04
102. A zero-coupon bond has a yield to maturity of 11% and a par value of $1,000. If the bond matures in 27 years, the bond should
sell for a price of _______ today.
A. $59.74
B. $501.87
C. $513.16
D. $483.49
103. You have just purchased a 12-year zero-coupon bond with a yield to maturity of 9% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 10% at the time you
sell.
A. 10.00%
B. 20.42%
C. -1.4%
D. 1.4%
104. You have just purchased a 7-year zero-coupon bond with a yield to maturity of 11% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 9% at the time you sell.
A. 10.00%
B. 23.8%
C. 13.8%
D. 1.4%
14-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
105. A convertible bond has a par value of $1,000 and a current market price of $975. The current price of the issuing firm's stock is
$42, and the conversion ratio is 22 shares. The bond's market conversion value is
A. $729.
B. $924.
C. $870.
D. $1,000.
106. A convertible bond has a par value of $1,000 and a current market price of $1,105. The current price of the issuing firm's stock
is $20, and the conversion ratio is 35 shares. The bond's market conversion value is
A. $700.
B. $810.
C. $870.
D. $1,000.
107. A convertible bond has a par value of $1,000 and a current market value of $950. The current price of the issuing firm's stock
is $22, and the conversion ratio is 40 shares. The bond's conversion premium is
A. $40.
B. $70.
C. $190.
D. $200.
108. A convertible bond has a par value of $1,000 and a current market value of $1,150. The current price of the issuing firm's stock
is $65, and the conversion ratio is 15 shares. The bond's conversion premium is
A. $40.
B. $150.
C. $175.
D. $200.
109. If a 7% coupon bond that pays interest every 182 days paid interest 32 days ago, the accrued interest would be
A. $5.67.
B. $7.35.
C. $6.35.
D. $6.15.
E. $7.12.
110. If a 7.5% coupon bond that pays interest every 182 days paid interest 62 days ago, the accrued interest would be
A. $11.67.
B. $12.35.
C. $12.77.
D. $11.98.
E. $12.15.
111. If a 9% coupon bond that pays interest every 182 days paid interest 112 days ago, the accrued interest would be
A. $27.69.
B. $27.35.
C. $26.77.
D. $27.98.
E. $28.15.
112. A 7% coupon bond with an ask price of $100.00 pays interest every 182 days. If the bond paid interest 32 days ago, the invoice
price of the bond would be
A. $1,005.67.
B. $1,007.35.
C. $1,006.35.
D. $1,006.15.
E. $1,007.12.
14-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
113. A 7.5% coupon bond with an ask price of $100.00 pays interest every 182 days. If the bond paid interest 62 days ago, the
invoice price of the bond would be
A. $1,011.67.
B. $1,012.35.
C. $1,012.77.
D. $1,011.98.
E. $1,012.15.
114. A 9% coupon bond with an ask price of 100:00 pays interest every 182 days. If the bond paid interest 112 days ago, the invoice
price of the bond would be
A. $1,027.69.
B. $1,027.35.
C. $1,026.77.
D. $1,027.98.
E. $1,028.15.
115. One year ago, you purchased a newly-issued TIPS bond that has a 5% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 3.2%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $50.00, $1,000
B. $32.00, $1,032
C. $50.00, $1,032
D. $32.00, $1,050
E. $51.60, $1,032
116. One year ago, you purchased a newly-issued TIPS bond that has a 4% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 3.6%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $40.00, $1,000
B. $41.44, $1,036
C. $40.00, $1,036
D. $36.00, $1,040
E. $76.00, $1,000
117. A CDO is a
A. command duty officer.
B. collateralized debt obligation.
C. commercial debt originator.
D. collateralized debenture originator.
E. common debt officer.
118. A CDS is a
A. command duty supervisor.
B. collateralized debt security.
C. commercial debt servicer.
D. collateralized debenture security.
E. credit default swap.
119. A credit default swap is
A. a fancy term for a low-risk bond.
B. an insurance policy on the default risk of a federal government bond or loan.
C. an insurance policy on the default risk of a corporate bond or loan.
D. an insurance policy on the default risk of federal government and corporate bonds and loans.
E. None of the options are correct.
120. The compensation from a CDS can come from
A. the CDS holder delivering the defaulted bond to the CDS issuer in return for the bond's par value.
B. the CDS issuer paying the swap holder the difference between the par value of the bond and the bond's market price.
14-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. the federal government paying off on the insurance claim.
D. the CDS holder delivering the defaulted bond to the CDS issuer in return for the bond's par value, and the CDS . issuer paying the swap
holder the difference between the par value of the bond and the bond's market price.
E. None of the options are correct.
121. SIVs are
A. structured investment vehicles.
B. structured interest rate vehicles.
C. semi-annual investment vehicles.
D. riskless investments.
E. structured insured variable rate instruments.
122. SIVs raise funds by ______ and then use the proceeds to ______.
A. issuing short-term commercial paper; retire other forms of their debt
B. issuing short-term commercial paper; buy other forms of debt such as mortgages
C. issuing long-term bonds; retire other forms of their debt
D. issuing long-term bonds; buy other forms of debt such as mortgages
123. CDOs are divided in tranches
A. that provide investors with securities with varying degrees of credit risk.
B. and each tranch is given a different level of seniority in terms of its claims on the underlying pool.
C. and none of the tranches is risky.
D. and equity tranch is very low risk.
E. that provide investors with securities with varying degrees of credit risk, and each tranch is given a different level . of seniority in
terms of its claims on the underlying pool.
124. Mortgage-backed CDOs were a disaster in 2007 because
A. they were formed by pooling high quality fixed-rate loans with low interest rates.
B. they were formed by pooling subprime mortgages.
C. home prices stalled.
D. the mortgages were variable rate loans, and interest rates increased.
E. they were formed by pooling subprime mortgages, home prices stalled, the mortgages were variable rate loans, and interest rates
increased.
Chapter 14 Test Bank - Static Key
Multiple Choice Questions
1. The current yield on a bond is equal to
A. annual interest payment divided by the current market price.
B. the yield to maturity.
C. annual interest divided by the par value.
D. the internal rate of return.
E. None of the options are correct.
Annual interest payment divided by the current market price is current yield and is quoted as such in the financial press.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond yields and returns
2. If a 7% coupon bond is trading for $975.00, it has a current yield of
A. 7.00%.
B. 6.53%.
C. 7.24%.
D. 8.53%.
E. 7.18%.
14-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
70/975 = 7.18.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
3. If a 7.25% coupon bond is trading for $982.00, it has a current yield of
A. 7.38%.
B. 6.53%.
C. 7.25%.
D. 8.53%.
E. 7.18%.
72.50/982 = 7.38.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
4. If a 6.75% coupon bond is trading for $1,016.00, it has a current yield of
A. 7.38%.
B. 6.64%.
C. 7.25%.
D. 8.53%.
E. 7.18%.
67.50/1016 = 6.6437.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
5. If a 7.75% coupon bond is trading for $1,019.00, it has a current yield of
A. 7.38%.
B. 6.64%.
C. 7.25%.
D. 7.61%.
E. 7.18%.
77.50/1019 = 7.605.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
6. If a 6% coupon bond is trading for $950.00, it has a current yield of
A. 6.5%.
B. 6.3%.
C. 6.1%.
D. 6.0%.
E. 6.6%.
60/950 = 6.3.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
14-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
7. If an 8% coupon bond is trading for $1,025.00, it has a current yield of
A. 7.8%.
B. 8.7%.
C. 7.6%.
D. 7.9%.
E. 8.1%.
80/1025 = 7.8.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
8. If a 7.5% coupon bond is trading for $1,050.00, it has a current yield of
A. 7.0%.
B. 7.4%.
C. 7.1%.
D. 6.9%.
E. 6.7%.
75/1050 = 7.1.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
9. A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 10%, and has a yield to
maturity of 12%. The current yield on this bond is
A. 10.65%.
B. 10.45%.
C. 10.95%.
D. 10.52%.
E. None of the options are correct.
FV = 1,000, n = 4, PMT = 100, i = 12, PV = 939.25; $100/$939.25 = 10.65%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
10. A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 8.25%, and has a
yield to maturity of 8.64%. The current yield on this bond is
A. 8.65%.
B. 8.45%.
C. 7.95%.
D. 8.36%.
E. None of the options are correct.
FV = 1,000, n = 4, PMT = 82.50, i = 8.64, PV = 987.26; $82.50/$987.26 = 8.36%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
14-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
11. A coupon bond pays annual interest, has a par value of $1,000, matures in 12 years, has a coupon rate of 11%, and has a yield to
maturity of 12%. The current yield on this bond is
A. 10.39%.
B. 10.43%.
C. 10.58%.
D. 11.73%.
E. None of the options are correct.
FV = 1,000, n = 12, PMT = 110, i = 12, PV = 938.06; $110/$938.06 = 11.73%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
12. A coupon bond pays annual interest, has a par value of $1,000, matures in 12 years, has a coupon rate of 8.7%, and has a yield to
maturity of 7.9%. The current yield on this bond is
A. 8.39%.
B. 8.43%.
C. 8.83%.
D. 8.66%.
E. None of the options are correct.
FV = 1,000, n = 12, PMT = 87, i = 7.9, PV = 1,060.60; $87/$1,060.60 = 8.20%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
13. Of the following five investments, ________ is (are) considered the safest.
A. commercial paper
B. corporate bonds
C. U.S. agency issues
D. Treasury bonds
E. Treasury bills
Only Treasury issues are insured by the U.S. government; the shorter-term the instrument, the safer the instrument.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
14. Of the following five investments, ________ is (are) considered the least risky.
A. Treasury bills
B. corporate bonds
C. U.S. agency issues
D. Treasury bonds
E. commercial paper
Only Treasury issues are insured by the U.S. government; the shorter-term the instrument, the safer the instrument.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
15. To earn a high rating from the bond-rating agencies, a firm should have
A. a low times-interest-earned ratio.
B. a low debt-to-equity ratio.
14-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. a high quick ratio.
D. a low debt-to-equity ratio and a high quick ratio.
E. a low times-interest-earned ratio and a high quick ratio.
High values for the times interest and quick ratios and a low debt to equity ratio are desirable indicators of safety.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond ratings and credit risk
14-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
16. A firm with a low rating from the bond-rating agencies would have
A. a low times-interest-earned ratio.
B. a low debt-to-equity ratio.
C. a low quick ratio.
D. a low debt-to-equity ratio and a low quick ratio.
E. a low times-interest-earned ratio and a low quick ratio.
High values for the times interest and quick ratios and a low debt to equity ratio are desirable indicators of safety.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond ratings and credit risk
17. At issue, coupon bonds typically sell
A. above par value.
B. below par value.
C. at or near par value.
D. at a value unrelated to par.
E. None of the options are correct.
If the investment banker has appraised the market and the quality of the bond correctly, the bond will sell at or near par (unless interest
rates have changed very dramatically and very quickly around the time of issuance).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond price and quotes
18. Accrued interest
A. is quoted in the bond price in the financial press.
B. must be paid by the buyer of the bond and remitted to the seller of the bond.
C. must be paid to the broker for the inconvenience of selling bonds between maturity dates.
D. is quoted in the bond price in the financial press and must be paid by the buyer of the bond and remitted to the seller of the bond.
E. is quoted in the bond price in the financial press and must be paid to the broker for the inconvenience of selling bonds between
maturity dates.
Accrued interest must be paid by the buyer, but is not included in the quotations page price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond price and quotes
19. The invoice price of a bond that a buyer would pay is equal to
A. the asked price plus accrued interest.
B. the asked price less accrued interest.
C. the bid price plus accrued interest.
D. the bid price less accrued interest.
E. the bid price.
The buyer of a bond will buy at the asked price and will be invoiced for any accrued interest due to the seller.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond price and quotes
14-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
20. An 8% coupon U.S. Treasury note pays interest on May 30 and November 30 and is traded for settlement on August 15. The
accrued interest on the $100,000 face value of this note is
A. $491.80.
B. $800.00.
C. $983.61.
D. $1,661.20.
E. None of the options are correct.
76/183($4,000) = $1,661.20. Approximation: .08/12 × 100,000 = 666.67 per month. 666.67/month × 2.5 months = 1.666.67.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond price and quotes
21. A coupon bond is reported as having an ask price of 108% of the $1,000 par value in the Wall Street Journal. If the last interest
payment was made one month ago and the coupon rate is 9%, the invoice price of the bond will be
A. $1,087.50.
B. $1,110.10.
C. $1,150.00.
D. $1,160.25.
E. None of the options are correct.
$1,080 + $7.5 (accrued interest) = $1,087.50.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond price and quotes
22. A coupon bond is reported as having an ask price of 113% of the $1,000 par value in the Wall Street Journal. If the last interest
payment was made two months ago and the coupon rate is 12%, the invoice price of the bond will be
A. $1,100.
B. $1,110.
C. $1,150.
D. $1,160.
E. None of the options are correct.
$1,130 + $20 (accrued interest) = $1,150.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond price and quotes
23. The bonds of Ford Motor Company have received a rating of "B" by Moody's. The "B" rating indicates
A. the bonds are insured.
B. the bonds are junk bonds.
C. the bonds are referred to as "high-yield" bonds.
D. the bonds are insured or junk bonds.
E. the bonds are "high-yield" or junk bonds.
B ratings are risky bonds, often called junk bonds (or high-yield bonds by those marketing such bonds).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond ratings and credit risk
14-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
24. The bond market
A. can be quite "thin."
B. primarily consists of a network of bond dealers in the over-the-counter market.
C. consists of many investors on any given day.
D. can be quite "thin" and primarily consists of a network of bond dealers in the over-the-counter market.
E. primarily consists of a network of bond dealers in the over-the-counter market and consists of many investors on any given day.
The bond market, unlike the stock market, can be a very thinly traded market. In addition, most bonds are traded by dealers.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond markets and trading
25. Ceteris paribus, the price and yield on a bond are
A. positively related.
B. negatively related.
C. sometimes positively and sometimes negatively related.
D. not related.
E. indefinitely related.
Bond prices and yields are inversely related.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond yields and returns
26. The ______ is a measure of the average rate of return an investor will earn if the investor buys the bond now and holds until
maturity.
A. current yield
B. dividend yield
C. P/E ratio
D. yield to maturity
E. discount yield
The yield to maturity is a measure of the average rate of return an investor will earn if the investor buys the bond now and holds
until maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond yields and returns
27. The _________ gives the number of shares for which each convertible bond can be exchanged.
A. conversion ratio
B. current ratio
C. P/E ratio
D. conversion premium
E. convertible floor
The conversion premium is the amount for which the bond sells above conversion value; the price of bond as a straight bond
provides the floor. The other terms are not specifically relevant to convertible bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
14-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
28. A coupon bond is a bond that
A. pays interest on a regular basis (typically every six months).
B. does not pay interest on a regular basis but pays a lump sum at maturity.
C. can always be converted into a specific number of shares of common stock in the issuing company.
D. always sells at par value.
E. None of the options are correct.
A coupon bond will pay the coupon rate of interest on a regular basis unless the firm defaults on the bond. Convertible bonds are
specific types of bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
29. A ___________ bond is a bond where the bondholder has the right to cash in the bond before maturity at a specified price after a
specific date.
A. callable
B. coupon
C. put
D. Treasury
E. zero-coupon
Any bond may be redeemed prior to maturity, but all bonds other than put bonds are redeemed at a price determined by the
prevailing interest rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
30. Callable bonds
A. are called when interest rates decline appreciably.
B. have a call price that declines as time passes.
C. are called when interest rates increase appreciably.
D. are more likely to be called when interest rates decline and have a call price that declines as time passes.
E. have a call price that declines as time passes and are called when interest rates increase appreciably.
Callable bonds often are refunded (called) when interest rates decline appreciably. The call price of the bond (approximately par and
one year's coupon payment) declines to par as time passes and maturity is reached.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
31. A Treasury bond due in one year has a yield of 5.7%; a Treasury bond due in 5 years has a yield of 6.2%. A bond issued by Ford
Motor Company due in 5 years has a yield of 7.5%; a bond issued by Shell Oil due in one year has a yield of 6.5%. The default risk
premiums on the bonds issued by Shell and Ford, respectively, are
A. 1.0% and 1.2%.
B. 0.7% and 1.5%.
C. 1.2% and 1.0%.
D. 0.8% and 1.3%.
E. None of the options are correct.
Shell: 6.5% - 5.7% = .8%; Ford: 7.5% - 6.2% = 1.3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
14-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Topic: Financial distress and default risk
32. A Treasury bond due in one year has a yield of 4.6%; a Treasury bond due in five years has a yield of 5.6%. A bond issued by
Lucent Technologies due in five years has a yield of 8.9%; a bond issued by Exxon due in one year has a yield of 6.2%. The default
risk premiums on the bonds issued by Exxon and Lucent Technologies, respectively, are
A. 1.6% and 3.3%.
B. 0.5% and 0.7%.
C. 3.3% and 1.6%.
D. 0.7% and 0.5%.
E. None of the options are correct.
Exxon: 6.2% - 4.6% = 1.6%; Lucent Technologies: 8.9% - 5.6% = 3.3%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Financial distress and default risk
33. A Treasury bond due in one year has a yield of 6.2%; a Treasury bond due in five years has a yield of 6.7%. A bond issued by
Xerox due in five years has a yield of 7.9%; a bond issued by Exxon due in one year has a yield of 7.2%. The default risk premiums
on the bonds issued by Exxon and Xerox, respectively, are
A. 1.0% and 1.2%.
B. 0.5% and .7%.
C. 1.2% and 1.0%.
D. 0.7% and 0.5%.
E. None of the options are correct.
Exxon: 7.2% - 6.2% = 1.0%; Xerox: 7. 9% - 6.7% = 1.2%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Financial distress and default risk
34. A Treasury bond due in one year has a yield of 4.3%; a Treasury bond due in five years has a yield of 5.06%. A bond issued by
Boeing due in five years has a yield of 7.63%; a bond issued by Caterpillar due in one year has a yield of 7.16%. The default risk
premiums on the bonds issued by Boeing and Caterpillar, respectively, are
A. 3.33% and 2.10%.
B. 2.57% and 2.86%.
C. 1.2% and 1.0%.
D. 0.76% and 0.47%.
E. None of the options are correct.
Boeing: 7.63% - 5.06% = 2.57%; Caterpillar: 7.16% - 4.30% = 2.86%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Financial distress and default risk
35. Floating-rate bonds are designed to ___________, while convertible bonds are designed to __________.
A. minimize the holders'interest rate risk; give the investor the ability to share in the price appreciation of the company's stock
B. maximize the holders'interest rate risk; give the investor the ability to share in the price appreciation of the company's stock
C. minimize the holders'interest rate risk; give the investor the ability to benefit from interest rate changes
D. maximize the holders'interest rate risk; give investor the ability to share in the profits of the issuing company
E. None of the options are correct.
14-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Floating-rate bonds allow the investor to earn a rate of interest income tied to current interest rates, thus negating one of the major
disadvantages of fixed income investments. Convertible bonds allow the investor to benefit from the appreciation of the stock price,
either by converting to stock or holding the bond, which will increase in price as the stock price increases.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond types and features
36. A coupon bond that pays interest annually is selling at a par value of $1,000, matures in five years, and has a coupon rate of 9%.
The yield to maturity on this bond is
A. 8.0%.
B. 8.3%.
C. 9.0%.
D. 10.0%.
E. None of the options are correct.
When a bond sells at par value, the coupon rate is equal to the yield to maturity.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
37. A coupon bond that pays interest semi-annually is selling at a par value of $1,000, matures in seven years, and has a coupon rate
of 8.6%. The yield to maturity on this bond is
A. 8.0%.
B. 8.6%.
C. 9.0%.
D. 10.0%.
E. None of the options are correct.
When a bond sells at par value, the coupon rate is equal to the yield to maturity.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
38. A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%.
The intrinsic value of the bond today will be ______ if the coupon rate is 7%.
A. $712.99
B. $620.92
C. $1,123.01
D. $886.28
E. $1,000.00
FV = 1,000, PMT = 70, n = 5, i = 10, PV = 886.28.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
14-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
39. A coupon bond that pays interest annually has a par value of $1,000, matures in seven years, and has a yield to maturity of 9.3%.
The intrinsic value of the bond today will be ______ if the coupon rate is 8.5%.
A. $712.99
B. $960.14
C. $1,123.01
D. $886.28
E. $1,000.00
FV = 1,000, PMT = 85, n = 7, i = 9.3, PV = 960.138.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
40. A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%.
The intrinsic value of the bond today will be _________ if the coupon rate is 12%.
A. $922.77
B. $924.16
C. $1,075.82
D. $1,077.20
E. None of the options
FV = 1000, PMT = 120, n = 5, i = 10, PV = 1075.82.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
41. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in five years, and has a yield to maturity of
10%. The intrinsic value of the bond today will be __________ if the coupon rate is 8%.
A. $922.78
B. $924.16
C. $1,075.80
D. $1,077.20
E. None of the options
FV = 1000, PMT = 40, n = 10, i = 5, PV = 922.78
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond price and quotes
Topic: Bond valuation
42. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in seven years, and has a yield to maturity of
9.3%. The intrinsic value of the bond today will be ________ if the coupon rate is 9.5%.
A. $922.77
B. $1,010.12
C. $1,075.80
D. $1,077.22
E. None of the options are correct.
FV = 1,000, PMT = 47.50, n = 14, i = 4.65, PV = 1,010.12.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
14-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
43. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in five years, and has a yield to maturity of
10%. The intrinsic value of the bond today will be ________ if the coupon rate is 12%.
A. $922.77
B. $924.16
C. $1,075.80
D. $1,077.22
E. None of the options are correct.
FV = 1000, PMT = 60, n = 10, i = 5, PV = 1077.22.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
44. A coupon bond that pays interest of $100 annually has a par value of $1,000, matures in five years, and is selling today at a $72
discount from par value. The yield to maturity on this bond is
A. 6.00%.
B. 8.33%.
C. 12.00%.
D. 60.00%.
E. None of the options are correct.
FV = 1,000, PMT = 100, n = 5, PV = 928, i = 11.997%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
45. You purchased an annual interest coupon bond one year ago that now has six years remaining until maturity. The coupon rate of
interest was 10%, and par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. The amount you
paid for this bond one year ago was
A. $1,057.50.
B. $1,075.50.
C. $1,088.50.
D. $1.092.46.
E. $1,104.13.
FV = 1,000, PMT = 100, n = 7, i = 8, PV = 1,104.13.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
46. You purchased an annual interest coupon bond one year ago that had six years remaining to maturity at that time. The coupon
interest rate was 10%, and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on
holding the bond for that year would have been
A. 7.00%.
B. 7.82%.
C. 8.00%.
D. 11.95%.
E. None of the options are correct.
FV = 1,000, PMT = 100, n = 6, i = 8, PV = 1,092.46; FV = 1000, PMT = 100, n = 5, i = 8, PV = 1,079.85; HPR = (1,079.85
1,092.46 + 100)/1,092.46 = 8%.
AACSB: Knowledge Application
14-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
47. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually.
Bond A will mature in five years, while bond B will mature in six years. If the yields to maturity on the two bonds change from
12% to 10%,
A. both bonds will increase in value, but bond A will increase more than bond B.
B. both bonds will increase in value, but bond B will increase more than bond A.
C. both bonds will decrease in value, but bond A will decrease more than bond B.
D. both bonds will decrease in value, but bond B will decrease more than bond A.
E. None of the options are correct.
The longer the maturity, the greater the price change when interest rates change.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Interest rate risk
48. A zero-coupon bond has a yield to maturity of 9% and a par value of $1,000. If the bond matures in eight years, the bond should
sell for a price of _______ today.
A. $422.41
B. $501.87
C. $513.16
D. $483.49
E. None of the options are correct.
8
$1,000/(1.09) = $501.87.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
49. You have just purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 11% at the time you
sell.
A. 10.00%
B. 20.42%
C. 13.8%
D. 1.4%
E. None of the options are correct.
$1,000/(1.10)^10 = $385.54; $1,000/(1.11)^9 = $390.92; ($390.92 - $385.54)/$385.54 = 1.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
50. A Treasury bill with a par value of $100,000 due one month from now is selling today for $99,010. The effective annual yield is
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
$990/$99,010 = 0.01; (1.01)
12
- 1.0 = 12.68%.
14-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
51. A Treasury bill with a par value of $100,000 due two months from now is selling today for $98,039 with an effective annual
yield of
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
6
$1,961/$98,039 = 0.02; (1.02) - 1 = 12.62%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
52. A Treasury bill with a par value of $100,000 due three months from now is selling today for $97,087 with an effective annual
yield of
A. 12.40%.
B. 12.55%.
C. 12.62%.
D. 12.68%.
E. None of the options are correct.
4
$2,913/$97,087 = 0.03; (1.03) - 1.00 = 12.55%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
53. A coupon bond pays interest semi-annually, matures in five years, has a par value of $1,000, a coupon rate of 12%, and an
effective annual yield to maturity of 10.25%. The price the bond should sell for today is
A. $922.77.
B. $924.16.
C. $1,075.80.
D. $1,077.20.
E. None of the options are correct.
1/2
(1.1025)
- 1 = 5%, N = 10, I/Y = 10%, PMT = 60, FV = 1000, Þ PV = 1,077.22.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
54. A convertible bond has a par value of $1,000 and a current market price of $850. The current price of the issuing firm's stock is $29,
and the conversion ratio is 30 shares. The bond's market conversion value is
A. $729.
B. $810.
C. $870.
D. $1,000.
E. None of the options are correct.
30 shares × $29/share = $870.
14-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond valuation
55. A convertible bond has a par value of $1,000 and a current market value of $850. The current price of the issuing firm's stock is
$27, and the conversion ratio is 30 shares. The bond's conversion premium is
A. $40.
B. $150.
C. $190.
D. $200.
E. None of the options are correct.
$850 - $810 = $40.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
56. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond A is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct. ($1,000 $909.09) $909.09 = 10%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
57. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond B is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
1/2
($1,000 - $811.62)/$811.62 = 0.2321; (1.2321)
- 1.0 = 11%.
14-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
58. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond C is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
1/3
($1,000 - $711.78)/$711.78 = 0.404928; (1.404928)
- 1.0 = 12%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
59. Consider the following $1,000-par-value zero-coupon bonds:
The yield to maturity on bond D is
A. 10%.
B. 11%.
C. 12%.
D. 14%.
E. None of the options are correct.
1/4
($1,000 - $635.52)/$635.52 = 0.573515; (1.573515)
- 1.0 = 12%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
60. A 10% coupon bond with annual payments and 10 years to maturity is callable in three years at a call price of $1,100. If the
bond is selling today for $975, the yield to call is
A. 10.26%.
B. 10.00%.
C. 9.25%.
D. 13.98%.
E. None of the options are correct.
14-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
FV = 1100, n = 3, PMT = 100, PV = 975, i = 13.98%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
61. A 12% coupon bond with semi-annual payments is callable in five years. The call price is $1,120. If the bond is selling today for
$1,110, what is the yield to call?
A. 12.03%
B. 10.86%
C. 10.95%
D. 9.14%
E. None of the options are correct.
YTC = FV = 1120, n = 10, PMT = 60, PV = 1,110m Þ i = 5.48%, 5.48 × 2 = 10.95.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
62. A 10% coupon bond maturing in 10 years that requires annual payments is expected to make all coupon payments but to pay
only 50% of par value at maturity. What is the expected yield on this bond if the bond is purchased for $975?
A. 10.00%
B. 6.68%
C. 11.00%
D. 8.68%
E. None of the options are correct.
FV = 500, PMT = 100, n = 10, PV = 975, i = 6.68%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
63. You purchased an annual-interest coupon bond one year ago with six years remaining to maturity at the time of purchase. The
coupon interest rate is 10%, and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%, your annual total rate of
return on holding the bond for that year would have been
A. 7.00%.
B. 8.00%.
C. 9.95%.
D. 11.95%.
E. None of the options are correct.
FV = 1000, PMT = 100, n = 6, i = 8, PV = 1092.46; FV = 1,000, PMT = 100, n = 5, i = 7, PV = 1,123.01; HPR = (1,123.01
1,092.46 + 100)/1,092.46 = 11.95%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
64. The ________ is used to calculate the present value of a bond.
A. nominal yield
B. current yield
C. yield to maturity
D. yield to call
14-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. None of the options are correct.
Yield to maturity is the discount rate used in the bond valuation formula. For callable bonds, yield to call is sometimes the more
appropriate calculation for the investor (if interest rates are expected to decrease).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond valuation
65. The yield to maturity on a bond is
A. below the coupon rate when the bond sells at a discount and equal to the coupon rate when the bond sells at a premium.
B. the discount rate that will set the present value of the payments equal to the bond price.
C. based on the assumption that any payments received are reinvested at the coupon rate.
D. None of the options are correct.
The yield to maturity on a bond is the discount rate that will set the present value of the payments equal to the bond price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Bond yields and returns
66. A bond will sell at a discount when
A. the coupon rate is greater than the current yield, and the current yield is greater than yield to maturity.
B. the coupon rate is greater than yield to maturity.
C. the coupon rate is less than the current yield, and the current yield is greater than the yield to maturity.
D. the coupon rate is less than the current yield, and the current yield is less than yield to maturity.
E. None of the options are true.
In order for the investor to earn more than the current yield, the bond must be selling for a discount. Yield to maturity will be greater
than current yield as investor will have purchased the bond at discount and will be receiving the coupon payments over the life of
the bond.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond yields and returns
67. Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If interest rates remain constant, one year
from now, the price of this bond will be
A. higher.
B. lower.
C. the same.
D. $1,000.
E. Cannot be determined.
This bond is a premium bond as interest rates have declined since the bond was issued. If interest rates remain constant, the price of
a premium bond declines as the bond approaches maturity.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
68. A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current
price of $850, and a yield to maturity of 12%. Intuitively and without using calculations, if interest payments are reinvested at 10%,
the realized compound yield on this bond must be
A. 10.00%.
B. 10.9%.
14-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. 12.0%.
D. 12.4%.
E. None of the options are correct.
In order to earn yield to maturity, the coupons must be reinvested at the yield to maturity. However, as the bond is selling at
discount, the yield must be higher than the coupon rate. Therefore, B is the only possible answer.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
69. A bond with a 12% coupon, 10 years to maturity, and selling at $88.00 has a yield to maturity of
A. over 14%.
B. between 13% and 14%.
C. between 12% and 13%.
D. between 10% and 12%.
E. less than 12%.
YTM = 14.33%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
70. Using semi-annual compounding, a 15-year zero-coupon bond that has a par value of $1,000 and a required return of 8% would
be priced at approximately
A. $308.
B. $315.
C. $464.
D. $555.
E. None of the options are correct.
FV = 1000, n = 30, I = 4, PV = 308.32.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
71. The yield to maturity of a 20-year zero-coupon bond that is selling for $372.50 with a value at maturity of $1,000 is
A. 5.1%.
B. 8.8%.
C. 10.8%.
D. 13.4%.
E. None of the options are correct.
[$1,000/($372.50]
1/20
- 1 = 5.1%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
72. Which one of the following statements about convertibles is true?
A. The longer the call protection on a convertible, the less the security is worth.
B. The more volatile the underlying stock, the greater the value of the conversion feature.
C. The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the convertible is
worth.
14-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
D. The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock.
E. Convertibles are not callable.
The longer the call protection the more attractive the bond. The smaller the spread (c), the less the bond is worth. Convertibles are
debentures (unsecured bonds). All convertibles are callable at the option of the issuer.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond valuation
73. Which one of the following statements about convertibles are false?
I) The longer the call protection on a convertible, the less the security is worth.
II) The more volatile the underlying stock, the greater the value of the conversion feature.
III) The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the convertible
is worth.
IV) The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock.
A. I only
B. II only
C. I and III
D. IV only
E. I, III, and IV
The longer the call protection, the more attractive the bond. The smaller the spread (c), the less the bond is worth. Convertibles are
debentures (unsecured bonds). All convertibles are callable at the option of the issuer.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond valuation
74. Consider a $1,000-par-value 20-year zero-coupon bond issued at a yield to maturity of 10%. If you buy that bond when it is
issued and continue to hold the bond as yields decline to 9%, the imputed interest income for the first year of that bond is
A. zero.
B. $14.87.
C. $45.85.
D. $7.44.
E. None of the options are correct.
20
$1,000/(1.10)
19
= $148.64; $1,000/(1.10)
= $163.51; $163.51- $148.64 = $14.87.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
75. The bond indenture includes
A. the coupon rate of the bond.
B. the par value of the bond.
C. the maturity date of the bond.
D. All of the options are correct.
E. None of the options are correct.
The bond indenture includes the coupon rate, par value, and maturity date of the bond, as well as any other contractual features.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
14-38
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
76. Most corporate bonds are traded
A. on a formal exchange operated by the New York Stock Exchange.
B. by the issuing corporation.
C. over the counter by bond dealers linked by a computer quotation system.
D. on a formal exchange operated by the American Stock Exchange.
E. on a formal exchange operated by the Philadelphia Stock Exchange.
Most corporate bonds are traded in a loosely organized network of bond dealers linked by a computer quote system. Only a small
proportion is traded on the New York Exchange.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond markets and trading
77. The process of retiring high-coupon debt and issuing new bonds at a lower coupon to reduce interest payments is called
A. deferral.
B. reissue.
C. repurchase.
D. refunding.
E. None of the options are correct.
The process of refunding refers to calling high-coupon bonds and issuing new, lower coupon debt.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond refunding
78. Convertible bonds
A. give their holders the ability to share in price appreciation of the underlying stock.
B. offer lower coupon rates than similar nonconvertible bonds.
C. offer higher coupon rates than similar nonconvertible bonds.
D. give their holders the ability to share in price appreciation of the underlying stock and offer lower coupon rates than similar
nonconvertible bonds.
E. give their holders the ability to share in price appreciation of the underlying stock and offer higher coupon rates than similar
nonconvertible bonds.
Convertible bonds offer appreciation potential through the ability to share in price appreciation of the underlying stock but offer a
lower coupon and yield than similar nonconvertible bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond types and features
79. TIPS are
A. securities formed from the coupon payments only of government bonds.
B. securities formed from the principal payments only of government bonds.
C. government bonds with par value linked to the general level of prices.
D. government bonds with coupon rates linked to the general level of prices.
E. zero-coupon government bonds.
Treasury Inflation Protected Securities (TIPS) are bonds whose par value adjusts according to the general level of prices. This
changes coupon payments, but not the stated coupon rate.
14-39
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: U.S. Treasury and agency securities
80. Altman’s Z scores are assigned based on a firm's financial characteristics and are used to predict
A. required coupon rates for new bond issues.
B. bankruptcy risk.
C. the likelihood of a firm becoming a takeover target.
D. the probability of a bond issue being called.
E. None of the options are correct.
Z-scores are used to predict significant bankruptcy risk.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial distress and default risk
81. When a bond indenture includes a sinking fund provision,
A. firms must establish a cash fund for future bond redemption.
B. bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed.
C. bondholders may lose because their bonds can be repurchased by the corporation at below-market prices.
D. firms must establish a cash fund for future bond redemption, and bondholders always benefit because principal repayment on the
scheduled maturity date is guaranteed.
E. None of the options are true.
A sinking fund provisions requires the firm to redeem bonds over several years, either by open market purchase or at a special call
price from bondholders. This can result in repurchase in advance of scheduled maturity at below-market prices.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond types and features
82. Subordination clauses in bond indentures
A. may restrict the amount of additional borrowing the firm can undertake.
B. are always bad for investors.
C. provide higher priority to senior creditors in the event of bankruptcy.
D. may restrict the amount of additional borrowing the firm can undertake and provide higher priority to senior creditors in the
event of bankruptcy.
E. All of the options are true.
Subordination clauses in bond indentures may restrict the amount of additional borrowing the firm can undertake and provide higher
priority to senior creditors in the event of bankruptcy.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
83. Collateralized bonds
A. rely on the general earning power of the firm for the bond's safety.
B. are backed by specific assets of the issuing firm.
C. are considered the safest variety of bonds.
D. are backed by specific assets of the issuing firm and are generally considered the safest variety of bonds.
E. All of the options are true.
Collateralized bonds are considered the safest variety of bonds because they are backed by specific assets of the firm, rather than
relying on the firm's general earning power.
14-40
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
84. Debt securities are often called fixed-income securities because
A. the government fixes the maximum rate that can be paid on bonds.
B. they are held predominantly by older people who are living on fixed incomes.
C. they pay a fixed amount at maturity.
D. they promise either a fixed stream of income or a stream of income determined by a specific formula.
E. they were the first type of investment offered to the public which allowed them to "fix" their income at a higher level by
investing in bonds.
This definition is given in the chapter's introduction. It helps the student understand the nature of bonds.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
85. A zero-coupon bond is one that
A. effectively has a zero-percent coupon rate.
B. pays interest to the investor based on the general level of interest rates rather than at a specified coupon rate.
C. pays interest to the investor without requiring the actual coupon to be mailed to the corporation.
D. is issued by state governments because they don't have to pay interest.
E. is analyzed primarily by focusing ("zeroing in") on the coupon rate.
Zero-coupon bonds pay no interest. Investors receive the face value at maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond types and features
86. Swingin'Soiree, Inc. is a firm that has its main office on the Right Bank in Paris. The firm just issued bonds with a final payment
amount that depends on whether the Seine River floods. This type of bond is known as
A. a contingency bond.
B. a catastrophe bond.
C. an emergency bond.
D. an incident bond.
E. an eventuality bond.
Catastrophe bonds are used to transfer risk from the firm to the capital markets.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
87. One year ago, you purchased a newly-issued TIPS bond that has a 6% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 4.2%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $60.00, $1,000
B. $42.00, $1,042
C. $60.00, $1,042
D. $62.52, $1,042
E. $102.00, $1,000
14-41
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The bond price, which is indexed to the inflation rate, becomes $1,000 × 1.042 = $1,042. The interest payment is based on the coupon rate
and the new face value. The interest amount equals $1,042 × .06 = $62.52.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: U.S. Treasury and agency securities
88. Bond analysts might be more interested in a bond's yield to call if
A. the bond's yield to maturity is insufficient.
B. the firm has called some of its bonds in the past.
C. the investor only plans to hold the bond until its first call date.
D. interest rates are expected to rise.
E. interest rates are expected to fall.
If interest rates fall the firm is more likely to call the issue and refinance at lower rates. This is similar to an individual refinancing a
home. The student has to think through each of the reasons given and make the connection between falling rates and the motivation
to refinance.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 3 Challenge
Topic: Bond yields and returns
89. What is the relationship between the price of a straight bond and the price of a callable bond?
A. The straight bond's price will be higher than the callable bond's price for low interest rates.
B. The straight bond's price will be lower than the callable bond's price for low interest rates.
C. The straight bond's price will change as interest rates change, but the callable bond's price will stay the same.
D. The straight bond and the callable bond will have the same price.
E. There is no consistent relationship between the two types of bonds.
For low interest rates, the price difference is due to the value of the firm's option to call the bond at the call price. The firm is more
likely to call the issue at low interest rates, so the option is valuable. At higher interest rates the firm is less likely to call and this
option loses value. The prices converge for high interest rates. A graphical representation is shown in Figure 14.4.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Bond valuation
90. Three years ago, you purchased a bond for $974.69. The bond had three years to maturity, a coupon rate of 8%, paid annually,
and a face value of $1,000. Each year, you reinvested all coupon interest at the prevailing reinvestment rate shown in the table
below. Today is the bond's maturity date. What is your realized compound yield on the bond?
A. 6.43%
B. 7.96%
C. 8.23%
D. 8.97%
E. 9.13%
The investment grows to a total future value of $80 × (1.072) × (1.094) + $80 × (1.094) + $1,080 = $1,261.34 over the three-year
period. The realized compound yield is the yield that will compound the original investment to yield the same future value:
14-42
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3
3
$974.69 × (1 + rcy) = $1,261.34, (1 + rcy) = 1.29409, 1 + rcy = 1.0897, rcy = 8.97%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
91. Which of the following is not a type of international bond?
A. Samurai bonds
B. Yankee bonds
C. Bulldog bonds
D. Elton bonds
E. All of the options are international bonds.
Samurai bonds, Yankee bonds, and bulldog bonds are mentioned in the textbook.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Bond types and features
92. A coupon bond that pays interest annually has a par value of $1,000, matures in six years, and has a yield to maturity of 11%.
The intrinsic value of the bond today will be ______ if the coupon rate is 7.5%.
A. $712.99
B. $851.93
C. $1,123.01
D. $886.28
E. $1,000.00
FV = 1,000, PMT = 75, n = 6, i = 11, PV = 851.93.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
93. A coupon bond that pays interest annually has a par value of $1,000, matures in eight years, and has a yield to maturity of 9%.
The intrinsic value of the bond today will be ______ if the coupon rate is 6%.
A. $833.96
B. $620.92
C. $1,123.01
D. $886.28
E. $1,000.00
FV = 1,000, PMT = 60, n = 8, i = 9, PV = 833.96.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
94. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in six years, and has a yield to maturity of
9%. The intrinsic value of the bond today will be __________ if the coupon rate is 9%.
A. $922.78
B. $924.16
C. $1,075.80
D. $1,000.00
E. None of the options are correct.
14-43
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
FV = 1,000, PMT = 45, n = 12, i = 4.5, PV = 1,000.00.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
95. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in seven years, and has a yield to maturity of
11%. The intrinsic value of the bond today will be __________ if the coupon rate is 8.8%.
A. $922.78
B. $894.51
C. $1,075.80
D. $1,077.20
E. None of the options are correct.
FV = 1,000, PMT = 44, n = 14, i = 5.5, PV = 894.51.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
96. A coupon bond that pays interest of $90 annually has a par value of $1,000, matures in nine years, and is selling today at a $66
discount from par value. The yield to maturity on this bond is
A. 9.00%.
B. 10.15%.
C. 11.25%.
D. 12.32%.
E. None of the options are correct.
FV = 1,000, PMT = 90, n = 9, PV = 934, i = 10.15%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
97. A coupon bond that pays interest of $40 semi-annually has a par value of $1,000, matures in four years, and is selling today at a
$36 discount from par value. The yield to maturity on this bond is
A. 8.69%.
B. 9.09%.
C. 10.43%.
D. 9.76%.
E. None of the options are correct.
FV = 1,000, PMT = 40, n = 8, PV = 964, i = 9.09%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
98. You purchased an annual interest coupon bond one year ago that now has 18 years remaining until maturity. The coupon rate of
interest was 11%, and par value was $1,000. At the time you purchased the bond, the yield to maturity was 10%. The amount you
paid for this bond one year ago was
A. $1,057.50.
B. $1,075.50.
C. $1,083.65.
D. $1.092.46.
14-44
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. $1,104.13.
FV = 1,000, PMT = 110, n = 19, i = 10, PV = 1,083.65.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
99. You purchased an annual interest coupon bond one year ago that had nine years remaining to maturity at that time. The coupon
interest rate was 10%, and the par value was $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold
the bond after receiving the first interest payment and the yield to maturity continued to be 8%, your annual total rate of return on
holding the bond for that year would have been
A. 8.00%.
B. 7.82%.
C. 7.00%.
D. 11.95%.
E. None of the options are correct.
FV = 1,000, PMT = 100, n = 9, i = 8, PV = 1,124.94; FV = 1000, PMT = 100, n = 8, i = 8, PV = 1,114.93; HPR = (1,114.93
1,124.94 + 100)/1,124.94 = 8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
100. Consider two bonds, F and G. Both bonds presently are selling at their par value of $1,000. Each pays interest of $90 annually.
Bond F will mature in 15 years while bond G will mature in 26 years. If the yields to maturity on the two bonds change from 9% to
10%,
A. both bonds will increase in value, but bond F will increase more than bond G.
B. both bonds will increase in value, but bond G will increase more than bond F.
C. both bonds will decrease in value, but bond F will decrease more than bond G.
D. both bonds will decrease in value, but bond G will decrease more than bond F.
E. None of the options are correct.
The longer the maturity, the greater the price changes when interest rates change.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Interest rate risk
101. A zero-coupon bond has a yield to maturity of 12% and a par value of $1,000. If the bond matures in 18 years, the bond should
sell for a price of _______ today.
A. $422.41
B. $501.87
C. $513.16
D. $130.04
18
$1,000/(1.12)
= $130.04.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
102. A zero-coupon bond has a yield to maturity of 11% and a par value of $1,000. If the bond matures in 27 years, the bond should
sell for a price of _______ today.
A. $59.74
14-45
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. $501.87
C. $513.16
D. $483.49
27
$1,000/(1.11)
= $59.74.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
103. You have just purchased a 12-year zero-coupon bond with a yield to maturity of 9% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 10% at the time you
sell.
A. 10.00%
B. 20.42%
C. -1.4%
D. 1.4%
12
$1,000/(1.09)
11
= $355.53; $1,000/(1.10)
= $350.49; ($350.49 - $355.53)/$355.53 = 1.4%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
104. You have just purchased a 7-year zero-coupon bond with a yield to maturity of 11% and a par value of $1,000. What would
your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 9% at the time you sell.
A. 10.00%
B. 23.8%
C. 13.8%
D. 1.4%
7
6
$1,000/(1.11) = $481.66; $1,000/(1.09) = $596.27; ($596.27 - $481.66)/$481.66 = 23.8%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
105. A convertible bond has a par value of $1,000 and a current market price of $975. The current price of the issuing firm's stock is $42,
and the conversion ratio is 22 shares. The bond's market conversion value is
A. $729.
B. $924.
C. $870.
D. $1,000.
22 shares × $42/share = $924.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond valuation
106. A convertible bond has a par value of $1,000 and a current market price of $1,105. The current price of the issuing firm's stock
is $20, and the conversion ratio is 35 shares. The bond's market conversion value is
A. $700.
B. $810.
C. $870.
D. $1,000.
14-46
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
35 shares × $20/share = $700.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond valuation
107. A convertible bond has a par value of $1,000 and a current market value of $950. The current price of the issuing firm's stock
is $22, and the conversion ratio is 40 shares. The bond's conversion premium is
A. $40.
B. $70.
C. $190.
D. $200.
$950 - $880 = $70.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
108. A convertible bond has a par value of $1,000 and a current market value of $1,150. The current price of the issuing firm's stock
is $65, and the conversion ratio is 15 shares. The bond's conversion premium is
A. $40.
B. $150.
C. $175.
D. $200.
$1,150 - $975 = $175.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond valuation
109. If a 7% coupon bond that pays interest every 182 days paid interest 32 days ago, the accrued interest would be
A. $5.67.
B. $7.35.
C. $6.35.
D. $6.15.
E. $7.12.
$35 × (32/182) = $6.15.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
110. If a 7.5% coupon bond that pays interest every 182 days paid interest 62 days ago, the accrued interest would be
A. $11.67.
B. $12.35.
C. $12.77.
D. $11.98.
E. $12.15.
$37.5 × (62/182) = $12.77.
14-47
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
111. If a 9% coupon bond that pays interest every 182 days paid interest 112 days ago, the accrued interest would be
A. $27.69.
B. $27.35.
C. $26.77.
D. $27.98.
E. $28.15.
$45 × (112/182) = $27.69.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond yields and returns
112. A 7% coupon bond with an ask price of $100.00 pays interest every 182 days. If the bond paid interest 32 days ago, the invoice
price of the bond would be
A. $1,005.67.
B. $1,007.35.
C. $1,006.35.
D. $1,006.15.
E. $1,007.12.
$1,000 + [35 × (32/182)] = $1,006.15.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond price and quotes
113. A 7.5% coupon bond with an ask price of $100.00 pays interest every 182 days. If the bond paid interest 62 days ago, the
invoice price of the bond would be
A. $1,011.67.
B. $1,012.35.
C. $1,012.77.
D. $1,011.98.
E. $1,012.15.
$1,000 + [37.5 × (62/182)] = $1,012.77.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond price and quotes
114. A 9% coupon bond with an ask price of 100:00 pays interest every 182 days. If the bond paid interest 112 days ago, the invoice
price of the bond would be
A. $1,027.69.
B. $1,027.35.
C. $1,026.77.
D. $1,027.98.
E. $1,028.15.
$1,000 + [45 × (112/182)] = $1,027.69.
14-48
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Bond price and quotes
115. One year ago, you purchased a newly-issued TIPS bond that has a 5% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 3.2%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $50.00, $1,000
B. $32.00, $1,032
C. $50.00, $1,032
D. $32.00, $1,050
E. $51.60, $1,032
The bond price, which is indexed to the inflation rate, becomes $1,000 × 1.032 = $1,032. The interest payment is based on the coupon rate
and the new face value. The interest amount equals $1,032 × .05 = $51.60.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: U.S. Treasury and agency securities
116. One year ago, you purchased a newly-issued TIPS bond that has a 4% coupon rate, five years to maturity, and a par value of
$1,000. The average inflation rate over the year was 3.6%. What is the amount of the coupon payment you will receive, and what is
the current face value of the bond?
A. $40.00, $1,000
B. $41.44, $1,036
C. $40.00, $1,036
D. $36.00, $1,040
E. $76.00, $1,000
The bond price, which is indexed to the inflation rate, becomes $1,000 × 1.036 = $1,036. The interest payment is based on the coupon rate
and the new face value. The interest amount equals $1,036 × .04 = $41.44.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: U.S. Treasury and agency securities
117. A CDO is a
A. command duty officer.
B. collateralized debt obligation.
C. commercial debt originator.
D. collateralized debenture originator.
E. common debt officer.
A CDO is a collateralized debt obligation.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Debt financing
118. A CDS is a
A. command duty supervisor.
B. collateralized debt security.
C. commercial debt servicer.
D. collateralized debenture security.
E. credit default swap.
14-49
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A CDS is a credit default swap.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Swaps
119. A credit default swap is
A. a fancy term for a low-risk bond.
B. an insurance policy on the default risk of a federal government bond or loan.
C. an insurance policy on the default risk of a corporate bond or loan.
D. an insurance policy on the default risk of federal government and corporate bonds and loans.
E. None of the options are correct.
A credit default swap is an insurance policy on the default risk of federal government and corporate bonds and loans
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Swaps
120. The compensation from a CDS can come from
A. the CDS holder delivering the defaulted bond to the CDS issuer in return for the bond's par value.
B. the CDS issuer paying the swap holder the difference between the par value of the bond and the bond's market price.
C. the federal government paying off on the insurance claim.
D. the CDS holder delivering the defaulted bond to the CDS issuer in return for the bond's par value, and the CDS issuer paying the
swap holder the difference between the par value of the bond and the bond's market price.
E. None of the options are correct.
The compensation from a CDS can come from the CDS holder delivering the defaulted bond to the CDS issuer in return for the
bond's par value or the CDS issuer paying the swap holder the difference between the par value of the bond and the bond's market
price.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Swaps
121. SIVs are
A. structured investment vehicles.
B. structured interest rate vehicles.
C. semi-annual investment vehicles.
D. riskless investments.
E. structured insured variable rate instruments. SIVs are structured investment vehicles.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Financial intermediaries and market participants
122. SIVs raise funds by ______ and then use the proceeds to ______.
A. issuing short-term commercial paper; retire other forms of their debt
B. issuing short-term commercial paper; buy other forms of debt such as mortgages
C. issuing long-term bonds; retire other forms of their debt
D. issuing long-term bonds; buy other forms of debt such as mortgages
SIVs raise funds by issuing short-term commercial paper and then use the proceeds to buy other forms of debt such as mortgages.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
14-50
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Financial intermediaries and market participants
123. CDOs are divided in tranches
A. that provide investors with securities with varying degrees of credit risk.
B. and each tranch is given a different level of seniority in terms of its claims on the underlying pool.
C. and none of the tranches is risky.
D. and equity tranch is very low risk.
E. that provide investors with securities with varying degrees of credit risk, and each tranch is given a different level of seniority in
terms of its claims on the underlying pool.
CDOs are divided into tranches that provide investors with securities with varying degrees of credit risk, and each tranch is given a
different level of seniority in terms of its claims on the underlying pool.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Debt financing
124. Mortgage-backed CDOs were a disaster in 2007 because
A. they were formed by pooling high quality fixed-rate loans with low interest rates.
B. they were formed by pooling subprime mortgages.
C. home prices stalled.
D. the mortgages were variable rate loans, and interest rates increased.
E. they were formed by pooling subprime mortgages, home prices stalled, the mortgages were variable rate loans, and interest rates
increased.
Mortgage-backed CDOs were a disaster in 2007 because they were formed by pooling subprime mortgages, home prices stalled, the
mortgages were variable rate loans, and interest rates increased.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Mortgage securities and issues
14-51
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 14 Test Bank - Static Summary
Category
# of Questions
AACSB: Knowledge Application
79
AACSB: Reflective Thinking
45
Accessibility: Keyboard Navigation
119
Blooms: Apply
78
Blooms: Remember
38
Blooms: Understand
8
Difficulty: 1 Basic
47
Difficulty: 2 Intermediate
71
Difficulty: 3 Challenge
6
Topic: Bond markets and trading
2
Topic: Bond price and quotes
10
Topic: Bond ratings and credit risk
3
Topic: Bond refunding
1
Topic: Bond types and features
16
Topic: Bond valuation
28
Topic: Bond yields and returns
46
Topic: Debt financing
2
Topic: Financial distress and default risk
5
Topic: Financial intermediaries and market participants
2
Topic: Interest rate risk
2
Topic: Mortgage securities and issues
1
Topic: Swaps
3
Topic: U.S. Treasury and agency securities
4
14-52
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 15 Test Bank - Static
Student:__________________________________________________________________________
Multiple Choice Questions
1. Structure of interest rates is
A. the relationship between the rates of interest on all securities.
B. the relationship between the interest rate on a security and its time to maturity.
C. the relationship between the yield on a bond and its default rate.
D. All of the options are correct.
E. None of the options are correct.
2. Treasury STRIPS are
A. securities issued by the Treasury with very long maturities.
B. extremely risky securities.
C. created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow.
D. created by pooling mortgage payments made to the Treasury.
3. The value of a Treasury bond should
A. be equal to the sum of the value of STRIPS created from it.
B. be less than the sum of the value of STRIPS created from it.
C. be greater than the sum of the value of STRIPS created from it.
D. All of the options are correct.
4. If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows), you could
A. profit by buying the stripped cash flows and reconstituting the bond.
B. not profit by buying the stripped cash flows and reconstituting the bond.
C. profit by buying the bond and creating STRIPS.
D. not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating
STRIPS.
E. None of the options are correct.
5. If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows), you could
A. profit by buying the stripped cash flows and reconstituting the bond.
B. not profit by buying the stripped cash flows and reconstituting the bond.
C. profit by buying the bond and creating STRIPS.
D. not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating
STRIPS.
E. None of the options are correct.
6. If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows),
A. arbitrage would probably occur.
B. arbitrage would probably not occur.
C. the FED would adjust interest rates.
D. None of the options are correct.
7. If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows),
A. arbitrage would probably occur.
B. arbitrage would probably not occur.
C. the FED would adjust interest rates.
D. None of the options are correct.
8. Bond stripping and bond reconstitution offer opportunities for ______, which can occur if the _________ is violated.
A. arbitrage; law of one price
B. arbitrage; restrictive covenants
C. huge losses; law of one price
D. huge losses; restrictive covenants
15-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
9. ______ can occur if _____.
A. Arbitrage; the law of one price is not violated
B. Arbitrage; the law of one price is violated
C. Low-risk economic profit; the law of one price is not violated
D. Low-risk economic profit; the law of one price is violated
E. Arbitrage and low-risk economic profit; the law of one price is violated
10. The yield curve shows at any point in time
A. the relationship between the yield on a bond and the duration of the bond.
B. the relationship between the coupon rate on a bond and time to maturity of the bond.
C. the relationship between yield on a bond and the time to maturity on the bond.
D. All of the options are correct.
E. None of the options are correct.
11. An inverted yield curve implies that
A. long-term interest rates are lower than short-term interest rates.
B. long-term interest rates are higher than short-term interest rates.
C. long-term interest rates are the same as short-term interest rates.
D. intermediate-term interest rates are higher than either short- or long-term interest rates.
E. None of the options are correct.
12. An upward sloping yield curve is a(n) _______ yield curve.
A. normal
B. humped
C. inverted
D. flat
E. None of the options are correct.
13. According to the expectations hypothesis, an upward-sloping yield curve implies that
A. interest rates are expected to remain stable in the future.
B. interest rates are expected to decline in the future.
C. interest rates are expected to increase in the future.
D. interest rates are expected to decline first, then increase.
E. interest rates are expected to increase first, then decrease.
14. Which of the following are possible explanations for the term structure of interest rates?
A. The expectations theory
B. The liquidity preference theory
C. Modern portfolio theory
D. The expectations theory and the liquidity preference theory
15. The expectations theory of the term structure of interest rates states that
A. forward rates are determined by investors'expectations of future interest rates.
B. forward rates exceed the expected future interest rates.
C. yields on long- and short-maturity bonds are determined by the supply and demand for the securities.
D. All of the options are correct.
E. None of the options are correct.
16. Suppose that all investors expect that interest rates for the 4 years will be as follows:
15-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
What is the price of a 3-year zero-coupon bond with a par value of $1,000?
A. $863.83
B. $816.58
C. $772.18
D. $765.55
E. None of the options are correct.
17. Suppose that all investors expect that interest rates for the 4 years will be as follows:
If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment in the first
year if the implied forward rates stay the same? (Par value of the bond = $1,000)
A. 5%
B. 7%
C. 9%
D. 10%
E. None of the options are correct.
18. Suppose that all investors expect that interest rates for the 4 years will be as follows:
What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Par value = $1,000)
A. $1,092
B. $1,054
C. $1,000
D. $1,073
E. None of the options are correct.
19. Suppose that all investors expect that interest rates for the 4 years will be as follows:
What is the yield to maturity of a 3-year zero-coupon bond?
A. 7.03%
B. 9.00%
C. 6.99%
15-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
D. 7.49%
E. None of the options are correct.
20. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
According to the expectations theory, what is the expected forward rate in the third year?
A. 7.00%
B. 7.33%
C. 9.00%
D. 11.19%
E. None of the options are correct.
21. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the yield to maturity on a 3-year zero-coupon bond?
A. 6.37%
B. 9.00%
C. 7.33%
D. 10.00%
E. None of the options are correct.
22. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Par value = $1,000.)
A. $742.09
B. $1,222.09
C. $1,000.00
D. $1,141.92
E. None of the options are correct.
23. An upward-sloping yield curve
A. may be an indication that interest rates are expected to increase.
B. may incorporate a liquidity premium.
C. may reflect the confounding of the liquidity premium with interest rate expectations.
15-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
D. All of the options are correct.
E. None of the options are correct.
24. The "break-even" interest rate for year n that equates the return on an n-period zero-coupon bond to that of an n 1
period zero-coupon bond rolled over into a one-year bond in year n is defined as
A. the forward rate.
B. the short rate.
C. the yield to maturity.
D. the discount rate.
E. None of the options are correct.
25. When computing yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested
at the
A. coupon rate.
B. current yield.
C. yield to maturity at the time of the investment.
D. prevailing yield to maturity at the time interest payments are received.
E. the average yield to maturity throughout the investment period.
26. Given the bond described above, if interest were paid semi-annually (rather than annually), and the bond continued
to be priced at $850, the resulting effective annual yield to maturity would be
A. less than 12%.
B. more than 12%.
C. 12%.
D. Cannot be determined.
E. None of the options are correct.
27. Forward rates ____________ future short rates because ____________.
A. are equal to; they are both extracted from yields to maturity
B. are equal to; they are perfect forecasts
C. differ from; they are imperfect forecasts
D. differ from; forward rates are estimated from dealer quotes while future short rates are extracted from yields to
maturity
E. are equal to; although they are estimated from different sources, they both are used by traders to make purchase
decisions
28. The pure yield curve can be estimated
A. by using zero-coupon Treasuries.
B. by using stripped Treasuries if each coupon is treated as a separate "zero."
C. by using corporate bonds with different risk ratings.
D. by estimating liquidity premiums for different maturities.
E. by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero."
29. The on the run yield curve is
A. a plot of yield as a function of maturity for zero-coupon bonds.
B. a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par.
C. a plot of yield as a function of maturity for corporate bonds with different risk ratings.
D. a plot of liquidity premiums for different maturities.
30. The yield curve
15-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
A. is a graphical depiction of term structure of interest rates.
B. is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields.
C. is usually depicted for corporate bonds of different ratings.
D is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to
hold risk constant across maturities and yields.
E. is a graphical depiction of term structure of interest rates and is usually depicted for corporate bonds of different
ratings.
31.
What should the purchase price of a 2-year zero-coupon bond be if it is purchased at the beginning of year 2 and has face
value of $1,000?
A. $877.54
B. $888.33
C. $883.32
D. $893.36
E. $871.80
32.
What would the yield to maturity be on a four-year zero-coupon bond purchased today?
A. 5.80%
B. 7.30%
C. 6.65%
D. 7.25%
E. None of the options are correct.
33.
15-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Calculate the price at the beginning of year 1 of a 10% annual coupon bond with face value $1,000 and 5 years to
maturity.
A. $1,105
B. $1,132
C. $1,179
D. $1,150
E. $1,119
34. Given the yield on a 3-year zero-coupon bond is 7.2% and forward rates of 6.1% in year 1 and 6.9% in year 2, what
must be the forward rate in year 3?
A. 8.4%
B. 8.6%
C. 8.1%
D. 8.9%
E. None of the options are correct.
35. An inverted yield curve is one
A. with a hump in the middle.
B. constructed by using convertible bonds.
C. that is relatively flat.
D. that plots the inverse relationship between bond prices and bond yields.
E. that slopes downward.
36. Investors can use publicly available financial data to determine which of the following?
I) The shape of the yield curve
II) Expected future short-term rates (if liquidity premiums are ignored)
III) The direction the Dow indexes are heading
IV) The actions to be taken by the Federal Reserve
A. I and II
B. I and III
C. I, II, and III
D. I, III, and IV
E. I, II, III, and IV
37. Which of the following combinations will result in a sharply-increasing yield curve?
A. Increasing future expected short rates and increasing liquidity premiums
B. Decreasing future expected short rates and increasing liquidity premiums
C. Increasing future expected short rates and decreasing liquidity premiums
D. Increasing future expected short rates and constant liquidity premiums
E. Constant future expected short rates and increasing liquidity premiums
38. The yield curve is a component of
A. the Dow Jones Industrial Average.
B. the consumer price index.
C. the index of leading economic indicators.
D. the producer price index.
E. the inflation index.
39. The most recently issued Treasury securities are called
A. on the run.
B. off the run.
C. on the market.
D. off the market.
E. None of the options are correct.
40. Suppose that all investors expect that interest rates for the 4 years will be as follows:
15-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
What is the price of 3-year zero-coupon bond with a par value of $1,000?
A. $889.08
B. $816.58
C. $772.18
D. $765.55
E. None of the options are correct.
41. If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment
in the first year if the implied forward rates stay the same? (Par value of the bond = $1,000.) Suppose that all investors
expect that interest rates for the 4 years will be as follows:
A. 5%
B. 3%
C. 9%
D. 10%
E. None of the options are correct.
42. What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Par value = $1,000.) Suppose that
all investors expect that interest rates for the 4 years will be as follows:
A. $1,092.97
B. $1,054.24
C. $1,028.51
D. $1,073.34
E. None of the options are correct.
15-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
43. What is the yield to maturity of a 3-year zero-coupon bond?
Suppose that all investors expect that interest rates for the 4 years will be as follows:
A. 7.00%
B. 9.00%
C. 6.99%
D. 4.00%
E. None of the options are correct.
44. According to the expectations theory, what is the expected forward rate in the third year?
The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
A. 7.23%
B. 9.37%
C. 9.00%
D. 10.9%
45. What is the yield to maturity on a 3-year zero-coupon bond?
The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
A. 6.37%
B. 9.00%
C. 7.33%
D. 8.24%
15-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
46. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the price of a 4-year maturity bond with a 10% coupon rate paid annually? (Par values = $1,000.)
A. $742.09
B. $1,222.09
C. $1,035.66
D. $1,141.84
47. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
You have purchased a 4-year maturity bond with a 9% coupon rate paid annually. The bond has a par value of $1,000. What would
the price of the bond be one year from now if the implied forward rates stay the same?
A. $995.63
B. $1,108.88
C. $1,000.00
D. $1,042.78
48. Given the bond described above, if interest were paid semi-annually (rather than annually) and the bond continued to be priced
at $917.99, the resulting effective annual yield to maturity would be
A. less than 10%.
B. more than 10%.
C. 10%.
D. Cannot be determined.
E. None of the options are correct.
15-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
49. What should the purchase price of a 2-year zerocoupon bond be if it is purchased at the beginning of
year 2 and has face value of $1,000?
A. $877.54
B. $888.33
C. $883.32
D. $894.21
E. $871.80
50. What would the yield to maturity be on a four-year
zero-coupon bond purchased today?
A. 5.75%
B. 6.30%
C. 5.65%
D. 5.25%
51. Calculate the price at the beginning of year 1 of an
8% annual coupon bond with face value $1,000 and 5
years to
maturity.
A. $1,105.47
B. $1,131.91
C. $1,084.25
D. $1,150.01
15-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
E. $719.75
52. Given the yield on a 3-year zero-coupon bond is 7%
and forward rates of 6% in year 1 and 6.5% in year 2,
what must be the forward rate in year 3?
A. 7.2%
B. 8.6%
C. 8.5%
D. 6.9%
53. What should the purchase price of a 1-year zerocoupon bond be if it is purchased today and has face
value of $1,000?
A. $966.37
B. $912.87
C. $950.21
D. $956.02
E. $945.51
54. What should the purchase price of a 2-year zerocoupon bond be if it is purchased today and has face
value of $1,000?
A. $966.87
B. $911.37
C. $950.21
D. $956.02
E. $945.51
55. What should the purchase price of a 3-year zerocoupon bond be if it is purchased today and has face
value of $1,000?
15-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. $887.42
B. $871.12
C. $879.54
D. $856.02
E. $866.32
56. What should the purchase price of a 4-year zerocoupon bond be if it is purchased today and has face
value of $1,000?
A. $887.42
B. $821.15
C. $879.54
D. $856.02
E. $866.32
57. What should the purchase price of a 5-year zerocoupon bond be if it is purchased today and has face
value of $1,000?
A. $776.14
B. $721.15
C. $779.54
D. $756.02
E. $766.32
58. What is the yield to maturity of a 1-year bond?
15-13
Copyright © 2017 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
59. What is the yield to maturity of a 5-year bond?
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
60. What is the yield to maturity of a 4-year bond?
A. 4.69%
B. 4.95%
C. 5.02%
D. 5.05%
E. 5.08%
61. What is the yield to maturity of a 3-year bond?
15-14
Copyright © 2017 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
62. What is the yield to maturity of a 2-year bond?
15-15
Copyright © 2017 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. 4.6%
B. 4.9%
C. 5.2%
D. 4.7%
E. 5.8%
Chapter 15 Test Bank - Static Key
1. Structure of interest rates is
A. the relationship between the rates of interest on all securities.
B. the relationship between the interest rate on a security and its time to maturity.
C. the relationship between the yield on a bond and its default rate.
D. All of the options are correct.
E. None of the options are correct.
The term structure of interest rates is the relationship between two variables, years and yield to maturity (holding all else constant).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Term structure of interest rates
2. Treasury STRIPS are
A. securities issued by the Treasury with very long maturities.
B. extremely risky securities.
C. created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow.
D. created by pooling mortgage payments made to the Treasury.
Treasury STRIPS are created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
3. The value of a Treasury bond should
A. be equal to the sum of the value of STRIPS created from it.
B. be less than the sum of the value of STRIPS created from it.
C. be greater than the sum of the value of STRIPS created from it.
D. All of the options are correct.
The value of a Treasury bond should be equal to the sum of the value of STRIPS created from it.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
15-16
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Topic: U.S. Treasury and agency securities
4. If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows), you could
A. profit by buying the stripped cash flows and reconstituting the bond.
B. not profit by buying the stripped cash flows and reconstituting the bond.
C. profit by buying the bond and creating STRIPS.
D. not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating STRIPS.
E. None of the options are correct.
Only buying STRIPS and reconstituting the bond would be profitable.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
5. If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows), you could
A. profit by buying the stripped cash flows and reconstituting the bond.
B. not profit by buying the stripped cash flows and reconstituting the bond.
C. profit by buying the bond and creating STRIPS.
D. not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating STRIPS.
E. None of the options are correct.
Buying and stripping the bond would be profitable so answer D is correct.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
6. If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows),
A. arbitrage would probably occur.
B. arbitrage would probably not occur.
C. the FED would adjust interest rates.
D. None of the options are correct.
If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows) arbitrage would probably
occur.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
7. If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows),
A. arbitrage would probably occur.
B. arbitrage would probably not occur.
C. the FED would adjust interest rates.
D. None of the options are correct.
If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows) arbitrage would probably
occur.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
15-17
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
8. Bond stripping and bond reconstitution offer opportunities for ______, which can occur if the _________ is violated.
A. arbitrage; law of one price
B. arbitrage; restrictive covenants
C. huge losses; law of one price
D. huge losses; restrictive covenants
Bond stripping and bond reconstitution offer opportunities for arbitrage, which can occur if the law of one price is violated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
9. ______ can occur if _____.
A. Arbitrage; the law of one price is not violated
B. Arbitrage; the law of one price is violated
C. Low-risk economic profit; the law of one price is not violated
D. Low-risk economic profit; the law of one price is violated
E. Arbitrage and low-risk economic profit; the law of one price is violated
Arbitrage (also known as riskless economic profit) can occur if the law of one price is violated.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Arbitrage and its limits
10. The yield curve shows at any point in time
A. the relationship between the yield on a bond and the duration of the bond.
B. the relationship between the coupon rate on a bond and time to maturity of the bond.
C. the relationship between yield on a bond and the time to maturity on the bond.
D. All of the options are correct.
E. None of the options are correct.
The yield curve shows the relationship between yield on a bond and the time to maturity on the bond.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
11. An inverted yield curve implies that
A. long-term interest rates are lower than short-term interest rates.
B. long-term interest rates are higher than short-term interest rates.
C. long-term interest rates are the same as short-term interest rates.
D. intermediate-term interest rates are higher than either short- or long-term interest rates.
E. None of the options are correct.
The inverted, or downward sloping, yield curve is one in which short-term rates are higher than long-term rates. The inverted yield
curve has been observed frequently, although not as frequently as the upward sloping, or normal, yield curve.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
12. An upward sloping yield curve is a(n) _______ yield curve.
15-18
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. normal
B. humped
C. inverted
D. flat
E. None of the options are correct.
The upward sloping yield curve is referred to as the normal yield curve, probably because, historically, the upward sloping yield
curve is the shape that has been observed most frequently.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
13. According to the expectations hypothesis, an upward-sloping yield curve implies that
A. interest rates are expected to remain stable in the future.
B. interest rates are expected to decline in the future.
C. interest rates are expected to increase in the future.
D. interest rates are expected to decline first, then increase.
E. interest rates are expected to increase first, then decrease.
An upward sloping yield curve is based on the expectation that short-term interest rates will increase.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Interest rate theories
14. Which of the following are possible explanations for the term structure of interest rates?
A. The expectations theory
B. The liquidity preference theory
C. Modern portfolio theory
D. The expectations theory and the liquidity preference theory
The expectations theory and the liquidity preference theory are theories that have been proposed to explain the term structure.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Interest rate theories
15. The expectations theory of the term structure of interest rates states that
A. forward rates are determined by investors'expectations of future interest rates.
B. forward rates exceed the expected future interest rates.
C. yields on long- and short-maturity bonds are determined by the supply and demand for the securities.
D. All of the options are correct.
E. None of the options are correct.
The forward rate equals the market consensus expectation of future short interest rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Interest rate theories
16. Suppose that all investors expect that interest rates for the 4 years will be as follows:
15-19
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
What is the price of a 3-year zero-coupon bond with a par value of $1,000?
A. $863.83
B. $816.58
C. $772.18
D. $765.55
E. None of the options are correct.
$1,000/(1.05)(1.07)(1.09) = $816.58.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
17. Suppose that all investors expect that interest rates for the 4 years will be as follows:
If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment in the first year if the
implied forward rates stay the same? (Par value of the bond = $1,000)
A. 5%
B. 7%
C. 9%
D. 10%
E. None of the options are correct.
The forward interest rate given for the first year of the investment is given as 5% (see table above).
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
18. Suppose that all investors expect that interest rates for the 4 years will be as follows:
What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Par value = $1,000)
15-20
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $1,092
B. $1,054
C. $1,000
D. $1,073
E. None of the options are correct.
[(1.05)(1.07)]
1/2
1 = 6%; FV = 1000, n = 2, PMT = 100, i = 6, PV = $1,073.34.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
19. Suppose that all investors expect that interest rates for the 4 years will be as follows:
What is the yield to maturity of a 3-year zero-coupon bond?
A. 7.03%
B. 9.00%
C. 6.99%
D. 7.49%
E. None of the options are correct.
1/3
[(1.05)(1.07)(1.09)]
1 = 6.99.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
20. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
According to the expectations theory, what is the expected forward rate in the third year?
A. 7.00%
B. 7.33%
C. 9.00%
D. 11.19%
E. None of the options are correct.
881.68/808.88
1 = 9%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Interest rate theories
15-21
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
21. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the yield to maturity on a 3-year zero-coupon bond?
A. 6.37%
B. 9.00%
C. 7.33%
D. 10.00%
E. None of the options are correct.
1/3
(1,000/808.81)
1 = 7.33%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
22. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Par value = $1,000.)
A. $742.09
B. $1,222.09
C. $1,000.00
D. $1,141.92
E. None of the options are correct.
1/4
(1,000/742.09)
1 = 7.74%; FV = 1,000, PMT = 120, n = 4, i = 7.74, PV = $1,141.92.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
23. An upward-sloping yield curve
A. may be an indication that interest rates are expected to increase.
B. may incorporate a liquidity premium.
C. may reflect the confounding of the liquidity premium with interest rate expectations.
D. All of the options are correct.
E. None of the options are correct.
One of the problems of the most commonly used explanation of term structure, the expectations hypothesis, is that it is difficult to
separate out the liquidity premium from interest rate expectations.
AACSB: Reflective Thinking
15-22
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
24. The "break-even" interest rate for year n that equates the return on an n-period zero-coupon bond to that of an n 1 period zerocoupon bond rolled over into a one-year bond in year n is defined as
A. the forward rate.
B. the short rate.
C. the yield to maturity.
D. the discount rate.
E. None of the options are correct.
The forward rate for year n, fn, is the "break-even" interest rate for year n that equates the return on an n-period zero-coupon bond
to that of an n 1 period zero-coupon bond rolled over into a one-year bond in year n.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Forward rates
25. When computing yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested at the
A. coupon rate.
B. current yield.
C. yield to maturity at the time of the investment.
D. prevailing yield to maturity at the time interest payments are received.
E. the average yield to maturity throughout the investment period.
In order to earn the yield to maturity quoted at the time of the investment, coupons must be reinvested at that rate.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Bond yields and returns
26. Given the bond described above, if interest were paid semi-annually (rather than annually), and the bond continued to be priced
at $850, the resulting effective annual yield to maturity would be
A. less than 12%.
B. more than 12%.
C. 12%.
D. Cannot be determined.
E. None of the options are correct.
FV = 1000, PV = 850, PMT = 50, n = 40, i = 5.9964 (semi-annual); (1.059964) 2 1 = 12.35%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
27. Forward rates ____________ future short rates because ____________.
A. are equal to; they are both extracted from yields to maturity
B. are equal to; they are perfect forecasts
15-23
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. differ from; they are imperfect forecasts
D. differ from; forward rates are estimated from dealer quotes while future short rates are extracted from yields to maturity
E. are equal to; although they are estimated from different sources, they both are used by traders to make purchase decisions
Forward rates are the estimates of future short rates extracted from yields to maturity but they are not perfect forecasts because the
future cannot be predicted with certainty; therefore they will usually differ.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Forward rates
28. The pure yield curve can be estimated
A. by using zero-coupon Treasuries.
B. by using stripped Treasuries if each coupon is treated as a separate "zero."
C. by using corporate bonds with different risk ratings.
D. by estimating liquidity premiums for different maturities.
E. by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero."
The pure yield curve is calculated using stripped or zero-coupon Treasuries.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Yield curve
29. The on the run yield curve is
A. a plot of yield as a function of maturity for zero-coupon bonds.
B. a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par.
C. a plot of yield as a function of maturity for corporate bonds with different risk ratings.
D. a plot of liquidity premiums for different maturities.
The on the run yield curve is a plot of yield as a function of maturity for recently issued coupon bonds trading at or near par.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Yield curve
30. The yield curve
A. is a graphical depiction of term structure of interest rates.
B. is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields.
C. is usually depicted for corporate bonds of different ratings.
D.is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to hold risk constant
across maturities and yields.
E. is a graphical depiction of term structure of interest rates and is usually depicted for corporate bonds of different ratings.
The yield curve (yields vs. maturities, all else equal) is depicted for U.S. Treasuries more frequently than for corporate bonds, as the
risk is constant across maturities for Treasuries.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
15-24
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
31.
What should the purchase price of a 2-year zero-coupon bond be if it is purchased at the beginning of year 2 and has face value of
$1,000?
A. $877.54
B. $888.33
C. $883.32
D. $893.36
E. $871.80
$1,000/[(1.064)(1.071)] = $877.54.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Forward rates
32.
What would the yield to maturity be on a four-year zero-coupon bond purchased today?
A. 5.80%
B. 7.30%
C. 6.65%
D. 7.25%
E. None of the options are correct.
[(1.058) (1.064) (1.071) (1.073)]
1/4
1 = 6.65%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
15-25
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
33.
Calculate the price at the beginning of year 1 of a 10% annual coupon bond with face value $1,000 and 5 years to maturity.
A. $1,105
B. $1,132
C. $1,179
D. $1,150
E. $1,119
1/5
i = [(1.058) (1.064) (1.071) (1.073) (1.074)]
1 = 6.8%; FV = 1000, PMT = 100, n = 5, i = 6.8, PV = $1,131.91.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Forward rates
34. Given the yield on a 3-year zero-coupon bond is 7.2% and forward rates of 6.1% in year 1 and 6.9% in year 2, what must be the
forward rate in year 3?
A. 8.4%
B. 8.6%
C. 8.1%
D. 8.9%
E. None of the options are correct.
3
f3 = (1.072) /[(1.061) (1.069)] 1 = 8.6%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
35. An inverted yield curve is one
A. with a hump in the middle.
B. constructed by using convertible bonds.
C. that is relatively flat.
D. that plots the inverse relationship between bond prices and bond yields.
E. that slopes downward.
An inverted yield curve occurs when short-term rates are higher than long-term rates.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
15-26
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
36. Investors can use publicly available financial data to determine which of the following?
I) The shape of the yield curve
II) Expected future short-term rates (if liquidity premiums are ignored)
III) The direction the Dow indexes are heading
IV) The actions to be taken by the Federal Reserve
A. I and II
B. I and III
C. I, II, and III
D. I, III, and IV
E. I, II, III, and IV
Only the shape of the yield curve and future inferred rates can be determined. The movement of the Dow Indexes and Federal
Reserve policy are influenced by term structure but are determined by many other variables also.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Yield curve
37. Which of the following combinations will result in a sharply-increasing yield curve?
A. Increasing future expected short rates and increasing liquidity premiums
B. Decreasing future expected short rates and increasing liquidity premiums
C. Increasing future expected short rates and decreasing liquidity premiums
D. Increasing future expected short rates and constant liquidity premiums
E. Constant future expected short rates and increasing liquidity premiums
Both of the forces will act to increase the slope of the yield curve.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Yield curve
38. The yield curve is a component of
A. the Dow Jones Industrial Average.
B. the consumer price index.
C. the index of leading economic indicators.
D. the producer price index.
E. the inflation index.
Since the yield curve is often used to forecast the business cycle, it is used as one of the leading economic indicators.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: Yield curve
39. The most recently issued Treasury securities are called
A. on the run.
B. off the run.
C. on the market.
D. off the market.
E. None of the options are correct.
The most recently issued Treasury securities are called on the run.
AACSB: Reflective Thinking
15-27
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Topic: U.S. Treasury and agency securities
40.
Suppose that all investors expect that interest rates for the 4 years will be as follows:
What is the price of 3-year zero-coupon bond with a par value of $1,000?
A. $889.08
B. $816.58
C. $772.18
D. $765.55
E. None of the options are correct.
$1,000/(1.03)(1.04)(1.05) = $889.08.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
41. If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment in the first
year if the implied forward rates stay the same? (Par value of the bond = $1,000.) Suppose that all investors expect that interest rates
for the 4 years will be as follows:
A. 5%
B. 3%
C. 9%
D. 10%
E. None of the options are correct.
The forward interest rate given for the first year of the investment is given as 3% (see table above).
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
15-28
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
42. What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Par value = $1,000.) Suppose that all
investors expect that interest rates for the 4 years will be as follows:
A. $1,092.97
B. $1,054.24
C. $1,028.51
D. $1,073.34
E. None of the options are correct.
[(1.03)(1.04)]
1/2
1 = 3.5%; FV = 1,000, n = 2, PMT = 50, i = 3.5, PV = $1,028.51.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
43. What is the yield to maturity of a 3-year zero-coupon bond?
Suppose that all investors expect that interest rates for the 4 years will be as follows:
A. 7.00%
B. 9.00%
C. 6.99%
D. 4.00%
E. None of the options are correct.
1/3
[(1.03)(1.04)(1.05)]
1 = 4%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
44. According to the expectations theory, what is the expected forward rate in the third year?
The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
15-29
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. 7.23%
B. 9.37%
C. 9.00%
D. 10.9%
862.57/788.66
1 = 9.37%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Interest rate theories
45. What is the yield to maturity on a 3-year zero-coupon bond?
The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
A. 6.37%
B. 9.00%
C. 7.33%
D. 8.24%
1/3
(1,000/788.66)
1 = 8.24%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
46. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
What is the price of a 4-year maturity bond with a 10% coupon rate paid annually? (Par values = $1,000.)
A. $742.09
B. $1,222.09
C. $1,035.66
D. $1,141.84
15-30
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1/4
(1,000/711.00)
1 = 8.9%; FV = 1000, PMT = 100, n = 4, i = 8.9, PV = $1,035.66.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Bond yields and returns
47. The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000.
You have purchased a 4-year maturity bond with a 9% coupon rate paid annually. The bond has a par value of $1,000. What would
the price of the bond be one year from now if the implied forward rates stay the same?
A. $995.63
B. $1,108.88
C. $1,000.00
D. $1,042.78
1/3
(925.16/711.00)
1.0 = 9.17%; FV = 1000, PMT = 90, n = 3, i = 9.17, PV = $995.63.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Forward rates
48. Given the bond described above, if interest were paid semi-annually (rather than annually) and the bond continued to be priced
at $917.99, the resulting effective annual yield to maturity would be
A. less than 10%.
B. more than 10%.
C. 10%.
D. Cannot be determined.
E. None of the options are correct.
FV = 1,000, PV = 917.99, PMT = 45, n = 36, i = 4.995325 (semi-annual); (1.04995325)
2
1 = 10.24%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Bond yields and returns
49. What should the purchase price of a 2-year zero-coupon bond be if it is purchased at the beginning of year 2 and has face value
of $1,000?
15-31
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $877.54
B. $888.33
C. $883.32
D. $894.21
E. $871.80
$1,000/[(1.055)(1.06)] = $894.21.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Forward rates
50. What would the yield to maturity be on a four-year zero-coupon bond purchased today?
A. 5.75%
B. 6.30%
C. 5.65%
D. 5.25%
[(1.05) (1.055) (1.06) (1.065)]
1/4
1 = 5.75%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
51. Calculate the price at the beginning of year 1 of an 8% annual coupon bond with face value $1,000 and 5 years to maturity.
A. $1,105.47
B. $1,131.91
C. $1,084.25
15-32
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
D. $1,150.01
E. $719.75
i = [(1.05) (1.055) (1.06) (1.065) (1.07)]
1/5
1 = 6%; FV = 1000, PMT = 80, n = 5, i = 6, PV = $1084.25.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 3 Challenge
Topic: Forward rates
52. Given the yield on a 3-year zero-coupon bond is 7% and forward rates of 6% in year 1 and 6.5% in year 2, what must be the
forward rate in year 3?
A. 7.2%
B. 8.6%
C. 8.5%
D. 6.9%
3
f3 = (1.07) /[(1.06) (1.065)] 1 = 8.5%.
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
53. What should the purchase price of a 1-year zero-coupon bond be if it is purchased today and has face value of $1,000?
A. $966.37
B. $912.87
C. $950.21
D. $956.02
E. $945.51
$1,000/(1.046) = $956.02.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
54. What should the purchase price of a 2-year zero-coupon bond be if it is purchased today and has face value of $1,000?
15-33
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. $966.87
B. $911.37
C. $950.21
D. $956.02
E. $945.51
$1,000/[(1.046)(1.049)] = $911.37.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
55. What should the purchase price of a 3-year zero-coupon bond be if it is purchased today and has face value of $1,000?
A. $887.42
B. $871.12
C. $879.54
D. $856.02
E. $866.32
$1,000/[(1.046)(1.049)(1.052)] = $866.32.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
56. What should the purchase price of a 4-year zero-coupon bond be if it is purchased today and has face value of $1,000?
A. $887.42
B. $821.15
C. $879.54
D. $856.02
E. $866.32
$1,000/[(1.046)(1.049)(1.052)(1.055)] = $821.15.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
15-34
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
57. What should the purchase price of a 5-year zero-coupon bond be if it is purchased today and has face
value of $1,000?
A. $776.14
B. $721.15
C. $779.54
D. $756.02
E. $766.32
$1,000/[(1.046)(1.049)(1.052)(1.055)(1.058)] = $776.14.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
58. What is the yield to maturity of a 1-year bond?
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
4.6% (given in table).
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
59. What is the yield to maturity of a 5-year bond?
15-35
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
[(1.046)(1.049)(1.052)(1.055)(1.058)]
1/5
1 = 5.2%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
60. What is the yield to maturity of a 4-year bond?
A. 4.69%
B. 4.95%
C. 5.02%
D. 5.05%
E. 5.08%
1/4
[(1.046)(1.049)(1.052)(1.055)]
1 = 5.05%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
61. What is the yield to maturity of a 3-year bond?
15-36
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
A. 4.6%
B. 4.9%
C. 5.2%
D. 5.5%
E. 5.8%
1/3
[(1.046)(1.049)(1.052)]
1 = 4.9%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
62. What is the yield to maturity of a 2-year bond?
A. 4.6%
B. 4.9%
C. 5.2%
D. 4.7%
E. 5.8%
1/2
[(1.046)(1.049)]
1 = 4.7%.
AACSB: Knowledge Application
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Forward rates
15-37
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 15 Test Bank - Static Summary
Category
AACSB: Knowledge Application
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Apply
Blooms: Remember
Blooms: Understand
Difficulty: 1 Basic
Difficulty: 2 Intermediate
Difficulty: 3 Challenge
Topic: Arbitrage and its limits
Topic: Bond yields and returns
Topic: Forward rates
Topic: Interest rate theories
Topic: Term structure of interest rates
Topic: U.S. Treasury and agency securities
Topic: Yield curve
# of Questions
35
27
29
35
18
9
16
39
7
6
7
29
5
1
3
11
15-38
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Chapter 16 Test Bank - Static
Student: ___________________________________________________________________________
Multiple Choice Questions
1. The duration of a bond is a function of the bond's
A. coupon rate.
B. yield to maturity.
C. time to maturity.
D. All of the options are correct.
E. None of the options are correct.
2. Ceteris paribus, the duration of a bond is positively correlated with the bond's
A. time to maturity.
B. coupon rate.
C. yield to maturity.
D. All of the options are correct.
E. None of the options are correct.
3. Ceteris paribus, the duration of a bond is negatively correlated with the bond's
A. time to maturity.
B. coupon rate.
C. yield to maturity.
D. coupon rate and yield to maturity.
E. None of the options are correct.
4. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is lower.
B. coupon rate is higher.
C. yield to maturity is lower.
D. current yield is higher.
E. None of the options are correct.
5. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is higher.
B. coupon rate is higher.
C. yield to maturity is higher.
D. All of the options are correct.
E. None of the options are correct.
6. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is lower.
B. coupon rate is lower.
C. yield to maturity is higher.
D. term to maturity is lower and yield to maturity is higher.
E. None of the options are correct.
7. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's
A. term to maturity is lower.
B. coupon rate is higher.
C. yield to maturity is lower.
D. term to maturity is lower and coupon rate is higher.
E. All of the options are correct.
8. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's
16-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. term to maturity is lower.s
B. coupon rate is higher.
C. yield to maturity is higher.
D. term to maturity is lower and coupon rate is higher.
E. All of the options are correct.
9. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's
A. term to maturity is higher.
B. coupon rate is lower.
C. yield to maturity is higher.
D. term to maturity is higher and coupon rate is lower.
E. All of the options are correct.
10. The "modified duration" used by practitioners is equal to the Macaulay duration
A. times the change in interest rate.
B. times (one plus the bond's yield to maturity).
C. divided by (one minus the bond's yield to maturity).
D. divided by (one plus the bond's yield to maturity).
E. None of the options are correct.
11. The "modified duration" used by practitioners is equal to ______ divided by (one plus the bond's yield to maturity).
A. current yield
B. the Macaulay duration
C. yield to call
D. yield to maturity
E. None of the options are correct.
12. Given the time to maturity, the duration of a zero-coupon bond is higher when the discount rate is
A. higher.
B. lower.
C. equal to the risk-free rate.
D. The bond's duration is independent of the discount rate.
E. None of the options are correct.
13. The interest-rate risk of a bond is
A. the risk related to the possibility of bankruptcy of the bond's issuer.
B. the risk that arises from the uncertainty of the bond's return caused by changes in interest rates.
C. the unsystematic risk caused by factors unique in the bond.
D the risk related to the possibility of bankruptcy of the bond's issuer, and the risk that arises from the uncertainty of . the bond's
return caused by changes in interest rates.
E. All of the options are correct.
14. Which of the following two bonds is more price sensitive to changes in interest rates?
1) A par value bond, X, with a 5-year year to maturity and a 10% coupon rate.
2) A zero-coupon bond, Y, with a 5-year year to maturity and a 10% yield to maturity.
A. Bond X because of the higher yield to maturity
B. Bond X because of the longer time to maturity
C. Bond Y because of the longer duration
D. Both have the same sensitivity because both have the same yield to maturity.
E. None of the options are correct.
15. Holding other factors constant, which one of the following bonds has the smallest price volatility?
A. 5-year, 0% coupon bond
B. 5-year, 12% coupon bond
C. 5 year, 14% coupon bond
D. 5-year, 10% coupon bond
16-2
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. Cannot tell from the information given
16. Which of the following is not true?
A. Holding other things constant, the duration of a bond increases with time to maturity.
B. Given time to maturity, the duration of a zero-coupon decreases with yield to maturity.
C. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower.
D. Duration is a better measure of price sensitivity to interest-rate changes than is time to maturity.
E. All of the options are correct.
17. Which of the following statements are true?
I) Holding other things constant, the duration of a bond decreases with time to maturity.
II) Given time to maturity, the duration of a zero-coupon increases with yield to maturity.
III) Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower.
IV) Duration is a better measure of price sensitivity to interest-rate changes than is time to maturity.
A. I only
B. I and II
C. III only
D. III and IV
E. I, II, and IV
18. The duration of a 5-year zero-coupon bond is
A. smaller than 5.
B. larger than 5.
C. equal to 5.
D. equal to that of a 5-year 10% coupon bond.
E. None of the options are correct.
19. The basic purpose of immunization is to
A. eliminate default risk.
B. produce a zero net-interest-rate risk.
C. offset price and reinvestment risk.
D. eliminate default risk and produce a zero net-interest-rate risk.
E. produce a zero net-interest-rate risk and offset price and reinvestment risk.
20. The duration of a par-value bond with a coupon rate of 8% (paid annually) and a remaining time to maturity of 5 years is
A. 5 years.
B. 5.4 years.
C. 4.17 years.
D. 4.31 years.
21. The duration of a perpetuity with a yield of 8% is
A. 13.50 years.
B. 12.11 years.
C. 6.66 years.
D. Cannot be determined
22. A seven-year par value bond has a coupon rate of 9% (paid annually) and a modified duration of
A. 7 years.
B. 5.49 years.
C. 5.03 years.
D. 4.87 years.
23. Par-value bond XYZ has a modified duration of 6. Which one of the following statements regarding the bond is true?
A. If the market yield increases by 1%, the bond's price will decrease by $60.
B. If the market yield increases by 1%, the bond's price will increase by $50.
16-3
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. If the market yield increases by 1%, the bond's price will decrease by $50.
D. If the market yield increases by 1%, the bond's price will increase by $60.
24. Which of the following bonds has the longest duration?
A. An 8-year maturity, 0% coupon bond
B. An 8-year maturity, 5% coupon bond
C. A 10-year maturity, 5% coupon bond
D. A 10-year maturity, 0% coupon bond
E. Cannot tell from the information given
25. Which one of the following par-value 12% coupon bonds experiences a price change of $23 when the market yield changes by
50 basis points?
A. The bond with a duration of 6 years
B. The bond with a duration of 5 years
C. The bond with a duration of 2.7 years
D. The bond with a duration of 5.15 years
26. Which one of the following statements is true concerning the duration of a perpetuity?
A. The duration of a 15% yield perpetuity that pays $100 annually is longer than that of a 15% yield perpetuity that pays $200
annually.
B. The duration of a 15% yield perpetuity that pays $100 annually is shorter than that of a 15% yield perpetuity that pays $200
annually.
C. The duration of a 15% yield perpetuity that pays $100 annually is equal to that of a 15% yield perpetuity that pays $200 annually.
D. The duration of a perpetuity cannot be calculated.
27. The two components of interest-rate risk are
A. price risk and default risk.
B. reinvestment risk and systematic risk.
C. call risk and price risk.
D. price risk and reinvestment risk.
E. None of the options are correct.
28. The duration of a coupon bond
A. does not change after the bond is issued.
B. can accurately predict the price change of the bond for any interest-rate change.
C. will decrease as the yield to maturity decreases.
D. All of the options are true.
E. None of the options are true.
29. Indexing of bond portfolios is difficult because
A. the number of bonds included in the major indexes is so large that it would be difficult to purchase them in the proper
proportions.
B. many bonds are thinly traded, so it is difficult to purchase them at a fair market price.
C. the composition of bond indexes is constantly changing.
D. All of the options are true.
30. Duration measures
A. weighted-average time until a bond's half-life.
B. weighted-average time until cash flow payment.
C. the time required to make excessive profit from the investment.
D. weighted-average time until a bond's half-life and the time required to make excessive profit from the investment.
E. weighted-average time until cash flow payment and the time required to make excessive profit from the investment.
31. Duration
A. assesses the time element of bonds in terms of both coupon and term to maturity.
B. allows structuring a portfolio to avoid interest-rate risk.
16-4
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. is a direct comparison between bond issues with different levels of risk.
D. assesses the time element of bonds in terms of both coupon and term to maturity and allows structuring a portfolio to avoid
interest-rate risk.
E. assesses the time element of bonds in terms of both coupon and term to maturity and is a direct comparison . between bond issues
with different levels of risk.
32. Identify the bond that has the longest duration (no calculations necessary).
A. 20-year maturity with an 8% coupon
B. 20-year maturity with a 12% coupon
C. 20-year maturity with a 0% coupon
D. 10-year maturity with a 15% coupon
E. 12-year maturity with a 12% coupon
33. When interest rates decline, the duration of a 10-year bond selling at a premium
A. increases.
B. decreases.
C. remains the same.
D. increases at first, then declines.
E. decreases at first, then increases.
34. An 8%, 30-year corporate bond was recently being priced to yield 10%. The Macaulay duration for the bond is 10.20 years.
Given this information, the bond's modified duration would be
A. 8.05.
B. 9.44.
C. 9.27.
D. 11.22.
E. None of the options are correct.
35. An 8%, 15-year bond has a yield to maturity of 10% and duration of 8.05 years. If the market yield changes by 25 basis points,
how much change will there be in the bond's price?
A. 1.83%
B. 2.01%
C. 3.27%
D. 6.44%
36. One way that banks can reduce the duration of their asset portfolios is through the use of
A. fixed-rate mortgages.
B. adjustable-rate mortgages.
C. certificates of deposit.
D. short-term borrowing.
37. The duration of a bond normally increases with an increase in
A. term to maturity.
B. yield to maturity.
C. coupon rate.
D. All of the options are correct.
E. None of the options are correct.
38. Immunization is not a strictly passive strategy because
A. it requires choosing an asset portfolio that matches an index.
B. there is likely to be a gap between the values of assets and liabilities in most portfolios.
C. it requires frequent rebalancing as maturities and interest rates change.
D. durations of assets and liabilities fall at the same rate.
E. None of the options are correct.
39. Some of the problems with immunization are
16-5
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. duration assumes that the yield curve is flat.
B. duration assumes that if shifts in the yield curve occur, these shifts are parallel.
C. immunization is valid for one interest-rate change only.
D. durations and horizon dates change by the same amounts with the passage of time.
E immunization is valid for one interest-rate change only, duration assumes that the yield curve is flat, and that if . shifts in the yield
curve occur, these shifts are parallel.
40. If a bond portfolio manager believes
I) in market efficiency, he or she is likely to be a passive portfolio manager.
II) that he or she can accurately predict interest-rate changes, he or she is likely to be an active portfolio manager.
III) that he or she can identify bond-market anomalies, he or she is likely to be a passive portfolio manager.
A. I only
B. II only
C. III only
D. I and II
E. I, II, and III
41. Cash flow matching on a multiperiod basis is referred to as
A. immunization.
B. contingent immunization.
C. dedication.
D. duration matching.
E. rebalancing.
42. Immunization through duration matching of assets and liabilities may be ineffective or inappropriate because
A. conventional duration strategies assume a flat yield curve.
B. duration matching can only immunize portfolios from parallel shifts in the yield curve.
C. immunization only protects the nominal value of terminal liabilities and does not allow for inflation adjustment.
D conventional duration strategies assume a flat yield curve, and immunization only protects the nominal value of . terminal
liabilities and does not allow for inflation adjustment.
E. All of the options are correct.
43. The curvature of the price yield curve for a given bond is referred to as the bond's
A. modified duration.
B. immunization.
C. sensitivity.
D. convexity.
E. tangency.
44. Consider a bond selling at par with modified duration of 10.6 years and convexity of 210. A 2% decrease in yield would cause
the price to increase by 21.2% according to the duration rule. What would be the percentage price change according to the durationwith-convexity rule?
A. 21.2%
B. 25.4%
C. 17.0%
D. 10.6%
45. A substitution swap is an exchange of bonds undertaken to
A. change the credit risk of a portfolio.
B. extend the duration of a portfolio.
C. reduce the duration of a portfolio.
D. profit from apparent mispricing between two bonds.
E. adjust for differences in the yield spread.
46. A rate anticipation swap is an exchange of bonds undertaken to
A. shift portfolio duration in response to an anticipated change in interest rates.
16-6
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
B. shift between corporate and government bonds when the yield spread is out of line with historical values.
C. profit from apparent mispricing between two bonds.
D. change the credit risk of the portfolio.
E. increase return by shifting into higher yield bonds.
47. An analyst who selects a particular holding period and predicts the yield curve at the end of that holding period is engaging in
A. a rate anticipation swap.
B. immunization.
C. horizon analysis.
D. an intermarket spread swap.
E. None of the options are correct.
48. Interest-rate risk is important to
A. active bond portfolio managers.
B. passive bond portfolio managers.
C. both active and passive bond portfolio managers.
D. neither active nor passive bond portfolio managers.
E. obsessive bond portfolio managers.
49. Which of the following are true about the interest-rate sensitivity of bonds?
I) Bond prices and yields are inversely related.
II) Prices of long-term bonds tend to be more sensitive to interest-rate changes than prices of short-term bonds.
III) Interest-rate risk is correlated with the bond's coupon rate.
IV) The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at
which the bond is currently selling.
A. I and II
B. I and III
C. I, II, and IV
D. II, III, and IV
E. I, II, III, and IV
50. Which of the following are false about the interest-rate sensitivity of bonds?
I) Bond prices and yields are inversely related.
II) Prices of long-term bonds tend to be more sensitive to interest-rate changes than prices of short-term bonds.
III) Interest-rate risk is correlated with the bond's coupon rate.
IV) The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at
which the bond is currently selling.
A. I
B. III
C. I, II, and IV
D. II, III, and IV
E. I, II, III, and IV
51. Which of the following researchers have contributed significantly to bond portfolio management theory?
I) Sidney Homer
II) Harry Markowitz
III) Burton Malkiel
IV) Martin Liebowitz
V) Frederick Macaulay
A. I and II
B. III and V
C. III, IV, and V
D. I, III, IV, and V
E. I, II, III, IV, and V
52. According to the duration concept,
16-7
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. only coupon payments matter.
B. only maturity value matters.
C. the coupon payments made prior to maturity make the effective maturity of the bond greater than its actual time to maturity.
D. the coupon payments made prior to maturity make the effective maturity of the bond less than its actual time to maturity.
E. coupon rates don't matter.
53. Duration is important in bond portfolio management because
I) it can be used in immunization strategies.
II) it provides a gauge of the effective average maturity of the portfolio.
III) it is related to the interest rate sensitivity of the portfolio.
IV) it is a good predictor of interest-rate changes.
A. I and II
B. I and III
C. III and IV
D. I, II, and III
E. I, II, III, and IV
54. Two bonds are selling at par value, and each has 17 years to maturity. The first bond has a coupon rate of 6%, and the second
bond has a coupon rate of 13%. Which of the following is true about the durations of these bonds?
A. The duration of the higher coupon bond will be higher.
B. The duration of the lower coupon bond will be higher.
C. The duration of the higher coupon bond will equal the duration of the lower coupon bond.
D. There is no consistent statement that can be made about the durations of the bonds.
E. The bond's durations cannot be determined without knowing the prices of the bonds.
55. Two bonds are selling at par value, and each has 17 years to maturity. The first bond has a coupon rate of 6%, and the second
bond has a coupon rate of 13%. Which of the following is false about the durations of these bonds?
A. The duration of the higher coupon bond will be higher.
B. The duration of the lower coupon bond will be higher.
C. The duration of the higher coupon bond will equal the duration of the lower coupon bond.
D. There is no consistent statement that can be made about the durations of the bonds.
E The duration of the higher coupon bond will be higher, and the duration of the higher coupon bond will equal the . duration of the
lower coupon bond.
56. Which of the following two bonds is more price sensitive to changes in interest rates?
1) A par-value bond, A, with a 12 year to maturity and a 12% coupon rate.
2) A zero-coupon bond, B, with a 12 year to maturity and a 12% yield to maturity.
A. Bond A because of the higher yield to maturity
B. Bond A because of the longer time to maturity
C. Bond B because of the longer duration
D. Both have the same sensitivity because both have the same yield to maturity.
E. None of the options are correct.
57. Which of the following two bonds is more price sensitive to changes in interest rates?
1) A par-value bond, D, with a 2 year to maturity and an 8% coupon rate.
2) A zero-coupon bond, E, with a 2 year to maturity and an 8% yield to maturity.
A. Bond D because of the higher yield to maturity
B. Bond E because of the longer duration
C. Bond D because of the longer time to maturity
D. Both have the same sensitivity because both have the same yield to maturity.
58. Holding other factors constant, which one of the following bonds has the smallest price volatility?
A. 7-year, 0% coupon bond
B. 7-year, 12% coupon bond
16-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
C. 7 year, 14% coupon bond
D. 7-year, 10% coupon bond
E. Cannot tell from the information given
59. Holding other factors constant, which one of the following bonds has the smallest price volatility?
A. 20-year, 0% coupon bond
B. 20-year, 6% coupon bond
C. 20 year, 7% coupon bond
D. 20-year, 9% coupon bond
E. Cannot tell from the information given
60. The duration of a 15-year zero-coupon bond is
A. smaller than 15.
B. larger than 15.
C. equal to 15.
D. equal to that of a 15-year 10% coupon bond.
E. None of the options are correct.
61. The duration of a 20-year zero-coupon bond is
A. equal to 20.
B. larger than 20.
C. smaller than 20.
D. equal to that of a 20-year 10% coupon bond.
62. The duration of a perpetuity with a yield of 10% is
A. 13.50 years.
B. 11 years.
C. 6.66 years.
D. Cannot be determined
63. The duration of a perpetuity with a yield of 6% is
A. 13.50 years.
B. 12.11 years.
C. 17.67 years.
D. Cannot be determined
64. Par-value-bond F has a modified duration of 9. Which one of the following statements regarding the bond is true?
A. If the market yield increases by 1%, the bond's price will decrease by $90.
B. If the market yield increases by 1%, the bond's price will increase by $90.
C. If the market yield increases by 1%, the bond's price will decrease by $60.
D. If the market yield decreases by 1%, the bond's price will increase by $60.
65. Par-value-bond GE has a modified duration of 11. Which one of the following statements regarding the bond is true?
A. If the market yield increases by 1%, the bond's price will decrease by $55.
B. If the market yield increases by 1%, the bond's price will increase by $55.
C. If the market yield increases by 1%, the bond's price will decrease by $110.
D. If the market yield increases by 1%, the bond's price will increase by $110.
66. Which of the following bonds has the longest duration?
A. A 15-year maturity, 0% coupon bond.
B. A 15-year maturity, 9% coupon bond.
C. A 20-year maturity, 9% coupon bond.
D. A 20-year maturity, 0% coupon bond.
E. Cannot tell from the information given
67. Which of the following bonds has the longest duration?
16-9
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
A. A 12-year maturity, 0% coupon bond.
B. A 12-year maturity, 8% coupon bond.
C. A 4-year maturity, 8% coupon bond.
D. A 4-year maturity, 0% coupon bond.
E. Cannot tell from the information given
68. A 10%, 30-year corporate bond was recently being priced to yield 12%. The Macaulay duration for the bond is 11.3 years.
Given this information, the bond's modified duration would be
A. 8.05.
B. 10.09.
C. 9.27.
D. 11.22.
69. A 6%, 30-year corporate bond was recently being priced to yield 8%. The Macaulay duration for the bond is 8.4 years. Given
this information, the bond's modified duration would be
A. 8.05.
B. 9.44.
C. 9.27.
D. 7.78.
70. A 9%, 16-year bond has a yield to maturity of 11% and duration of 9.25 years. If the market yield changes by 32 basis points,
how much change will there be in the bond's price?
A. 1.85%
B. 2.01%
C. 2.67%
D. 6.44%
71. A 7%, 14-year bond has a yield to maturity of 6% and duration of 7 years. If the market yield changes by 44 basis points, how
much change will there be in the bond's price?
A. 1.85%
B. 2.91%
C. 3.27%
D. 6.44%
72. Consider a bond selling at par with modified duration of 12 years and convexity of 265. A 1% decrease in yield would cause the
price to increase by 12%, according to the duration rule. What would be the percentage price change according to the duration-withconvexity rule?
A. 21.2%
B. 25.4%
C. 17.0%
D. 13.3%
73. Consider a bond selling at par with modified duration of 22 years and convexity of 415. A 2% decrease in yield would cause the
price to increase by 44% according to the duration rule. What would be the percentage price change according to the duration-withconvexity rule?
A. 21.2%
B. 25.4%
C. 17.0%
D. 52.3%
74. The duration of a par-value bond with a coupon rate of 6.5% and a remaining time to maturity of 4 years is
A. 3.65 years.
B. 3.45 years.
C. 3.85 years.
D. 4.00 years.
16-10
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
75. The duration of a par-value bond with a coupon rate of 7% and a remaining time to maturity of 3 years is
A. 3 years.
B. 2.71 years.
C. 2.81 years.
D. 2.91 years.
76. The duration of a par-value bond with a coupon rate of 8.7% and a remaining time to maturity of 6 years is
A. 6.0 years.
B. 5.1 years.
C. 4.27 years.
D. 3.95 years.
E. None of the options are correct.
Chapter 16 Test Bank - Static Key
Multiple Choice Questions
1. The duration of a bond is a function of the bond's
A. coupon rate.
B. yield to maturity.
C. time to maturity.
D. All of the options are correct.
E. None of the options are correct.
Duration is calculated by discounting the bond's cash flows at the bond's yield to maturity and, except for zero-coupon bonds, is
always less than time to maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Gradable: automatic
Topic: Duration
2. Ceteris paribus, the duration of a bond is positively correlated with the bond's
A. time to maturity.
B. coupon rate.
C. yield to maturity.
D. All of the options are correct.
E. None of the options are correct.
Duration is negatively correlated with coupon rate and yield to maturity.
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Duration
3. Ceteris paribus, the duration of a bond is negatively correlated with the bond's
A. time to maturity.
B. coupon rate.
C. yield to maturity.
D. coupon rate and yield to maturity.
E. None of the options are correct.
Duration is negatively correlated with coupon rate and yield to maturity.
AACSB: Reflective Thinking
16-11
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Duration
4. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is lower.
B. coupon rate is higher.
C. yield to maturity is lower.
D. current yield is higher.
E. None of the options are correct.
The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the
yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond
price sensitivity to interest rate changes (interest-rate risk).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Interest rate risk
5. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is higher.
B. coupon rate is higher.
C. yield to maturity is higher.
D. All of the options are correct.
E. None of the options are correct.
The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the
yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond
price sensitivity to interest rate changes (interest-rate risk).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Interest rate risk
6. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's
A. term to maturity is lower.
B. coupon rate is lower.
C. yield to maturity is higher.
D. term to maturity is lower and yield to maturity is higher.
E. None of the options are correct.
The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the
yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond
price sensitivity to interest rate changes (interest-rate risk).
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Interest rate risk
7. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's
A. term to maturity is lower.
B. coupon rate is higher.
C. yield to maturity is lower.
D. term to maturity is lower and coupon rate is higher.
16-12
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
E. All of the options are correct.
The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the
yield to maturity, the greater the interest-rate risk. These concepts are