Name: _____________________
ID number: _________________
FIN 406
Quiz 1
October 3, 2002
Instructions: Circle the best answer for each question in the exam. There are 45
questions and each question is worth 1 point. The exam is a closed book and closed notes
exam.
1
1.
Derivative securities can be based on _________.
a.
currencies
b.
common stocks
c.
home mortgages
d.
all of the above
2.
The material wealth of a society is determined by the economy’s __________,
which is a function of the economy’s ___________.
a.
investment bankers; financial assets
b.
investment bankers; real assets
c.
productive capacity; financial assets
d.
productive capacity; real assets
3.
Asset allocation refers to the _______________.
a.
allocation of the investment portfolio across broad asset classes
b.
analysis of the value of securities
c.
choice of specific assets within each asset class
d.
none of the above
4.
_____________ portfolio management calls for holding diversified portfolios
without spending effort or resources attempting to improve investment
performance through security analysis.
a.
active
b.
idiotic
c.
passive
d.
none of the above
5.
_____________ is not a true statement regarding municipal bonds.
a.
A municipal bond is a debt obligation issued by state or local
governments.
b.
A municipal bond is a debt obligation issued by the Federal Government.
c.
The interest income from a municipal bond is exempt from federal income
taxation.
d.
The interest income from a municipal bond is exempt from state and local
taxation in the issuing state.
6.
Money market securities are characterized by ______________.
a.
a very short term to maturity
b.
a medium term to maturity
c.
a long term to maturity
d.
none of the above
2
7.
Mutual funds perform the function of __________ for their shareholders.
a.
diversification
b.
professional management
c.
record keeping and administration
d.
all of the above
8.
When computing the bank discount yield in a leap year, you would use ________
days.
a.
260
b.
360
c.
365
d.
366
9.
The ask price of a treasury bill is ______________.
a.
the price at which the dealer in treasury bills is willing to sell the bill
b.
the price at which the dealer in treasury bills is willing to buy the bill
c.
greater than the ask price of the treasury bill expressed in dollar terms
d.
the price at which the investor can buy the treasury bill
10.
In a futures contract, the short position is taken by the person who ____________.
a.
commits to delivering the commodity
b.
commits to purchasing the commodity
c.
plays between second base and third base
d.
uses his margin
11.
A __________ gives its holder the right to sell an asset for a specified exercise
price on or before a specified expiration date.
a.
call option
b.
futures contract
c.
put option
d.
none of the above
12.
A treasury bill has a face value of $10,000 and is selling for $9,800. If the
treasury bill matures in 80 days, its effective annual yield is ___________.
a.
2.04%
b.
9.46%
c.
8.42%
d.
9.66%
13.
The asked discount yield on a treasury bill is 5%. The ask price of the bill is
______________ if it matures in 60 days and has a face value of $1,000.
a.
$950.00
b.
$991.67
c.
$952.38
d.
none of the above
3
14.
If the market prices of the 30 stocks in the Dow Jones Industrial Average all
change by the same dollar amount on a given day (ignoring stock splits), which
stock will have the greatest impact on the average?
a.
the one with the highest price
b.
the one with the lowest price
c.
all 30 stocks will have the same impact
d.
the answer cannot be determined by the information given
15.
Which of the following are not characteristic of common stock ownership?
a.
residual claimant
b.
unlimited liability
c.
voting rights
d.
all of the above are characteristics of stock ownership
16.
Assume that you have just purchased some shares in an investment company
reporting $300 million in assets, $20 million in liabilities, and 30 million shares
outstanding. What is the net asset value of these shares?
a.
$10
b.
$9.33
c.
$15
d.
$1.50
17.
Sponsors of unit investment trusts earn a profit by ______________.
a.
deducting a quarterly management fee from fund assets
b.
deducting a percentage of any gains in asset value
c.
selling shares in the trust at a premium to the cost of acquiring the
underlying assets
d.
none of the above
18.
Investors who wish to liquidate their holdings in a unit investment trust may
_______________.
a.
sell their shares back to the trustee at a discount
b.
sell their shares back to the trustee at net asset value
c.
sell their shares on the open market
d.
none of the above
19.
____________ is a false statement regarding open-end mutual funds.
a.
they offer investors a guaranteed rate of return
b.
they offer investors a well diversified portfolio
c.
they redeem their shares at their net asset value
d.
none of the above
4
20.
Mutual funds that hold both equities and fixed-income securities in relatively
stable proportions are called ______________.
a.
income funds
b.
balanced funds
c.
asset allocation funds
d.
index funds
21.
In a recent study, Malkiel finds that evidence of persistence in the performance of
mutual funds _______________ in the 1980s
a.
grows stronger
b.
remains about the same
c.
becomes slightly weaker
d.
virtually disappears
22.
Empirical evidence suggests that investors become ____________ as they
approach retirement.
a.
greedier
b.
less interested in investments
c.
more risk averse
d.
more risk tolerant
23.
The ___________ average ignores compounding.
a.
geometric
b.
arithmetic
c.
both a and b above
d.
none of the above
24.
Of the alternatives available, _____________ typically have the highest standard
deviation of returns.
a.
commercial paper
b.
corporate bonds
c.
stocks
d.
treasury bills
25.
If you purchase a stock for $50, receive dividends of $2, and sell the stock at the
end of the year for $53, what is your holding period return?
a.
5%
b.
10%
c.
14%
d.
18%
26.
The arithmetic average of 12%, 15%, and 20% is ________________.
a.
15.7%
b.
15%
c.
17.2
d.
20%
5
27.
The geometric average of 10%, 20% and 41% is ____________.
a.
14.9%
b.
18.2%
c.
19.7%
d.
23%
28.
The dollar weighted return is the same as the _______________.
a.
difference between cash inflows and outflows
b.
arithmetic average return
c.
geometric average return
d.
internal rate of return
29.
Suppose you pay $9,700 for a Treasury bill maturing in three months. What is the
effective annual rate of return for this investment?
a.
3.1%
b.
13%
c.
8.42%
d.
10.66%
30.
The reward/variability ratio is given by ________________.
a.
the slope of the capital allocation line
b.
the second derivative of the capital allocation line
c.
the point at which the second derivative of the investor’s indifference
curve reaches zero.
d.
none of the above.
31.
If you are promised a nominal return of 12% on a one year investment, and you
expect the rate of inflation to be 3%, what real rate do you expect to earn? (exact
rate, not approximation)
a.
5.48%
b.
8.74%
c.
9%
d.
12%
32.
A Treasury bill pays a 6% rate of return. A risk averse investor _____________
invest in a risky portfolio that pays 12% with a probability of 40% or 2% with a
probability of 60% because ___________________.
a.
might; she is rewarded a risk premium
b.
would not; because she is not rewarded any risk premium
c.
would not; because the risk premium is small
d.
cannot be determined
6
33.
Consider a treasury bill with a rate of return of 5% and the following risky
securities:
Expected Return
Variance
A
0.15
0.0400
B
0.10
0.0225
C
0.12
0.1000
D
0.13
0.0625
The investor must develop a complete portfolio by combining the risk-free asset
with one of the securities mentioned above. The security the investor would
choose as part of his complete portfolio would be _____________.
a.
security A
b.
security B
c.
security C
d.
security D
34.
An investor invests 40% of his wealth in a risky asset with an expected rate of
return of 15% and a variance of 4% and 60% in a treasury bill that pays 6%. The
portfolio’s expected rate of return and standard deviation are _____________ and
______________.
a.
8.0%; 12%
b.
9.6%; 8%
c.
9.6%; 10%
d.
11.4%; 12%
35.
Consider the following two investment alternatives. First, a risky portfolio that
pays 15% rate of return with a probability of 60% or 5% with a probability of
40%. Second, a treasury bill that pays 6%. The risk premium on the risky
investment is
a.
1%
b.
5%
c.
9%
d.
7%
36.
You invest $100 in a complete portfolio. The complete portfolio is composed of a
risky asset with an expected rate of return of 12% and a standard deviation of
15% and a treasury bill with a rate of return of 5%. ____________ of your money
should be invested in the risky asset to form a portfolio with an expected return of
9%.
a.
28%
b.
86%
c.
57%
d.
50%
7
37.
A portfolio is composed to two stocks, A and B. Stock A has a standard deviation
of return of 25% while stock B has a standard deviation of return of 5%. Stock A
comprises 20% of the portfolio while stock B comprises 80% of the portfolio. If
the variance of returns on the portfolio is 0.0050, the correlation coefficient
between the returns on A and B is ____________.
a.
-0.225
b.
-0.474
c.
0.474
d.
0.225
38.
The standard deviation of return on investment A is 0.1 while the standard
deviation of return on investment B is 0.05. If the covariance of returns on A and
B is 0.0030, the correlation coefficient between the returns A and B is
____________.
a.
0.12
b.
0.36
c.
0.60
d.
0.77
39.
An investor can design a risky portfolio based on two stocks, A and B. The
standard deviation of return on stock A is 20% while the standard deviation on
stock stock B is 15%. The correlation coefficient between the return on A and B is
0.The expected return on stock A is 20% while on stock B is 10%. The proportion
of the minimum variance portfolio that would be invested in stock B is ________.
a.
6%
b.
50%
c.
64%
d.
100%
40.
A portfolio is composed of two stocks, A and B. Stock A has a standard deviation
of return of 5% while stock B has a standard deviation of return of 15%. The
correlation coefficient between the returns on A and B is 0.5. Stock A comprises
40% of the portfolio while stock B comprises 60% of the portfolio. The variance
of return on the portfolio is ___________.
a.
0.0056
b.
0.0067
c.
0.0114
d.
0.0103
8
41.
According to Tobin’s separation property, portfolio choice can be separated into
two independent tasks consisting of ___________ and ___________.
a.
identifying all investor imposed constraints; identifying the set of
securities that conform to the investor’s constraints and offer the best riskreturn tradeoff
b.
identifying the investor’s degree of risk aversion; choosing securities from
industry groups that are consistent with the investor’s risk profile
c.
identifying the optimal risky portfolio; constructing a complete portfolio
from the T-bills and the optimal risky portfolio based on the investor’s
degree of risk aversion
d.
none of the above answers is correct.
42.
The values of beta coefficients of securities are ___________.
a.
always positive
b.
always negative
c.
always between +1 and –1
d.
usually positive, but not restricted in any particular way
43.
Rational risk-averse investors will always prefer portfolios ____________.
a.
located on the efficient frontier to those located on the capital market line
b.
located on the capital market line to those located on the efficient frontier
c.
at or near the minimum variance point on the efficient frontier
d.
rational risk-averse investors prefer the risk-free asset to all other asset
classes
44.
Risk that can be eliminated through diversification is called _____________ risk.
a.
firm-specific
b.
unique
c.
both of the above
d.
none of the above
45.
The term excess returns refers to ______________.
a.
returns earned illegally by means of insider trading
b.
the difference between the rate of return earned and the risk-free rate
c.
the difference between the rate of return earned on a particular security
and the rate of return earned on other securities of equivalent risk
d.
the portion of the return on a security which represents tax liability and
therefore cannot be reinvested
9
Answers to Quiz 1
(Since the correct answers are circled in red pen on your returned quizzes, only the work
for computational questions are provided here.)
12.
Holding period return = (face value – price)/price = 0.02041
Effective annual yield = (1.02041)(365/80) - 1 = 0.0966
I also accepted 9.46% since if you use 360/80 rather than 365/80, your answer is
closer to 9.46%.
13.
Ask discount yield = (face value – price)/face value x 360/60
0.05 = (1000-P)/1000 x 360/60  solving for P yields $991.67
16.
NAV = (assets-liabs)/shares outstanding = (300m-20m)/30m = $9.33
25.
Return = (selling price +dividend)/purch price - 1 = (53+2)/50 - 1 = 10%
26.
Arithmetric average = (0.12 + 0.15 + 0.20)/3 = 0.157 = 15.7%
27.
Geometric average = ((1.1)(1.2)(1.41))1/3 –1 = 23%
29.
Holding period return = (10,000-9,700)/9,700 = 0.0309278
EAR = (1.0309278)4 - 1 = 0.1296 = 13%
31.
(1 + nom rate) = (1+real rate)(1+inflation rate)
(1.12) = (1+real rate)(1.03)  solving for real rate yields 8.74%
32.
Expected return on the risky portfolio = (0.4)(0.12) + (0.6)(0.02) = 0.06
No point in investing in the risky portfolio since you can get the same rate of
return from the risk free asset (there is no risk premium)
33.
Calculate the slope of the CAL between the risk free asset and each of the risky
securities. Slope of the CAL
= (Expected return on risky asset – risk free rate)/std dev of risky asset
For A:
(0.15-0.05)/sqr root of 0.0400 = 0.5
For B:
= 0.33
For C:
= 0.22
For D:
= 0.32
Security A is best since it allows for a CAL with the highest slope.
34.
Expected return on portfolio = (0.4)(0.15) + (0.6)(0.06) = 0.096
Standard deviation = (0.4)(sqr root of 0.04) = 0.08
10
35.
Expected return on risky portfolio = (0.6)(0.15)+(0.4)(0.05) = 0.11
The risk premium = 0.11 – risk free rate = 0.11-0.06 = 0.05
36.
Expected return on portfolio = x(0.12) + (1-x)(0.05)
We want the expected return to equal 0.09 so
0.09 = x(0.12) + (1-x)(0.05)  solving for x yields 57%
37.
using the equation for variance of returns on a portfolio:
0.0050 = (0.2)2(0.25)2 + (0.8)2(0.05)2 + 2(0.2)(0.8)(0.25)(0.05)(corr)
solving for correlation yields 0.225
38.
correlation coeff = covariance/(std dev of A x std dev of B)
= 0.003/(0.1*0.05) = 0.6
39.
using the equation for solving the weight of asset B in the minimum variance
portfolio
= (0.2)2 - (0.2)(0.15)(0)
(0.15)2 + (0.2)2 - 2(0.2)(0.15)(0)
= 0.64 = 64%
40.
using the equation for variance of returns on a portfolio
= (0.4)2(0.05)2 + (0.6)2(0.15)2 + 2(0.4)(0.6)(0.05)(0.15)(0.5)
= 0.0004 + 0.0081 + (0.0018) = 0.0103
11